Economics: Study of the behavior of human beings in producing, distributing and consuming material goods and services in a world of scare resources.Management: The discipline of organizing and allocating a firm’s scare resources to achieve its desired objectives.

ME: It is the use of economic analysis to make business decisions involving the best use of an organization’s scare resources.Economics of business or managerial decisions.Integration of economic principles with business practices. Pertains to economic analysis that can help in solving business problems, policy and planning.

Traditional Economics & Tools & Techniques of Decision Sciences

Business Management

in theory& Practice: Decision, Problems

ME

In Economic Theory: Assumption of a single Goal i.e. rational consumer aims at

maximization of utility and a firm tries to maximize its profit. ET is based on Ceteris Paribus i.e. given conditions with

certainty of actions or events or within the framework of axioms.

In Business Decision Making: Multiple goals in running a business. Lack of certainty due to dynamic changes. Uncertainty may create disappointment in the realizations of

business expectations.

ET cant provide clear cut solutions but helps in arriving at a better decision.

ME helps bridge the gap between purely analytical problems dealt in ET and decision problems faced in real business.

MAIN CHARACTERISTICS OF ME

Applied Micro economicsScience as well as art of management

disciplines.Concerned with the firm's behavior in optimal

allocation of resources.Provides tools for best alternatives and

competing activities in any productive sector.Incorporates both Micro and Macro Economics

for optimal decisions.Helps Manager to understand the intricacies of

the business problems which make the problem solving easier and quicker.

contd.

.

Study of managerial economics essentially involves the analysis of certain major subjects like:

The business firm and its objectives

Demand analysis, estimation and forecasting

Production and Cost analysis

Pricing theory and policies

Profit analysis with special reference to break-even point

Capital budgeting for investment decisions

Competition.

Managerial Economics:

Uses analytical tools of mathematical and econometrics with two main approaches-

Descriptive Models are data based in describing and exploring economic relationships of reality in simplified abstract sense. Describe the economic forces that shape the internal and external environments of a business firm.

Prescriptive models are the optimizing models to guide the decision makers about set goal. Prescribe rules for managerial decision-making that furthers the objective of the firm.

DM provide a building block for developing optimizing models in solving the managerial and business problems.

Helps in depth analysis of key elements involved in the business.

IS ME POSITIVE OR NORMATIVE?+ve economics explains the economic phenomenon

as what is, what was and what will be.Normative economics prescribes what it ought to be.ME is a blending of pure or +ve science with applied

or normative science.+ve when confined to statements about causes and

effects and to functional relations of the economic variables.

It is normative when it involves norms and standards, mixing them with the cause effect analysis.

ME is a mix of both consideration in scientific approach.

DUTIES OF A MANAGERIAL ECONOMIST

Two broad aspects of his duties are –Decision Making Forward Planning

Demand Estimation and forecastingBusiness and sales forecastingAnalysis for extent and nature of competition.Analyzing the issues and problems of the concerned industry.Assisting the bus Planning process of the firm.Discovering the new and possible fields of business

endeavors and its cost benefit analysis.Advising on pricing , investment, and capital budget policy.Evaluation of capital budgets.Building micro and macro eco models for solving business

problems.Directing Economic research activities.Briefing the management on current domestic and global

economic issues and emergiing challenges.Keeps an eye on fast changing technological developments.

Managerial Economic analysis in Decision Making

ME adopts the scientific approach of economic analysis:Define the problemFormulation of the hypothesisAbstraction for the model buildingData collectionDeduction based on data analysisTesting the hypothesisEvaluating the test resultsConclusion for decisions

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A Decision-Making ModelObjectives

Define the problem

Alternative Solutions

Evaluation

Implement andmonitor the

decision

Organizationaland input

constraints

Social constraints

Scope of MEObjectives of a firmDemand Analysis and ForecastingCost and Production AnalysisPricing Decisions, Policies and PracticeProfit Management Capital BudgetingLinear Programming and the theory of gamesMarket structure and conditionsStrategic PlanningOthers Areas (Macroeconomic Management, Fiscal and

Monetary Policy, Impact of Liberalization, Globalization, privatization, marketization, international changes, environmental degradation, socio-political, cultural and external forces on management)

Importance of Managerial Eco. It gives guidance for identification of key variables in

decision making process. It helps the business executives to understand the various

intricacies of business and managerial problems and to take right decision at the right time.

It provides the necessary conceptual, technical skills, toolbox of analysis and techniques of thinking to solve various business problems.

It is both a science and an art. In the context of globalization, privatization, liberalization and a highly competitive dynamic economy, it helps in identifying various business and managerial problems, their causes and consequence, and suggests various policies and programs to overcome them.

.It helps the business executives to become much more responsive, realistic and competent to face the ever changing challenges in the modern business world.

It helps in the optimum use of scarce resources of a firm

to maximize its profits. It also helps in achieving other objectives a firm like

attaining industry leadership, market share expansion and social responsibilities etc.

It helps a firm in forecasting the most important

economic variables like demand, supply, cost, revenue, price, sales and profit etc and formulate sound business polices

It also helps in understanding the various external factors and forces which affect the decision making of a firm.

Market system- basicsMarket – System where buyers and sellers interact to

determine the price and quantity of goods or service.Based on two market forces – demand and supply.Purview of the market depends upon the expanse of

its buyers and sellers. Buyers and sellers need not come into personal

contact.Market refers to a commodity/ service or a

geographical area.Markets distinguished basis nature of goods and

services and extent of competition.

Consumer DemandIt is theDesire to buyWillingness to payAbility to paywhich determines the quantity with reference

to pricePeriod of timeplace

Definition of DemandThe demand for a product refers to the

amount of it which will be bought per unit of time at a particular price.

Individual demand and Market demandIndividual demand is a single consuming

entity’s demandMarket demand is the total demand of all

individual buyers at a particular price and over a given period of time.

Determinants of demandFactors influencing Individual demandPrice of productIncome availabilityTastes , habits and preferencesPrice of substitutes and complimentsConsumer expectationAdvertisement effectSeason prevailing at the time of purchaseFashion

Determinants…Market demandPriceDistribution of income and wealth in the community.Standards of living and spending habitsGrowth of populationNumber of buyers in the marketAge groupGender ratioFuture ExpectationsTaxation and tax structureFashion and InnovationClimateCustomsAdvertisements

Demand FunctionMathematical expression establishing relationship

between demand and its various variablesDx= F(Px, Ps,Pc,Yd,T, A, N, u)

Px – Own price

Ps - Price of a substitute

Pc – Price of complements

Yd – Disposable incomeT - buyers tastes and preferencesA – effect of advertisementN- population growthU – other aspects

Demand Function - contd..A linear demand function is as below :D= a – bPD= Units demandeda = Constant parameter signifying initial

demand irrespective of price.b = Constant parameter representing

functional relationship between D and P. Also measures the slope of the demand curve.

Law of demandAll other things remaining constant (ceteris

paribus), the quantity demanded of a commodity increases when its price decreases and decreases when its price increases.

Demand curve :

No Of Shirts

Price

of

Sh

irts

Assumptions underlying the Law of DemandHabits, tastes and fashions remain constant.Money, income of the consumer does not

change.Prices of other goods remain constant.The commodity in question has no substitute or

is not in competition by other goods.The commodity is a normal good and has no

prestige or status value.People do not expect changes in the price.Price is independent and demand is dependent.

Demand ScheduleDemand schedule is a tabular representation of

the quantity demanded of a commodity at various prices.

For instance, there are four buyers of apples in the market, namely A, B, C and D.

The demand by Buyers A, B, C and D are individual demands. Total demand by the four buyers is market demand. Therefore, the total market demand is derived by summing up the quantity demanded of a commodity by all buyers at each price.

Demand Schedule for apples

PRICE (Rs. per dozen)

Buyer A (demand in dozen)

Buyer B (demand in dozen)

Buyer C (demand in dozen)

Buyer D (demand in dozen)

Market Demand (dozens)

10 1 0 3 0 4

9 3 1 6 4 14

8 7 2 9 7 25

7 11 4 12 10 37

6 13 6 14 12 45

Demand CurveDemand curve is a diagrammatic

representation of demand schedule. It is a graphical representation of price- quantity relationship.

Individual demand curve shows the highest price which an individual is willing to pay for different quantities of the commodity.

While, each point on the market demand curve depicts the maximum quantity of the commodity which all consumers taken together would be willing to buy at each level of price, under given demand conditions.

Demand Curve

Features of demand curveDemand curve has a negative slope

The reasons for a downward sloping demand curve can be explained as follows-

Income effect- With the fall in price of a commodity, the purchasing power of consumer increases. Thus, he can buy same quantity of commodity with less money or he can purchase greater quantities of same commodity with same money. Similarly, if the price of a commodity rises, it is equivalent to decrease in income of the consumer as now he has to spend more for buying the same quantity as before. This change in purchasing power due to price change is known as income effect.

.

Substitution effect- When price of a commodity falls, it becomes relatively cheaper compared to other commodities whose price have not changed. Thus, the consumer tend to consume more of the commodity whose price has fallen, i.e, they tend to substitute that commodity for other commodities which have not become relatively dear.

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Law of diminishing marginal utilityIt is the basic cause of the law of demand. It states that as an individual consumes more

and more units of a commodity, the utility derived from it goes on decreasing. So as to get maximum satisfaction, an individual purchases in such a manner that the marginal utility of the commodity is equal to the price of the commodity. When the price of commodity falls, a rational consumer purchases more so as to equate the marginal utility and the price level. Thus, if a consumer wants to purchase larger quantities, then the price must be lowered. This is what the law of demand also states.

Exceptions to the law of demandThere are certain goods which are purchased mainly for

their snob appeal/ as status symbol, such as, diamonds, air conditioners, luxury cars, antique paintings, etc. The more expensive these goods become, more valuable will be they as status symbols and more will be there demand. Thus, such goods are purchased more at higher price and are purchased less at lower prices. Such goods are called as conspicuous goods.

The law of demand is also not applicable in case of giffen goods. Giffen goods are those inferior goods, whose income effect is stronger than substitution effect. These are consumed by poor households as a necessity. For instance, potatoes, animal fat oil, low quality rice, etc. An increase in price of such good increases its demand and a decrease in price of such good decreases its demand.

Exceptions to the law of demandThe law of demand does not apply in case of

expectations of change in price of the commodity, i.e, in case of speculation. Consumers tend to purchase less or tend to postpone the purchase if they expect a fall in price of commodity in future. Similarly, they tend to purchase more at high price expecting the prices to increase in future.

Change in Quanity demanded Vs Change in demandExtension and contraction of demand-

Movement along the same demand curve and represents the change in quantity demanded because of the change in price of the product.

Change in demandIncrease and decrease in demand – More is demanded at a given price when demand increases and vice versa. This change in demand is due to other factors than price.

Network externalities in demandDependence of individual demand on the

demand of other people in case of some products is network externality.

Two externalities :i)Bandwagon effectii)Veblen effect

Bandwagon effectThe demand for products is not by their

usefulness but mostly influenced by trend setters/ pace setters.

It is the result of the buyer’s desire to be in style or fashion.

This forms the basic objective of advertising and marketing of many products and manipulates market demand.

Helps in determining the pricing strategy of the business firm for such firms.

Veblen effectThe desire of a person to own exclusive/

unique product as a status symbol.A rise in price of such products enhances

their snob appeal and shifts the demand curve upwards.

Network externality is negative.The product loses its prestige when it starts

getting commonly used.

Veblen paradoxAt high prices, limited but high demand from

the rich.Slight upward variation in demand when the

prices are reduced a little.After a certain extent of price reduction,

demand dips.Once the product is made available to the

common man, it follows the usual law of demand.