MICRO ECONOMICS FOR MANAGERS

• Course code: 15MT12

• Credits: 3
• Total No. of sessions: 25
• Course Objectives:
 Introduce basic micro-economic concepts such as theories of demand,
supply, pricing and costs etc.
 Build a conceptual foundation for courses in the functional areas of
management such as marketing, finance etc. for understanding the
behaviour of consumers, firms and markets.

Student of MBA/PGDM: Will I ever use this?

Professor: Only if your career is successful.
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 Course Content
Unit I: Preliminaries in Economics
Choice as an economic problem- Basic postulates- Economic concepts-Factors of production-The circular
flow of economic activity-The nature of the firm-Concept of Economic Profit- Economics and decision
making-Economic models

Unit II: Demand Management

Demand theory and analysis- Application of price, income, cross and advertisement elasticity of demand-
The theory of consumer choice-Regression techniques and demand estimation & forecasting

Unit III: Production and Cost Management

Supply theory and analysis-Production theory and analysis: The production function-Economies of scale and
scope- Cost analysis-Profit contribution analysis

Unit IV: Profit Maximization in Various Market Structure

Perfect competition-Monopoly-Monopolistic competition-Oligopoly-Game theory and strategic behaviour
 

Unit V: Pricing Practices and Risk Analysis

Pricing of multiple products- Price discrimination- Average cost plus pricing- Marginal cost pricing- Transfer
pricing- Peak load pricing- Principal agent problem- The problem of moral hazard-A symmetric information

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 Suggested Books for Reading
Text Books:
1.William A. McEachern & Simrit kaur, Micro ECON, 2013
Edition, Cengage Learning
 
Reference Books: 
1. Tim Harford, The Undercover Economist, Abacus, 2006.
2. Suma Damodaran, Managerial Economics Oxford
University Press
3. Business Line (Newspaper)
4. The Economic Times (Newspaper)
5. Business Economics ( Fortnight magazine)

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 Economic Mysteries
• Why is airline food so bad?
• Why have paper towels replaced hot-air hand dryers in public restrooms?
• Why is CCD charging different than roadside shop
• Why is that you pay more for a first day movie show?
• Why do prices of some goods, like apples, go down during months of heaviest
consumption
• Why can’t I increase the price of bidi?
• Why is cricket making more money than hockey or other game?
• Why is petrol bunk mechanized in US and not in India
• Why do color photographs cost less than black and white photographs?
• Why are we not selling all the consumer items through PDS?
• Why is vegetable cheaper in Ooty?
• Why don’t you pay for sand in the sea shore?

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 Economics Reasoning Quiz
• The best things in life are free. (T/F)
• The largest cost of going to college is tuition, room and board.
(T/F)
• The purpose of economic activity is to improve the well-being of
some people at the expense of others. (T/F)
• Anything worth doing is worth doing well. (T/F)
• Life is priceless. (T/F)
• Your standard of living is different from that of your parents or
grandparents when they were your age. (T/F)

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 Guide to Economics Reasoning
• PEOPLE ECONOMIZE. People choose the alternative which seems best to them
because it involves the least cost and the greatest benefit.
• ALL CHOICES INVOLVE COST. Cost is the second best choice given up when people
make their best choice.
• PEOPLE RESPOND TO INCENTIVES. Incentives are actions or rewards that
encourage people to act. When incentives change, people’s behavior changes in
predictable ways.
• ECONOMIC SYSTEMS INFLUENCE INDIVIDUAL CHOICES AND INCENTIVES.
How people cooperate is governed by written and unwritten rules. As rules change,
incentives change and behavior changes.
• VOLUNTARY TRADE CREATES WEALTH. People can produce more in less time by
concentrating on what they do best. The surplus goods or services they produce can be
traded to obtain other valuable goods or services.

• THE CONSEQUENCES OF CHOICES LIE IN THE FUTURE. The important costs and
benefits in economic decision making are those which will appear in the future.
Economics stresses making decisions about the future because it is only the future that
we can influence. We cannot influence things that have happened in the past.
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 Cost-Benefit Approach to Decision Making
• C(X) = Cost of doing activity X
• B(X) = Benefit of doing activity X
• If B(X) > C(X) then do X

Should I go for movie today?

• B(X) = $50 to you.
• C(X) = $30 for ticket & travel.
• Should you go to movie?
EXAMPLE
Mr. X must decide whether to go out with your friends to a local Restaurant on a Thursday night.
Thebenefits include spending time with your friends and receiving free treats from the Chef (who
happens to be your best friend). The costs of the night include(at minimum) a cab ride home, missing
class the next day (and possibly missing a surprise quiz), and waking up with a nasty hangover. Costs
could run higher.

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Should graduate student sell a car to his father-
in-law?
EXAMPLE-1:
• $10,000 Chevrolet
• Car sells for $15,000 in home country.
• Estimates he can sell it for $14,000.
• Father-in-law wants to pay $10,000.
• What is the graduate student’s opportunity cost if he sells it to his father-in-law?
EXAMPLE-2:
Giving up your favourite movie to study (in order to get good grades).
The opportunity cost is the movie that has been forgone

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 Why Study Economics
•Managers need to make
decisions with multiple
choices.
•Economics deals with
trade, production,
consumption, external
environment
(government..),
international environment,
money market, physical
market and so on.

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Economics as a science
Choice making can be an art.
Can also be viewed as a problem requiring a solution
Scientific inquiry of a problem: This can take a form of
first analyzing the situation by identifying all the
relevant elements, variables, or factors; and then,
investigating the inter-relationships between these
variables.
Investigator makes some postulates
Positive science: concerned with “what is”
Normative science: what is right and wrong or what
ought to be

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Economics: Layman Definitions

 Economics is a social science concerned chiefly with way the

societies chooses to employ its limited resources, which have
alternative uses to produce goods and services for present ant
future consumption
 A social science concerned with proper uses and allocation of
resources for the achievement and maintenance of growth with
stability
 It is an art of analyzing, recording, interpretation and
communicating the results of economic transaction

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Economics from Economists…….
 Adam Smith: Economics is science of wealth

 JS Smith: He supports the definition of Adam Smith.” Economics is

the practical science of production and distribution of wealth.

 Marshall: "Economics is study of man’s action in ordinary business of

life, it enquires on how he gets his income and how he spends it.
Thus it is on one side it’s a study of money and on the other and more
important side, a study of man. "In this definition the expression
“man’s’ action in ordinary business of life refers to the fact that
economics studies the activities of real, social and normal human
beings. While the expression “how he gets income and how he spends
it” indicates the study of wealth. Marshall doesn’t indicate the nature
of science. He maintained that economic is positive science.

 Robbins: "Economics is science which studies human behavior as a

relationship between ends and scare means which have alternative
uses."
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Choice as an economic problem
 Preferred definition of economics: Study of choice under conditions of
scarcity
 Scarcity: Situation in which the amount of something available is
insufficient to satisfy the desire for it. And becomes challenging as
scarce resources have alternative uses.
 Limitations force each of us to make choices
 Economists study choices we make as individuals, and consequences of
those choices.
 Economists also study more subtle and indirect effects of individual
choice on our society
Will people work more or less hours if the government cuts taxes?
Will a gasoline tax cut petrol consumption?
 The outcome depends on the separate choices of millions of people
 The problem of choice becomes complicated if the numerous wants
can be ordered or prioritized

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Economist…. Adam Smith
 Published :The Wealth of Nations
(1776)
 The book identified land, labor, and
capital as the three factors of
production and the major
contributors to a nation's wealth.
 Smith's view, the ideal economy is
a self-regulating market system that
automatically satisfies the economic
needs of the populace.
 He described the market mechanism
as an "invisible hand" that leads all
individuals, in pursuit of their own
self-interests, to produce the greatest
benefit for society as a whole.

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Economist…. Thomas Robert Malthus
 Used the idea of diminishing returns to
explain low living standards.
 Human population, he argued, tended
to increase geometrically, outstripping
the production of food, which increased
arithmetically.
 The force of a rapidly growing
population against a limited amount of
land meant diminishing returns to labor.
 The result, he claimed, was chronically
low wages, which prevented the
standard of living for most of the
population from rising above the
subsistence level.

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Economist…. Karl Marx
 Marx argued that capitalism, like
previous socioeconomic systems,
would inevitably produce internal
tensions which would lead to its
destruction.
 Just as capitalism replaced feudalism,
he believed socialism would, in its turn,
replace capitalism, and lead to a
stateless, classless society called pure
communism

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 Divisions of Economics
• Economics can be divided into two broad categories:
• MICRO Economics-
• Concealed in the aggregate data are countless changes in the output levels of
individual firms, the consumption decisions of individual consumers, and
the prices of particular goods and services.
• It focuses on the behaviour of the individual actors on the economic stage,
that is firms and individuals and their interaction in the markets.
• MACRO Economics –
• It’s a study of the economic system as a whole. It includes techniques for
analyzing changes in total output, total employment, the consumer price
index.
• The unemployment rate, and exports and imports. It addresses question
about the effect of changes in investment, government spending, and tax
policy on exports, output, employment, and prices.

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 Divisions of Economics
Examples of microeconomic and macroeconomic concerns
Production Prices Income Employment
Microeconomi Production/Outp Price of Distribution of Employment by
cs ut in Individual Individual Goods Income and Individual
Industries and and Services Wealth Businesses &
Businesses     Industries
  Price of medical Wages in the Jobs in the steel
How much steel care auto industry
How many Price of gasoline industry Number of
offices Food prices Minimum wages employees in a
How many cars Apartment rents Executive firm
salaries
Poverty
Macroeconomi National Aggregate Price National Income Employment and
cs Production/Outp Level Total wages and Unemployment
ut   salaries   in the Economy
  Consumer price  
Total Industrial index Total corporate Total number of
Output Producer Price profits jobs
Gross Domestic index Unemployment
Product Rate of Inflation rate
18 Vidya SureshGrowth of Output September 2, 2021
 POSITIVE vs NORMATIVE ECONOMICS

• Positive Economics
It is about “what is”
e.g. It explains why great depression occurred.
• Normative Economics
It is about “what should be”

e.g. It aims to develop and recommend policies that will prevent another
great depression

The statement
“a government deficit will reduce unemployment and cause an increase in prices or
inflation” is a positive hypothesis,
while
“in setting policy, unemployment ought to matter more than inflation” is a normative
hypothesis”.

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 What is Managerial Economics
• It’s a applied microeconomics
• It focuses on demand, production, cost, pricing, market structure,
and government regulation.
• According to Haynes, Mote and Paul- “Managerial Economics is
economics applied in decision-making. It is a special branch of
economics bridging the gap between abstract theory and
managerial practices.”
• According to Spencer and Seegalman- “Managerial Economics is
the integration of economic theory with business practice for the
purpose of facilitating decision-making and forward planning by
management.”
• Thus, it deals with Decision making and forward planning. It’s
Prescriptive in nature.

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 Basic postulates
• Economic agent makes choice according to some rules. We do not
deal with behaviour that is inconsistent, illogical and random
• He has clarity of purpose. A clear motive which drives him to
make choices under different circumstances
• He is lively, intelligent, capable of assimilating whatever
information is available to him from environment

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 Economic Concepts
Economic Activity:
Any activity which involves use of scarce resources to satisfy some human needs or
wants is economic activity.
Consumption activity: direct satisfaction of human wants
Production activity: indirect satisfaction/ future use
Exchange: intermediate activity between production and consumption
Investment: The part of saving which is used for further production

Utility:
The degree of satisfaction derived from the consumption of goods and services is
known as utility.
It is person-time-place-consumption period specific
Utility of sand near sea and in city

Economic goods : utility, scarcity, and transferability

Scarcity: is the central focus of economics. This scarcity gives rise to opportunity
cost. The opportunity cost comes in at every level of economic activity

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 Economic Concepts
Wealth:
Its is a aggregation of all economic goods and services, and includes natural
resources. It’s a stock.

Income:
What a person earns by selling or providing services of the resources he owns. It’s a
flow

Price and Value:

The price of a commodity is the value expressed in money terms, and is always
expressed per unit of a commodity.
The ratio of prices of commodities is known as the relative prices. Exchange value of
a commodity is measured.
If the price of rice is Rs.10/kg and price of wheat is Rs.5/kg then exchange value of
rice in terms of wheat is 2

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 Economic Concepts
Factors of production:
P = f( land , labour, capital, enterprise)

Opportunity Cost:
Because of scarcity every action carries an opportunity cost
Opportunity cost: “True” cost of any choice
Cost of going to a movie
Cost of ticket
Cost of your time
The opportunity cost of any choice is what we must forego when we make that
choice. The opportunity cost of value of the next best alternative.
Opportunity Cost of college:
Fees (explicit costs)
What is your next best alternative (implicit costs)
Working?
Average income for an 18 year old HS graduate who works full time is
about $24000.

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 Economic Concepts
Production The process by which resources are transformed
into useful forms

Resources/ Inputs Anything provided by nature or previous

generations that can be used directly or indirectly to satisfy
human wants.

Capital Things that have been already been produced that are
in turn used to produce other goods and services

Producers Those people or groups of people, whether private

or public, who transform resources into usable products.

Outputs Usable products

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 The scope and subject-matter of economics can be better
known by answering the following questions
What goods are to be produced and in what quantities?

How are the different goods to be produced? i.e. what production methods are
employed for the production of various goods and services?

How the total output of goods and services of a society is being distributed among
its people?

Whether all available productive resources with a society are being fully utilized?

Is the economy’s productive capacity increasing, declining or remaining static

overtime?

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 The scope and subject-matter of economics can be better
known by answering the following questions

WHAT, HOW, AND FOR WHOM

i.e.
allocation of resources,
methods of techniques,
and distribution…

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 Circular flow of economic activity

• HOUSE-HOLDinsert a proper chart

which has all thesectors with arrow
marks-dolwnload the chart and then
make changes

• BUSINESS
Insert the chart

• CAPITAL MARKET

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 The nature of the firm
Firms exists because of the costs of production are lower and
returns to the owners of labor and capital are higher than if
the firm did not exist.

Profit maximization

Maximizing versus satisficing

Economic profit refers to revenues minus all relevant costs,

both explicit and implicit.

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 Basic Concepts: Economic model
An economic model typically consists of several functional
relationships, conditions, or constraints on one or all of
these functions, and one or more equilibrium conditions.

Generally, economic models are used to demonstrate an

economic principle, to explain an economic phenomenon,
or to predict the economic implications of some change
affecting one or more of the functional relationships.

Models are the replica of the real case. It represents most of

the features of the real life cases.
Take this slide
after economic
concepts

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 Economics and Decision Making
Nobel prize-winning economist Herbert Simon identifies the
primary activities in decision making:

• Finding occasions for making decisions

• Identifying possible courses of action
• Evaluating the revenues and costs associated with each
course of action.
• Choosing that one course that best meets the goal or
objective of the firm (i.e., that maximizes the value of the
firm)
Take this slide
after economic
concepts

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 The Economic Problem

• Pl write the definition with

example instead of bullet
points

Take this slide

after economic
concepts

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 Resources

• Inputs; factors of production

• Used to produce goods and services
• Goods and services are scarce
• because resources are scarce
1. Labor
2. Capital
3. Natural Resources
4. Entrepreneurial ability

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 Resources

• Labor – human effort

• Physical effort
• Mental effort
• Time
• Payment: Wage
• Capital – human creations
• Physical capital
• Human capital
• Payment: Interest
34 Vidya Suresh September 2, 2021
 Resources

• Natural resources – Gifts of nature

• Renewable
• Exhaustible
• Payment: Rent
• Entrepreneurial ability
• Talent, idea
• Risk of operation
• Payment: Profit

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 Goods and Services

• Good: see, feel, touch

• Service: intangible
• Scarce good/service
• The amount people desire
exceeds the amount available
at zero price
• Choice
• Give up some goods and services

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 Goods and Services

• Bads
• We want none of them; not even at a zero price
• Free goods and services
• “There is no such thing as a free lunch”
• Involve a cost to someone

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 Economic Decision Makers

• Households
• Consumers
• Demand goods and services
• Resource owners
• Supply resources
• Firms, Governments, Rest of the World
• Demand resources
• Produce goods and services

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 Markets

• Bring together buyers and

sellers
• Determine price and
quantity
• Product markets
• Goods and services
• Resource markets
• Resources

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 A Simple Circular-Flow Model

Flow of
• Resources
• Products
• Income
• Revenue
• Among economic decision makers
• Interaction
• Households
• Firms

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 Choice Requires Time and Information

• Time and information – scarce; valuable

• Rational decision makers

• Willing to pay for information

• Improve choices

• Acquire information

• Additional benefit expected

• exceeds the additional cost

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 Economic Analysis Is Marginal Analysis

• Expected marginal benefit

• Expected marginal cost
• Marginal
• Incremental, additional, extra
• Rational decision maker:
Change the status quo if expected
marginal benefit exceeds
expected marginal cost

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 Microeconomics and Macroeconomics

• Microeconomics
• Individual economic choices
• Markets coordinate the choices of
economic decision makers
• Individual pieces of the puzzle
• Macroeconomics
• Performance of the economy as a whole
• Big picture

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 The Science of
Economic Analysis

• Economic theory / model

• Simplification of economic reality

• Important elements of the problem
• Make predictions about the real word
• Good theory
• Guide
• Sort, save, understand information
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 The Scientific Method

1. Identify the question and define relevant variables

2. Specify assumptions
• Other-things-constant
• Behavioral assumptions
3. Formulate the hypothesis
• Key variables relate to each other
4. Test the hypothesis - evidence

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 A Yen for Vending Machines

• Japan – lower unemployment

• Low birthrate
• No immigration
• Aging population
• Vending machines
• Wider variety of products
• Preferred

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 Predicting Average
Behavior

• Individual behavior
• Difficult to predict
• Random actions of
individuals
• Offset one another
• Average behavior of
groups
• Predicted more accurately
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 Pitfalls of Faulty
Economic Analysis

• The fallacy that association is causation

• Event A caused event B – associated in time
• The fallacy of composition
• What is true for the individual is true for the group
• The mistake of ignoring the secondary effects
• Unintended consequences

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 College Major and Annual Earnings

• College degree
• Better jobs
• Higher pay
• Median annual earnings
• Men: $43,199
• Women: $32,155
• Major in economics
• Rank: #7
• No gap between men and women

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 Choice and Opportunity Cost

• Scarcity
• Make a choice
• Pass up another opportunity
• Opportunity cost
• The value of the best alternative forgone
• Opportunity lost
• Monetary aspect
• Non-monetary aspect

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The Opportunity Cost of College

• Value of best alternative forgone

• Forgone income(full-time job; $20,000)
• Minus income earned as a student(part-time work:
$10,000)
• Plus direct cost of college
• Tuition, fees, books ($6,000)
• $20,000 - $10,000 + $6,000 = $16,000
• Not included: room, board, personal expenses

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 Opportunity Cost

• Value of best alternative forgone

• Forgone income(full-time job;
$20,000)
• Minus income earned as a student
(part-time work: $10,000)
• Plus direct cost of college
• Tuition, fees, books ($6,000)
• $20,000 - $10,000 + $6,000 = $16,000
• Not included: room, board, personal
expenses

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 Sunk Cost and Choice

• Sunk cost
• Incurred cost
• Cannot be recovered
• Ignored when making economic choices
• Economic decision makers
• Relevant: costs affected by the choice
• Irrelevant: sunk costs

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 Specialization and Exchange

• Barter
• Trade products for other products
• Simple economies
• Few goods
• Little specialization
• Money
• Medium of exchange
• Facilitates exchange
• Greater specialization

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 Division of Labor
• Division of labor
• Specialization; Increased productivity
• Individual preferences; natural ability
• Experience
• No need to shift between tasks
• Laborsaving machinery
• Downside:
• Repetitive, tedious
• Routine tasks - robots

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 Efficiency and the PPF

• Production Possibilities Frontier (PPF)

• Assumptions
• Output: consumer and capital goods
• Productions: 1 year
• Fixed resources (quantity, quality)
• Fixed technology
• Fixed ‘rules of the game’
• Resources – scarce for the economy
• Economy’s production options

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 The Shape of the PPF

• Movement down along PPF

• Give up some consumer goods to get more capital
goods
• Bowed-out shape
• Law of increasing opportunity costs
• Slope of PPF
• Opportunity cost of 1 unit capital good

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 What Can Shift the PPF?
• Economic growth
• Expansion in the economy’s PPF
• Changes in resource availability
• Outward shift of PPF – increase in:
• Size, health of labor force
• Skills of labor force
• Availability of other resources
• Increases in capital stock
• More output; outward shift of PPF
• Technological change
• Employs resources more
efficiently
• Outward shift of PPF
• Improvements in the rules of the
game
• Formal and informal institutions
58 • Suresh
Vidya Economic growth September 2, 2021
• Outward shift of PPF
 Economic Systems

• Criteria
• Ownership of resources
• Allocation of resources
• Incentives
• Range from
• Pure capitalism, to
• Pure command system

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 Pure Capitalism

• Private property rights

• Unrestricted markets
• Answer the three questions
• Resources – most productive use
• Goods and services – most valued
• Voluntary buying and selling
• Adam Smith: “invisible hand”

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 Pure Capitalism: Flaws

• No central authority
• People with no resources could starve
• Monopoly
• Side effects for people not involved
• No public goods

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 Pure Command System

• Public/communal ownership of property

• Government planners
• Central plans
• Direct resources
• Coordinate production
• Answer the three questions
• Communism

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 Pure Command System: Flaws

• Resources
• Used inefficiently
• Wasted (no incentives)
• Preferences of planners
• Limited variety of products
• Less freedom of economic choice

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 Mixed and Transitional Economies

• Increasing role of government

• In capitalist economies
• Increasing role of markets
• In command economies
• Mixed economies
• Government
• Economic activity
• Regulates the private sector

64
•
Vidya Suresh Economies based on custom or religion
September 2, 2021