Managerial Economics

B.B.A.LL.B - 3rd Semester

• Module 01 Introduction : Meaning, Nature and Scope of Business
Economics, Micro and Macro Basic Economic Problems Market forces
in solving economic problems Circular Flow of Income and
Expenditure
• Module 02 Demand Analysis : Concept of Demand, Elasticity of
Demand and their types Revenue Concepts - Total Revenue, Marginal
Revenue, Average Revenue and their relationship
• Module 03 Supply Analysis : Concept and Law of Supply Factors
Affecting Supply
• Module 04 Cost Analysis : Accounting Costs and Economic Costs Short
Run Cost Analysis: Fixed, Variable and Total Cost Curves, Average and
Marginal Costs Long Run Cost Analysis: Economies and Diseconomies
of Scale and Long Run Average and Marginal Cost Curves
• Module 05 Pricing under Various Market Conditions : Perfect
Competition - Equilibrium of Firm and Industry under Perfect
Competition Monopoly - Price Determination under Monopoly
Monopolistic Competition - Price and Output Determination under
Monopolistic Competition
• Module 06 Distribution : Marginal Productivity Theory of Distribution
Rent: Modern Theory of Rent Wages : Wage Determination under
Imperfect Competition - Role of Trade Union and Collective Bargaining
in Wage Determination Interest Liquidity, Preference Theory of
Interest Profits: Dynamic, Innovation, Risk - Bearing and Uncertainty
Bearing Theories of Profits
 Modern Definition of Economics

• The modern definition, attributed to the 20th-century economist, Paul Samuelson,

builds upon the definitions of the past and defines the subject as a social science.
According to Samuelson, “Economics is the study of how people and society
choose, with or without the use of money, to employ scarce productive resources
which could have alternative uses, to produce various commodities over time and
distribute them for consumption now and in the future among various persons and
groups of society.”
• Laissez-faire is a French phrase that translates to “allow to do.” It refers to a

political ideology that rejects the practice of government intervention in an

economy. Further, the state is seen as an obstacle to

economic growth and development.

 Growth Oriented Definition of Economics

• Growth-orientation: Economic growth is measured by the change in national

output over time. The definition says that, Economics is concerned with

determining the pattern of employment of scarce resources to produce

commodities 'over time'.

 What is Managerial Economics

• Businesses run on various theories that are explained in Economics. Managerial

Economics is the stream of management studies that emphasizes solving
problems in businesses using the theories in micro and macroeconomics. This
branch of economics is used by firms to not only find a solution to problems in
daily running but also for long-term planning. We can also say that Managerial
economics is a practical application of theories in economics.
 Business Problem- an Economic Problem

• What to Produce

• How much to Produce

• How to Produce

• Where to Produce
 Mechanism to Solve the Problem Resource
Allocation Decision Making

• Allocation of Resources

• Exploitation of Resources by Whom and How

• The Problem of Distribution

 Definition of Managerial Economics
• Managerial economics is defined as the branch of economics which deals with the
application of various concepts, theories, methodologies of economics to solve practical
problems in business management. It is also reckoned as the amalgamation of economic
theories and business practices to ease the process of decision making. Managerial economics is
also said to cover the gap between the problems of logic and problems of policy.

• Managerial economics is used to find a rational solution to problems faced by firms. These
problems include issues around demand, cost, production, marketing, and it is used also for
future planning. The best thing about managerial economics is that it has a logical solution to
almost every problem that may arise during business management and that too by sticking to the
microeconomic policies of the firm.
 Nature of Managerial Economics

• We all know science as a systematic body of knowledge and it is based on

methodological observations. Similarly, Managerial Economics is also a science of
making decisions and finding alternatives, keeping the scarce of resources in mind.

• In science, we arrive at any conclusion after continuous experimentation. Similarly, in

managerial economics policies are formed after constant testing and trailing.

• In science, principles are universally acceptable and in managerial economics, policies

are universally applicable at least partially if not fully.
 Characteristics of Managerial Economics

• Art and Science

• Microeconomics

• Uses Macroeconomics

• Multi-disciplinary

• Management oriented and pragmatic

 Types of Managerial Economics

• Liberal Managerialism

Market is a free and democratic place in terms of decision making. Customers get a
lot many options to choose from. So, companies have to modify their policies
according to consumers’ demands and market trends. If not done so, it may result in
business failures. This is what we call liberal managerialism.
• Normative Managerialism

The normative view of managerial economics means that the decisions taken by the
administration would be normal, based on real-life experiences and practices. The
decisions reflect a practical approach regarding product design, forecasting,
marketing, supply and demand analysis, recruitments, and everything else that is
concerned with the growth of a business.
• Radical Managerialism

Radical managerialism means to come up with revolutionary solutions. Sometimes,

when the conventional approach to a problem doesn’t work, radical managerialism
may have the solution. However, it requires the manager to possess some
extraordinary skills and thinking to look beyond. In radical managerialism, consumer
needs and satisfaction are prioritized over profit maximization.
 Core Topics of Managerial Economics

• Demand Function and Estimation

• Demand Elasticity

• Production Function and Laws

• Cost Analysis

• Pricing and Output Determination in different market structures

• Pricing Policies and Practices

• Profit Planning

• Project Planning

• Capital Budgeting and Management

• Break-even Analysis

• Linear Programming

• Game Theory

• Government and Business

• Managerial economics analyses the internal and external factors impacting an

organization. It aims to resolve problems using micro and macroeconomic tools.

Thus, it is a practical approach where economic measures are undertaken to solve

business problems. In addition to solving problems, this approach extends to the

growth and sustainability of a firm.

 Microeconomics for Solving Operational
Problems
• Production Theory: In order to ensure high productivity with limited resources,
microeconomics studies the impact of production-related decisions: capital
requirement, labour requirement, production capacity, process, methods,
techniques, cost, and quality,

• Investment Theory: Companies diligently plan their capital investment to

ensure resource utilization—generating higher returns.
• Demand Theory: To ensure consumer satisfaction, managers analyze consumer
needs and requirements—they understand consumer attitudes and responses
toward company products or services.

• Market Structure Pricing Theory: It involves price determination and

management—the business prices its products and services very competitively. To
determine the price, the firms consider production cost, market demand, and
marketing cost.

• Profit Management: Profit maximization is the ultimate aim—this approach

focuses on cost and revenue.
 Macroeconomics for Handling External
Environment Issues
• Political (P): The government plays a critical role in a firm’s progress. Thus,
managerial economics studies how governance style, political unrest, and foreign
collaboration affect private sector companies.

• Economic (E): Business profitability greatly depends on government policies,

tax reforms, GDP, and the nation’s economic stability.

• Social (S): The social environment moulds businesses. This includes factors like
societal values, beliefs, attitudes, consumer awareness, employment conditions,
literacy rate, and trade unions.
• Technological (T): Technology enhances the production and distribution of goods
or services.

• Environmental (E): When awareness of environmental concerns increases—

firms face pressure to adopt sustainable and eco-friendly practices. This includes
the curtailing of pollution, waste management, preservation of water, and
preservation of natural resources.

• Legal (L): Businesses must operate within legal boundaries—national laws

pertaining to consumer rights, labour laws, health and safety laws, product
labelling regulations, and advertising guidelines.
 Major Steps In Effective Decision Making

• Defining the problem

• Identifying choices

• Evaluating the advantages and disadvantages

• choosing one choice

• Acting on the choice

• Reviewing the decision

 Scientific Research Methodology
• Defining the problem

• Formulation of the hypothesis

• Abstraction for the model building

• Data Collection

• Testing the hypothesis

• Deduction based on data analysis

• Evaluating the test results

• Conclusion for decisions

 Features of Market Economy
• Private Enterprise

• Government Intervention

• Economic Freedom

• Profit Motive

• Competition

• Product and Factor Market

• Price System

• Public Sector
 Advantages of a Market Economy

• Automatic Working

• Optimum Allocation of Resources

• Unrealistic Economic Freedom

• Economic Dynamism

• Absence of Government Interference

 Drawbacks of a Market Economy

• Lack of Economic Stability

• Growth of Monopolies

• Inequalities in Distribution

• Lack of Security

• Mal-allocation of Resources

• Myth of Consumer’s Sovereignty

 Basic Considerations in the Process of Decision
Making

• Decision Making in Certainty

• Decision Making Under Risk

• Decision Making Under Uncertainty

 Importance and Uses in Microeconomics
• It explains price determination and the allocation of resources

• Direct relevance in business decision making

• It serves as a guide for business/production planning

• Teaches art of economising

• Useful in determination of economic policies of the Govt.

• Serves as the basis of welfare economics

• Explains the phenomenon of international trade

Fundamental Principles of Managerial Economics

• Incremental Principle,

• Marginal Principle,

• Opportunity Cost Principle,

• Discounting Principle,

• Concept of Time Perspective Principle,

• Equi-Marginal Principle.
Marginal and Incremental Principle

• This principle states that a decision is said to be rational and sound if given the firm’s objective of
profit maximization, it leads to increase in profit, which is in either of two scenarios-

• If total revenue increases more than total cost.

• If total revenue declines less than total cost.

• Marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal
generally refers to small changes. Marginal revenue is change in total revenue per unit change in
output sold. Marginal cost refers to change in total costs per unit change in output produced (While
incremental cost refers to change in total costs due to change in total output). The decision of a firm
to change the price would depend upon the resulting impact/change in marginal revenue and
marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring
about the change in price.
Incremental analysis differs from marginal analysis only in that it analysis the change in the firm's

performance for a given managerial decision, whereas marginal analysis often is generated by a

change in outputs or inputs. Incremental analysis is generalization of marginal concept. It refers to

changes in cost and revenue due to a policy change. For example - adding a new business, buying new

inputs, processing products, etc. Change in output due to change in process, product or investment is

considered as incremental change. Incremental principle states that a decision is profitable if revenue

increases more than costs; if costs reduce more than revenues; if increase in some revenues is more

than decrease in others; and if decrease in some costs is greater than increase in others.
Equi-marginal Principle
Marginal Utility is the utility derived from the additional unit of a commodity consumed.
The laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when
the marginal utilities of various commodities he consumes are equal.
According to the modern economists, this law has been formulated in form of law of proportional
marginal utility.
It states that the consumer will spend his money-income on different goods in such a way that the
marginal utility of each good is proportional to its price, i.e.,
MUx / Px = MUy / Py = MUz / Pz
Where, MU represents marginal utility and P is the price of good.
Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the

technique of

production which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources in a manner

which

equalizes the ratio of marginal returns and marginal costs of various use of resources in

a specific use.
• Opportunity Cost Principle

• By opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. If
there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can hire a
factor of production if and only if that factor earns a reward in that occupation/job equal or greater
than it’s opportunity cost. Opportunity cost is the minimum price that would be necessary to retain a
factor-service in it’s given use. It is also defined as the cost of sacrificed alternatives. For instance, a
person chooses to forgo his present lucrative job which offers him Rs.50000 per month, and organizes
his own business. The opportunity lost (earning Rs. 50,000) will be the opportunity cost of running
his own business.
• Time Perspective Principle

According to this principle, a manger/decision maker should give due emphasis, both to
short-term and long-term impact of his decisions, giving apt significance to the different
time periods before reaching any decision. Short-run refers to a time period in which
some factors are fixed while others are variable. The production can be increased by
increasing the quantity of variable factors. While long-run is a time period in which all
factors of production can become variable. Entry and exit of seller firms can take place
easily. From consumers point of view, short-run refers to a period in which they respond
to the changes in price, given the taste and preferences of the consumers, while long-run
is a time period in which the consumers have enough time to respond to price changes
by varying their tastes and preferences.
• Discounting Principle

• According to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible. This is essential because a rupee worth of money at a future date is
not worth a rupee today. Money actually has time value. Discounting can be defined as a
process used to transform future dollars into an equivalent number of present dollars. For
instance, $1 invested today at 10% interest is equivalent to $1.10 next year.

• FV = PV*(1+r)t

• Where, FV is the future value (time at some future time), PV is the present value (value at
t0, r is the discount (interest) rate, and t is the time between the future value and present
value.
 Concept of Demand
• Demand is an economic concept that relates to a consumer's desire to purchase goods and
services and willingness to pay a specific price for them. An increase in the price of a
good or service tends to decrease the quantity demanded. Likewise, a decrease in the price
of a good or service will increase the quantity demanded.

• Demand is a concept that consumers and businesses are very familiar with because it
makes sense and occurs naturally in the course of practically any day. For example,
shoppers with an eye on products that they want will buy more when the products' prices
are low. When something happens to raise the prices, such as a change of season,
shoppers buy fewer or perhaps none at all.
 The Law of Demand
• The law of demand states that when prices rise, demand will fall.
When prices fall, demand will rise.

• The law of demand is simply an expression of the inverse relationship

between price and demand. It involves price only. None of the other
drivers of demand mentioned above are involved. If they do come into
play, the functioning of the law can be affected. Demand can be seen
to change for reasons other than price.
 Elasticity of Demand

• A change in the price of a commodity affects its demand. We can find

the elasticity of demand, or the degree of responsiveness of demand by

comparing the percentage price changes with the quantities demanded.

Cross Elasticity of Demand
Scope of Demand forecasting

• Firm Level

• Industry Level

• Macro Level
CRITERIA FOR DEMAND FORECASTING

• Accuracy

• Simplicity

• Economy

• Quickness

• Flexibility
 TYPES OF DEMAND FORECASTING

• Active & Passive

• Short-term & Long-term

• Micro & Macro

• Industry & Firm

• Total Market & Market segment

 Methods for demand forecasting
• A. Survey Method

1. Consumer Survey Method

2. Collective Opinion Method

3. Expert Opinion Method

4. Market Experimentation

• B. Statistical Method

1. Time Series Model

2. Econometric Model
 Production Function: Meaning

• Production is the result of co-operation of four factors of production

viz., land, labour, capital and organization.

• This is evident from the fact that no single commodity can be

produced without the help of any one of these four factors of
production.
• Therefore, the producer combines all the four factors of production in
a technical proportion. The aim of the producer is to maximize his
profit. For this sake, he decides to maximize the production at
minimum cost by means of the best combination of factors of
production.
• The producer secures the best combination by applying the principles of
equi-marginal returns and substitution. According to the principle of
equi-marginal returns, any producer can have maximum production
only when the marginal returns of all the factors of production are equal
to one another. For instance, when the marginal product of the land is
equal to that of labour, capital and organisation, the production becomes
maximum.
 Meaning of Production Function:

• In simple words, production function refers to the functional

relationship between the quantity of a good produced (output) and
factors of production (inputs).
• The new production function brought about by developing technology displays same
inputs and more output or the same output with lesser inputs. Sometimes a new
production function of the firm may be adverse as it takes more inputs to produce the
same output.

• Mathematically, such a basic relationship between inputs and outputs may be

expressed as:

• Q = f( L, C, N )

• Where Q = Quantity of output

• L = Labour

• C = Capital
• Hence, the level of output (Q), depends on the quantities of different

inputs (L, C, N) available to the firm. In the simplest case, where there

are only two inputs, labour (L) and capital (C) and one output (Q), the

production function becomes.

• Q =f (L, C)
 Definitions:

• “The production function is a technical or engineering relation

between input and output. As long as the natural laws of technology
remain unchanged, the production function remains unchanged.” Prof.
L.R. Klein
 What is the difference between a production
function and an isoquant?

• A production function describes the maximum output that can be

achieved with any given combination of inputs. An isoquant identifies
all of the different combinations of inputs that can be used to produce
one particular level of output.
 Isoquant Curve vs. Indifference Curve

• The isoquant curve is in a sense the flip side of another microeconomic

measure, the indifference curve. The mapping of the isoquant curve
addresses cost-minimization problems for producers—the best way to
manufacture goods. The indifference curve, on the other hand, measures
the optimal ways consumers use goods. It attempts to analyse consumer
behaviour, and map out consumer demand.
 Properties of Iso-Quants

• Property 1: An isoquant curve slopes downward, or is negatively sloped.

• Property 2: An isoquant curve, because of the MRTS effect, is convex to its

origin.

• Property 3: Isoquant curves cannot be tangent or intersect one another.

• Property 4: An isoquant curve should not touch the X or Y axis on the graph.

• Property 5: Isoquant curves are oval-shaped.

ISO-QUANTS
• Total Revenue
• A firm sells 100 units of a particular commodity for Rs. 10 each. If
you were to calculate the amount realized by the firm, the answer is
simple – Rs. 1,000 (100 x 10). This is the total revenue for the firm.
• Hence, the total revenue refers to the amount of money realized by a
firm on the sale of a commodity. Total revenue is expressed as follows:
• TR = P x Q … where TR – Total Revenue, P – Price, and Q – Quantity
of the commodity sold.
 Average Revenue
Average revenue is simply the revenue earned per unit
of the output. In simpler words,
it is the price of one unit of the output. Average revenue is expressed as follows:
AR=TR/Q … where
AR – Average Revenue,
TR – Total Revenue,
and Q – Quantity of the commodity sold.
By using the formula for total revenue, we get
AR=P×Q /Q
Or AR = P
For example,
a firm sells 100 units of a commodity and realizes a total revenue of Rs. 1,000.
Therefore, its average revenue is
AR=1000/100=Rs.10
Hence, the firm sells the commodity at a price of Rs. 10 per unit
 Marginal Revenue
• Marginal revenue (MR) is the change in total revenue resulting from
the sale of an additional unit of a commodity.
• For example, consider a firm selling 100 units of a commodity and
realizing a total revenue of Rs. 1,000.
• Further, it realizes a total revenue of Rs. 1,200 after selling 101 units
of the same commodity. Therefore, the marginal revenue is Rs. 200.
• Marginal revenue is also defined as the rate of change of total revenue
resulting from the sale of an additional unit of a commodity.
Therefore,
 MR=ΔTR / ΔQ
… where MR – Marginal revenue, TR – Total revenue,
Q – Quantity of the commodity sold,
and Δ – the rate of change.
Further, for one unit change in output, we have
MRn = TRn – TRn-1
Where,
•TRn – the total revenue when the sales are at the rate of ‘n’ units per period.
•TRn-1 – the total revenue when the sales are at the rate of (n-1) units per period.
Marginal Revenue, Average Revenue, Total Revenue and the Elasticity of
Demand
It is important to note that the marginal revenue, average revenue and price
elasticity of demand are
related to one another through the following formula:
MR=AR× e–1 / e
… where ‘e’ is the price elasticity of demand.
Further,
•If e = 1, then
MR=AR× 1–1 / 1=0
•If e > 1, then MR is positive.
•If e < 1, then MR is negative.
 Behavioural Principles
• Principle 1
• “A firm should not produce at all if total revenue from its product does
not equal or exceed its total variable cost.”
• Explanation: A firm produces products for profits. Therefore, if a
firm does not better by producing certain products, then it should
rather not produce them. Remember, a firm always has an option of
not producing anything. In a zero production scenario, the firm will
have an operating loss equal to its fixed costs. If the production adds
more cost than revenue to the firm, then it increases the loss of the
firm.
• Principle 2
• “It is profitable for the firm to increase the output whenever the
marginal revenue is greater than the marginal cost. Ideally, the firm must
continue expanding until the marginal revenue equals the marginal cost.
Also, apart from being equal, the marginal cost curve must cut the
marginal revenue curve from below.”
• Explanation: According to this principle, if a unit of production adds
more to the revenue than to the cost, then the said unit increases the
profits of the firm. On the other hand, if it adds more to the cost than to
the revenue, then the unit decreases the profits of the firm. The firm has
maximum profits at the point where the additional revenue from a unit
equals its additional cost.
• Q1. Assume that when the price is Rs. 20, quantity demanded is 9
units, and when the price is Rs. 19, quantity demanded is 10 units.
Based on this information, what is the marginal revenue resulting from
an increase in output from 9 units to 10 units?
• Rs. 20
• Rs. 19
• Rs. 10
• Rs. 1
• Answer: Scenario 1 – Price is Rs. 20 and the quantity demanded is 9
units. Therefore, the total revenue is
• TR1 = Price x Quantity = 20 x 9 = Rs. 180
• Q2. Assume that when the price is Rs.20, quantity demanded is 15
units, and when the price is Rs.18, quantity demanded is 16 units.
Based on this information, what is the marginal revenue resulting from
an increase in output from 15 units to 16 units?
• Rs. 18
• Rs. 16
• Rs. 12
• Rs. 28