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. 

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.

characteristics of managerial economics

 
1. Art and Science
 
Managerial Economics requires a lot of creativity and logical thinking to come up with a solution. A
managerial economist should possess the art of utilizing his capabilities, knowledge, and skills to
achieve the organizational objective. Managerial Economics is also considered as a stream of
science as it involves the application of different economic principles, techniques, and methods, to
solve business problems.
 
 
2. Microeconomics
 
In managerial economics, problems of a particular organization are looked upon rather than focusing
on the whole economy. Therefore it is termed as a part of microeconomics. 
 
 
3. Uses Macroeconomics
 
Any organization operates in a market that is a part of the whole economy, so external environments
affect the decisions within the organization. Managerial Economics uses the concepts of
macroeconomics to solve problems. Managers analyze the macroeconomic factors like market
conditions, economic reforms, government policies to understand their impact on the organization. 
 
 
4. Multi-disciplinary
 
 Managerial Economics uses different tools and principles from different disciplines like accounting,
finance, statistics, mathematics, production, operation research, human resource, marketing, etc.
This helps in coming up with a perfect solution. 
 
 
5. Management oriented and pragmatic
 
Managerial economics is a tool in the hands of managers that aids them in finding appropriate
solutions to business-related problems and uncertainties. As mentioned above, managerial
economics also helps in goal establishment, policy formation, and effective decision making. It is
a practical approach to find solutions. 

The 10 Economic Principles

1. People face trade-offs
Everyone faces decisions that put one option above the other. Most decisions, especially economic
ones, involve trading off one thing for another.

One of the main trade-offs we experience is between efficiency and equity. Efficiency refers to
something we can get the most out of, especially if the resource is scarce. Equity implies that all
members of society benefit equally from a resource.

2. The cost of something is what you give up to

get it
Since people face these trade-offs, a decision requires a comparison of the costs against the benefits
of alternative courses of action

Each item has an opportunity cost, in other words, what you’re giving up to get it. So, when facing a
decision, people should understand the opportunity cost involved in that decision and in each action.

 Ex. The opportunity cost of going to college is the money you could have earned if you used that
time to work.
3. Rational people think at the margin
economists like to assume that people are rational thinkers. Still, they look at marginal changes to
describe small adjustments to the plan of action. Another way of looking at this is that people make
decisions when they think at the margin.

When considering marginal changes, we as consumers are looking for the maximum satisfaction on
our purchases that fit with our budgets and incomes. 

 Example: Suppose that flying a 200-seat plane across the country costs the airline $1,000,000,
which means that the average cost of each seat must cost $5000 to break even. Suppose that the
plane is minutes away from departure and a passenger is willing to pay $3000 for a seat. Should
the airline sell the seat for $3000? In this case, the marginal cost of an additional passenger is
very small.

4. People respond to incentives

This economic principle isn’t surprising but makes a lot of sense when we consider the last few
principles. Since consumers make decisions by comparing benefits and cost, what happens when that
scale changes? That’s where incentives play a part.

Incentives inspire consumers to act by offering up an extra reward to those people who will change
their behavior. Incentives can also be positive or negative, meaning you can incentivize people to do
something or not to do something.

For example, a positive incentive would be offering employees a bonus if they work extra hours.
However, a negative incentive can be exemplified by extra taxes governments might put on things like
fuel that encourage people to use it less.

5. Trade can make everyone better off

Trade allows countries to specialize according to their comparative advantages and to enjoy a greater
variety of goods and services. In trade, all parties can win by focusing on what they’re best at.

The best example of this is countries that benefit from trading with each other. Most countries don’t
have all the resources they need to function effectively, so they turn to other countries for more or
even cheaper resources that they can trade. It also allows for a wider variety of goods to become
available in the country, which increases competition on a global scale.

6. Markets are usually a good way to organize

economic activity
In a market economy, decisions are made collectively by millions of households and firms that have a
stake in the economy. If you think about it, it’s like a cycle. Households decide where they’ll work, and
firms decide who they want to hire and what to produce. These two parties interact in the market
economy where decisions are guided by self-interest.
Sometimes, the market economy or aspects of it fail, and that’s where governments have to step in to
implement policy. But usually, the interaction between households and firms are guided almost
automatically, seemingly by an ‘invisible hand’ that helps direct economic activity.

7. Government can sometimes improve market

outcomes
Market failures occur when the market fails to allocate resources efficiently. Governments can step in
and intervene in order to promote efficiency and equity. Markets can fail when they fail to allocate
resources efficiently, and this happens as a result of externality, An example of this is pollution and
the well-being of the environment. Without the intervention of governments, the market could have a
negative impact without even meaning to.

8. A country’s standard of living depends on

country production
 As we know, there are different standards of living in different countries, and this is directly
correlated to the country’s productivity. The more goods and services produced in a country, the
higher the standard of living. As people consume a larger quantity of goods and services, their
standard of living will increase

 In places where workers are able to produce more goods, the standard of living is higher, and
vice versa. To increase the living standard, there need to be public policies that affect it without
negatively impacting productivity by way of increasing education and providing better access to
tools and technology.

9. Prices rise when the government prints too much

money
 The value of money falls when the government creates a lot of money, so individuals have
more money and the demand for goods and services increases.
 When the demand increases, price also increases and creates inflation of money.

10, Society Faces a Short-Run Tradeoff Between

Inflation and Unemployment
 In the short run, when prices increase, suppliers will want to increase their production of
goods and services. In order to achieve this, they need to hire more workers to produce those
goods and services. More hiring means lower unemployment while there is still inflation.
However, this is not the case in the long-run.
What Is a Market?
A market is a place where parties can gather to facilitate the exchange of goods and services. The parties involved
are usually buyers and sellers. The market may be physical like a retail outlet, where people meet face-to-face, or
virtual like an online market, where there is no direct physical contact between buyers and sellers. 

WHAT IS DEMAND?
Demand is the quantity of consumers who are willing and able to buy products at various prices during a
given period of time. Demand for any commodity implies the consumers' desire to acquire the good, the
willingness and ability to pay for it.

Determinants of Demand

There are many determinants of demand, but the top five determinants of demand are as follows: 

Product cost: Demand of the product changes as per the change in the price of the commodity. People
deciding to buy a product remain constant only if all the factors related to it remain unchanged.

The income of the consumers: When the income increases, the number of goods demanded also
increases. Likewise, if the income decreases, the demand also decreases.

Costs of related goods and services: For a complimentary product, an increase in the cost of one
commodity will decrease the demand for a complimentary product. Example: An increase in the rate of
bread will decrease the demand for butter. Similarly, an increase in the rate of one commodity will
generate the demand for a substitute product to increase. Example: Increase in the cost of tea will raise
the demand for coffee and therefore, decrease the demand for tea.

Consumer expectation: High expectation of income or expectation in the increase in price of a good

also leads to an increase in demand. Similarly, low expectation of income or low pricing of goods will
decrease the demand.

Buyers in the market: If the number of buyers for a commodity are more or less, then there will be a
shift in demand.
What is Law of demand?
The law of demand describes an inverse relationship between price and quantity demanded of a good. If
the price of the good increases, then the demand falls, because the consumer is usually reluctant to
spend more and more money on her purchase. If the price of the good decreases, the demand for the
good increases because with price being less, the consumer prefers to buy the good.

Quantity demanded defined

• The individual quantity demanded of a good is the specific quantity of a good that a consumer is
willing and able to buy during a time period at a specific price, ceteris paribus.

• The market quantity demanded for a good is the sum of all the individual quantities demanded of all
the consumers in the market. In other words, it is the sum of all the quantities of a good/service that
each consumer in the market is willing and able to buy during a time period at a specific price level,
ceteris paribus.

• We usually refer to “market quantity demanded” whenever we say “quantity demanded”.

What are the 6 factors that affect demand?

The factors that affect demand are as follows:

1. Price of product
2. Consumer’s Income.
3. Price of Related Goods.
4. Tastes and Preferences of Consumers.
 5. Consumer’s Expectations.
6. Number of Consumers in the Market.

What is Demand Schedule?

A demand schedule is a tabular arrangement of different prices of a product or service and its quantity at
various prices during a specific period. 

SUPPLY

the total amount of a specified product or service that is available to customers is known as
‘supply.’ It is very closely related to and goes hand in hand with demand. When supply
 exceeds demand for a product or service, the prices of said product fall. This is known as
the law of supply and demand.

There are a few factors of supply for goods and services. These factors are:

 Price of goods or service

 Price of production
 Price of Input
 Production units’ number
 Technology of production
 Producer expectation
 Policies of Government

• Law of Supply
– The law of supply states that, other things equal, the quantity supplied of a good rises when the price of the good
rises.

Law of supply states that other factors remaining constant, price and quantity supplied of a
good are directly related to each other. In other words, when the price paid by buyers for a
good rises, then suppliers increase the supply of that good in the market.

The above diagram shows the supply curve that is upward sloping (positive relation
between the price and the quantity supplied). When the price of the good was at P3,
suppliers were supplying Q3 quantity. As the price starts rising, the quantity supplied also
starts rising.
Determinants of Supply

Price of the Good/ Service

The most obvious one of the determinants of supply is the price of the product/service. With all other
parameters being equal, the supply of a product increases if its relative price is higher.

Price of Related Goods

Let’s say that the price of wheat rises. Hence, it becomes more profitable for firms to supply wheat as
compared to corn or soya bean. Hence, the supply of wheat will rise, whereas the supply of corn and soya
bean will experience a fall.

Hence, we can say that if the price of related goods rises, then the firm increases the supply of the goods
having a higher price. This leads to a drop in the supply of the goods having a lower price.

Price of the Factors of Production

Production of a good involves many costs. If there is a rise in the price of a particular factor of production,
then the cost of making goods that use a great deal of that factors experiences a huge increase. The cost of
production of goods that use relatively smaller amounts of the said factor increases marginally

For example, a rise in the cost of land will have a large effect on the cost of producing wheat and a small
effect on the cost of producing automobiles.

State of Technology

Technological innovations and inventions tend to make it possible to produce better quality and/or quantity of
goods using the same resources. Therefore, the state of technology can increase or decrease the supply of
certain goods.

Government Policy

Commodity taxes like excise duty, import duties, GST, etc. have a huge impact on the cost of production.
These taxes can raise overall costs. Hence, the supply of goods that are impacted by these taxes increases
only when the price increases. On the other hand, subsidies reduce the cost of production and usually lead to
an increase in supply.
What Is Price Elasticity of Demand?
Price elasticity of demand is a measurement of the change in the consumption of a product in relation to
a change in its price. Expressed mathematically, it is:

Price Elasticity of Demand = Percentage Change in Quantity Demanded ÷ Percentage Change in Price

 A good is perfectly elastic if the price elasticity is infinite (if demand changes
substantially even with minimal price change).
 If price elasticity is greater than 1, the good is elastic; if less than 1, it is inelastic.
 If a good’s price elasticity is 0 (no amount of price change produces a change in
demand), it is perfectly inelastic.
 If price elasticity is exactly 1 (price change leads to an equal percentage change
in demand), it is known as unitary elasticity.
 The availability of a substitute for a product affects its elasticity. If there are no
good substitutes and the product is necessary, demand won’t change when the
price goes up, making it inelastic.

 An elastic demand is one in which the change in quantity demanded due to a change

in price is large. An inelastic demand is one in which the change in quantity
demanded due to a change in price is small.
The formula for computing elasticity of demand is:
 (Q1 – Q2) / (Q1 + Q2)     
(P1 – P2) / (P1 + P2)
 If the formula creates an absolute value greater than 1, the demand is elastic .
Factors That Affect Price Elasticity of Demand
Availability of Substitutes
The more easily a shopper can substitute one product for another, the more the price will fall.
For example, in a world in which people like coffee and tea equally, if the price of coffee goes
up, people will have no problem switching to tea, and the demand for coffee will fall. This is
because coffee and tea are considered good substitutes for each other.
Urgency
The more discretionary a purchase is, the more its quantity of demand will fall in response to
price increases. That is, the product demand has greater elasticity.

Say you are considering buying a new washing machine, but the current one still works; it’s just
old and outdated. If the price of a new washing machine goes up, you’re likely to forgo that
immediate purchase and wait until prices go down or the current machine breaks down.

5 Types of Price Elasticity of Demand

1. Perfectly Elastic Demand:
When a small change in price of a product causes a major change in its demand, it is said to be perfectly
elastic demand. In perfectly elastic demand, a small rise in price results in fall in demand to zero, while a
small fall in price causes increase in demand to infinity. In such a case, the demand is perfectly elastic or
ep = 00.
2. Perfectly Inelastic Demand:
A perfectly inelastic demand is one when there is no change produced in the demand of a product with
change in its price. The numerical value for perfectly inelastic demand is zero (ep=0).

3. Relatively Elastic Demand:

Relatively elastic demand refers to the demand when the proportionate change produced in demand is
greater than the proportionate change in price of a product. The numerical value of relatively elastic
demand ranges between one to infinity. relatively elastic demand is known as more than unit
elastic demand (ep>1)
4. Relatively Inelastic Demand:
Relatively inelastic demand is one when the percentage change produced in demand is less than the
percentage change in the price of a product. For example, if the price of a product increases by 30% and
the demand for the product decreases only by 10%, then the demand would be called relatively inelastic.
The numerical value of relatively elastic demand ranges between zero to one (e p<1).

The demand curve of relatively inelastic demand is rapidly sloping, as shown in

Figure-5:
5. Unitary Elastic Demand:
When the proportionate change in demand produces the same change in the price of the product, the
demand is referred as unitary elastic demand. The numerical value for unitary elastic demand is equal to
one (ep=1).

Elasticity of Supply
The law of supply states that there is a direct relationship between the quantity supplied and the price of a
commodity. Price elasticity of supply measures how much the total quantity produced changes whenever there is a
price change. The elasticity of supply establishes a quantitative relationship between the supply of a
commodity and it’s price. Price elasticity of supply is calculated as a percentage change in the quantity
supplied divided by a percentage change in the price of a good.
Types of Elasticity of Supply
 
There are five types of elasticity of supply.

1. Relatively elastic supply

 
The co-efficient of elastic supply is greater than 1(Es > 1). One percent change in
the price of a commodity causes more than one per cent change in the quantity
supplied of the commodity.

2. Unitary elastic supply

 
The coefficient of elastic supply is equal to 1 (Es = 1). One percent change in the
price of a commodity causes an equal ( one per cent) change in the quantity
supplied of the commodity.
 
3. Relatively inelastic supply
 
The coefficient of elasticity is less than one (Es < 1). One percent change in the
price of a commodity causes a less than one per cent change in the quantity
supplied of the commodity.

4. Perfectly inelastic supply

 
The coefficient of elasticity is equal to zero (Es = 0). One percent change in the
price of a commodity causes no change in the quantity supplied of the commodity.

 
5. Perfectly elastic supply
The coefficient of elasticity of supply is infinity. (Es = α ). One percent change in
the price of a commodity causes an infinite change in the quantity supplied of the
commodity.