Introduction to Managerial

economics
Objective of firm
1.1 Manager
A Central person of a business firm who run
control and take necessary decisions to
achieve desired goal.
Definition of Managerial
Economics (cont.)
From the above definitions, we can draw
following conclusion:
 Managerial economics is a branch of economics.
 The term managerial economics can be used in place
of business economics.
 Managerial economics integrates the economic
theories with business practices.
 Managerial economics is the science of decision
making.
 Managerial economics has both descriptive and
prescriptive roles.
 Managerial economics predicts the consequences of
decisions made by the firms.
Definition of Managerial
Economics
Managerial economics is the branch of
economics which deals with the application
of economic theories and methods for
business and managerial decision making of
a firm.
Managerial economics is, thus, a part of
economic knowledge and economic theories
which is used as a tool of analysing business
problems for rational decision making.
Managerial economics is also called
business economics or economics of firm.
Role/ Importance/ Uses of
Managerial Economics in
Business Decision Making
The major role or importance or uses of
managerial economics can be explained as
follows:
1. Foundation of business decision making
2. Estimating economics relationship
3. Useful to understand business
environment
4. Useful for pricing decision
5. Prediction of relevant economic
quantities
Generally objective of firm is to maximize profit
There are some causes why the objective of firm
is plausible

Incentive for expansion of business

Measure of performance

Ensuring supply of future capital

Attractive for new investors

Research and development

Operation of free market economy

Total approach (TR-TC approach)
According to total approach profit is
maximum when there is highest difference
between TR and TC.
π=TR-TC where, π= profit of the firm, TR=
Total revenue ( a amount received by a
firm selling a specific quantity of product)
and TC= Total cost.
The concept of profit maximization can be
explained with the help of following figure
 TC TR

Revenue B
and cost

Break-even
M
points

0 Q Quantity
Q1 Q3
2
profit

π Profit
In above figure, there is loss up to Q1
level of output. At the Q1 level, TR=TC
thus it is break-even point. Beyond Q1
there is positive profit and at Q2 level
of output the difference between TR
and TC is maximum. Thus profit is
maximum at the level of output and
profit curve reaches to it peak point.
After Q2 level of output, profit goes on
decreasing and reaches to another
break-even point at Q3 level of output.
Again there is loss beyond Q3 level of
Marginal approach(MC-MR
approach
According to marginal approach a firm is in
equilibrium when it satisfies following two
conditions
i) MC=MR (Necessary condition)
ii) Slope of MC> slope of MR ( sufficient
condition)
 Equilibrium of firm in Perfect and
imperfect market
Imperfect
Perfect competition competition

MC and MR
MC
MC and MR

a e MC
M
R e

MR

q1 q2 Quantit
q1 q Quantit y
In figure point ‘e’2is y In figure point ‘e’ is
equilibrium point equilibrium point
because it satisfies because it satisfies both
both condition of condition of equilibrium
of firm
Numerical problems related with
profit maximization
Let the demand function p=100-4q, cost
function C=50+6q2 compute the profit
maximizing output, price and maximum
profit.

Tamakoshi electronics limited has following

demand and cost function P=2000-10q and
C=1000+200q calculate the price(P)
output(q) and total profit and Total revenue.
Economic profit vs. accounting
profit
continous
There are two concepts of profit;

accounting profit or business profit and

economic profit. To understand these two
terms we should understand explicit cost,
implicit cost and economic cost.
Explicit cost:- It is defined as the payment
made by a firm for the use of inputs
purchased or hired from outside or others.
Implicit cost:- It is defined as the value of
factors or inputs owned and used by the firm
or the enterpreneur on its own production
process.
Opportunity cost:- It is the forgone income
benefit sacrificed to get something else.
Economic cost:- It is the sum of explicit cost
and implicit cost.
economic profit
EXERCISE 1
Two former MBA students worked in the world Bank at
a salary Rs. 30,00,000 each for one year after they
graduated. After a year they decided to quit their job
and started a research institute. They used Rs.
15,00,000 to overheads (i.e. computer, furniture, etc.)
For the next year, they took Rs. 150,00,000 in
revenue each year and paid five research assistants
Rs. 10,00,000 annually each and rented an office for
Rs. 10,00,000 per year with miscellaneous expenses
Rs. 5,00,000 per year.
a. Define accounting cost and economic cost.
b. Compute accounting profit and economic profit.
Should they remain in research institute after the year
if they are indifferent between working for themselves
or other in a similar capacity?
Unit 2: Theory of consumer’s
behavior
Contn.
1. Concept of utility

The want satisfying power contained

on commodity is known as utility. The

concept of utility is ethically neutral

and it is both subjective as well as

objective phenomenon.
There are two approaches to
analyse the concept of utility;
Cardinal approach and Ordinal
approach.
A) Cardinal approach:- The
approach was developed by
Alfred Marshall. According to the
approach utility derived by a
consumer from a commodity
can express in cardinal number.
It has based on following
1. Rational consumer
2. Independent utilities
3. Constant marginal utility of
money
4. Cardinal utility
A.1) Concept of Total utility and
Marginal utility
Total utility is the amount of
utility derived by a consumer
consuming a specific units of a
commodity.
Table for total utility and marginal
utility
Units of Total Marginal
commodit utility utility
y
1 10 _
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2
 Total Utility & Marginal Utility
35

30

25
TU and MU

20

15
TU
10 MU

0
1 2 3 4 5 6 7
-5
Units of Commodity
utility Maximum
Total

H
point

Total utility
curve

0
Units of commodity
Marginal
utility

Marginal
utility
curve

0
Units of commodity
Equilibrium of consumer in cardinal
utility approach
According to cardinal utility
analysis a consumer is in
equilibrium when marginal utility of
a commodity is equal with marginal
utility of money, i.e. MUx=Mum
Where MUx= marginal utility of
commodity X
MUm= marginal utility of
money
Mux and
MUm

E MUm
Px

0 X Units of X
1 commodity
Equilibrium of consumer (case MUx
of single goods model)
Equilibrium of consumer in
multiple goods model
A consumer spends his/her
income to buy multiple goods
together. In this case the
consumer attains equilibrium
by equalizing per-rupee
marginal utilities from each
commodity, i.e.
MU x MU y MU z
Px

Py

Pz
...... 
MU n
Pn
B) Ordinal approach of utility
analysis
The ordinal utility analysis approach
assumes that utility is psychological
phenomenon and it is subjective in nature
thus it can not be expressed in cardinal
number.
The ordinal utility approach argues
that a consumer can compare the utilities
derived from various bundles of
commodities without expressing in cardinal
number.
B.1)Introduction to Indifference
curve
An indifference curve is the locus of
various combinations of two commodities
that give same level of satisfaction to
consumer. Since all these combination give
same level of satisfaction to consumer then
the consumer remain indifferent among
these combinations, i.e. there is no any
especial preference toward particular
combination.
 Indifference schedule
combinati
ons
Units of X
commodity
Units of Y
commodity
Marginal
rate of
substitutio
n (MRSxy)
A 1 20
-
B 2 15
5
C 3 11
4
D 4 8
3
E 5 6
2
F 6 5
1
25

20
Units of y commodity

15

10

0
0 1 2 3 4 5 6 7
Units of x commodity
 An indifference map showing different
indifference curves according to scale of
preference of consumer. Higher the
indifference curve higher satisfaction.
Units of Y
goods

IV

II
II I
I
Units of X goods
 Slope of an IC Curve
The slope of IC curve shows the how many units of
Y commodity has to give off to gain one more unit
of X commodity in order to derive same level of
satisfaction.
When we move from point A to point
B the utility is same but there is
more units of X and less unit of Y
A than point ‘A’. It means ΔX×MUX =
Units of

Y1
Δ ΔY×MUY
B
Y2 Y ΔX Or ΔY/ ΔX=-MUX/MUY Here, ΔY/ ΔX
Y

is the slope of indifference curve.

I The negative sign indicate that the
indifference curve has negative
X1 X2 Units of slope.
X
Properties of indifference curve
Negatively slopped
Higher the indifference curve higher will be
satisfaction
Non-intersecting
Convex to origin
Diminishing marginal rate of substitution.
Concept of budget line
Consumer has limited income to spend on
goods and services. The limited income is
called budget. Let suppose that a consumer
has M amount of budget to spend two
types of commodity X and Y. Let again
suppose that price of X is Px and price of Y
is PY . The budget equation can be
expressed as
M=PXX +PYY.
 Budget
In figure BL is the budget line. Budget line is
space.
B M/PY the locus of various combinations of two
goods X and Y that can be purchased
Units of

M=PXX+PYY spending given amount of budget at given

prices of X and Y.
Y

We can calculate slope of

M/PX budget line solving budget
0 L Units of equation
Y  M=P
pX
X  XX+PYY.
M
Budget X PY PY

line
Consumer spends entire budget on X Here –PX/PY is slope of budget
and Y goods. Thus the consumer line. The negative sign tells that
always choose the combination that the budget line falls from left to
lies on the budget line not inside the right. The M/P Y represents Y
budget space. In fact, consumer
intercept of the budget line.
always want to choose higher
combination beyond the budget
space but the limitation of budget
restrict him/her.
 Shift in budget line
The budget line shifts from its initial position to
new position due to following causes;
i) Change in budget amount(M)
ii) Change in prices of X and Y.

M1/PY Here when budget with consumer

increases from M to M1 then the
M/PY
budget line shift to right hand side.
Now the consumer can afford
higher combination of
commodities.
Units
of Y

M/PX M1/PX Units of

 Swing of budget line
when relative prices of commodities
change then the budget line swing as
shown in figure.
Units of

B2 When price of Y

Units of Y
When price of X
decreases. The budget
decreases. The
line swing to outward.
Y

budget line swing B1

B to outward

L1 L2 L
Units of Units of
X X
 Equilibrium of consumer
A consumer is in equilibrium when it maximizes
utility spending limited income. Let suppose that
the consumer has money income(M) and prices
of X and Y are PX and PY respectively. Let again
suppose that the consumer has an indifference
map showing its scale of preference.
The consumer is rational. Thus he/she
maximizes utility by spending limited income M
on two goods X and Y. To maximize utility
consumer try to attain highest possible
indifference curve. The equilibrium of consumer
has been presented in following figure below.
 Consumer Equilibrium
At the point e consumer is in equilibrium
because the consumer has attained
highest possible indifference curve.
At the point e , MUX/PX= MUY/PY
B
M/PY A the budget line BL is
commodity

B tangent At point e on IC
Units of Y

III. Thus slope of budget

Y1 e line is equal slope of IC
III at the point e.
I Therefore,
C
D II V -PX/PY=-MUX/MUY
II
L I I Or, MUX/MUY=PX/PY
0 X1 M/PX
Units of X
Equilibrium of commodity
consumer according
to ordinal utility
analysis
Conclusions for equilibrium of a
consumer in ordinal utility analysis
For the equilibrium of a consumer in ordinal
utility analysis the consumer must satisfy
that the per-rupee marginal utilities from
each commodities must be equal.
Unit III: Demand and Supply

Theory and analysis

Meaning and definition of demand
In ordinary language demand and desire
give same meaning but in economics there
is clear difference between demand and
desire. Desire is a wish of having something
or enjoying something but demand is the
desire backed by economic ability to afford
the thing and readiness to spend money.
Thus, only effective desire is demand.
Demand = Desire + ability to pay and
willingness to pay
Demand is quantitative variable which is
expressed in term of quantity. There
must be a time period and a specific
price with demand for clear business
information.
# Law of demand
The law of demand is one of the
important law in economics. It explains
the relation between demand of a
commodity and its price. According to
law of demand “if other things
remain same, there is inverse
The law of demand can be explained with
the help of following table and diagram.

Price of a Demand (kg/week)

commodity(Rs/kg)
5 50
10 45
15 40
20 35
25 30
30 20
Demand curve
price of commodity(Rs/kg)Demand curve
60 always falls from
left to right
50 indicating inverse
relation between
40 price of
commodity and
30 its demand. In
other words,
20 demand curve
has negative
10 slope.

0
20 25 30 35 40 45 50 55 60 65Demand
(kg/wee
k)
Determinants of demand
The factors that influence the
demand of a commodity are known as
determinants of demand. These are as
follows:
i) Price of commodity: Giffen goods.
ii)Income of consumer: Normal goods,
inferior goods. Normal goods are
classified into luxury and necessity.
iii)Prices of related goods: substitute
goods and compliment goods.
iv)Taste and preference of consumer:
v)Many more other factors:
Derivation of individual demand
curve and market demand curve
Derivation of individual demand curve
An individual demand curve is derived with
the help of individual demand schedule. An
individual demand schedule shows various
quantities of a commodity demanded by an
individual consumer at various prices of the
commodity if other determinants of
demand remain same.
 Individual demand schedule
Price of commodity Quantity demanded
(RS/cone) (cone/day)
50 2
45 4
40 6
35 8
30 10
25 12

In schedule a girl’s demand of ice-cream at different prices is shown.

At the price Rs 50 the girl demand only 2 cones per day. As the price
decreases she demand more and more units of ice cream . At the last
she demand 12 cones at lowest price 25.
Individual demand curve
price of ice-cream
60
D Demand curve of
50 girl

40

30
D
20

10 Demand of ice-cream

0
0 2 4 6 8 10 12 14
Derivation of market demand
curve
There are many consumers of a commodity
in a market. The total sum of demand of
the commodity demanded by all consumers
in a market at a particular price is known as
market demand of the commodity at the
price.
Market demand curve is derived by market
demand schedule which shows various
quantities of a commodity demanded in a
market at different prices of the commodity
if other determinants are given.
 Market demand schedule
For simplicity, let suppose that there are only
two consumers of a commodity in a market.
Their individual demand schedule and market
demand schedule has been presented in
following table
Price of ice- A 'demand B’s demand Market
cream for ice-cream for ice-cream demand
50 2 4 6

45 4 8 12
40 6 12 18
35 8 16 24
30 10 20 30
25 12 24 36
Change in quantity demand and
change in demand
If demand of a commodity is changed due
to change in price of the commodity then it
is called change in quantity demand. At the
condition demand curve of the commodity
does not shift to new position.
If demand of a commodity is changed due
to change in other determinants of demand
except change in price then it is called
change in demand. At the condition
demand function change to new demand
function.
Demand function
The functional relationship between demand of
a commodity and its determinants is called
demand function. Price of a commodity (P),
income of consumer(Y), prices of related goods
(Pr), taste and preference of consumer(T),
climate, size of population etc are some
important determinants of demand. Thus
demand function can be presented as
Qx= a-bp+cY+dPr……………………(i)
The equation (i) is the demand function that
shows the functional relationship between
demand of a commodity and its determinants.
Elasticity of demand
The law of demand simply explains the relation
between demand and price but it does not tell us
quantitative relation between change of
determinants and change in demand. Elasticity of
demand explains the quantitative relation between
change in demand and change in its determinants.
Basically there are three quantifiable determinants
of demand price of commodity(P), income of
consumer (Y) and prices of related goods(Pr). Thus
there are three types of elasticity of demand ;
price elasticity of demand, income elasticity of
demand and cross elasticity of demand.
(A) Price elasticity of demand(epd)

price elasticity of demand may be defined

as the relative degree of responsiveness of
demand of a commodity to a relative
change in price of commodity.
Mathematically,
(epd)=Proportionate change in
demand/proportionate change in price.
 proportionate/percentage change in demand
edp 
proportionate/percentage change in price
q / q q p
edp   where, q change in demand
p / p p q
p change in price, q initial demand, p initial price

The value of price elasticity of demand is always negative indicating

inverse relation between demand and price of a commodity. Though the
value of price elasticity of demand is negative, we present value of
elasticity in modules form to make comparable.
Types of price elasticity of
demand
Broadly there are five types of
price elasticity of demand. These
are as follows; p
d e 
i) Perfectly elastic demand( ):-
Demand of a commodity is said
to be perfectly elastic if very
small change in price or no
change in price leads to change
 price
D
D
D

0 Deman
Perfectly elastic Dd

pric
demand

e
Ii) Relatively elastic demand(
edp  1 ):-
D
Demandn of a commodity is said to
realtively elastic when small change in Deman
price leads to large change in demand. In D d
this case, demand curveedis p
flatter.
 1
(iii) Unitary elastic demand( ):-
Demand of a commodity is said to unitary pric
elastic if proportionate change in price and e
D
proportionate change in demand is equal.
In this case, demand curve Is neither flatter Deman
or not steeper. d
(iv)Relatively inelastic demand:- Demand of a commodity is said to be
relatively inelastic when a change in price of a commodity will change
relatively very small change in demand. In this case demand curve is
D
relatively steeper.

pric
e
(v) Perfectly inelastic demand:-
Demand of a commodity is said to be D
perfectly inelastic if demand of a deman
commodity does not respond to Relatively inelastic
d
change in price of the commodity. demand curve
Demand of the commodity remains D
P1
same for all prices of the commodity.

pric
In this case, demand curve is perfectly p2

e
vertical.
P3
D
deman
Perfectly inelastic
d
demand curve
(B) Income elasticity of demand (e yd)
Income of consumer is an important
determinant of demand. Change in income
of consumer largly influence demand of a
commodity.
“Income elasticity of demand may be
defined as the relative degree of
responsiveness proportion
of atedemand to a relative
proportionate change in demand
change in income

change in income q y
y q
of consumer.”
mathematically eyd=
= where ∆q=
change in demand
∆y= change in income, y= initial income
The value of income elasticity may be
positive, zero or negative. Normal goods
have positive income elasticity and
inferior goods have negative income
elasticity. The normal goods are
classified into luxury goods ( eyd>1) and
necessity goods (eyd<1).
(C) Cross elasticity of demand(ecd)
 prices of related goods influence demand of a
commodity. for example price of Coke affects demand
for Pepsi and price of petrol affects demand for
passenger vehicles etc.
Cross elasticity of demand may be defined as the
relative degree of responsiveness of demand of a
commodity say X to a relative change in price of
proportionate change in demand of X
another goods Y.
proportionate change in price of Y
Mathematically, e d=
c
q Py
Py q
=
where ∆q=change in demand ∆Py = change in price of
Y, q= initial demand and Py= initial price of Y
The cross elasticity of demand is useful
to classify commodity into substitute
goods and compliment goods.
If cross elasticity of demand is positive
then goods are substitute to each other.
If cross elasticity of demand is negative
then one goods is compliment of
another goods.
Uses of price elasticity of demand
in business decision making
Product pricing
Pricing of joint products
Demand forecasting
Pricing of inputs
Financial planning
Determination of marketing/promotional
strategies
Note: price elasticity of demand is also
helpful in international trade and
determination of government policy.
Uses of Income Elasticity of Demand
in business decision making
Determination of price of products
Demand Forecasting
Long term business planning.
Determination of Market Strategy.
Housing and other Development
Strategies.
Classification of Goods and market
Uses of Cross Elasticity of Demand
in business decision making
Demand forecasting
Formulation of business policy
Classification of goods
Classification of markets
Determination of pricing strategies
Determination of marketing/promotional
strategies etc.
Numerical examples
Let demand function q=2000-20P
a) compute price elasticity of demand at
P=5
b) compute price elasticity of demand at
P1=6 and P2= 8 at arc method.
• The following table shows place and
income elasticity of vegetables and
catering services. For each goods, explain
whether it is a luxury or a necessity, and
Commodities Price Income
whether demand is elastic elasticity
elasticity or inelastic.
Vegetable -0.17 0.87
Catering -2.61 1.64
services
supply
Meaning of supply:- supply is the quantity
of a commodity offered for sale in a market
at particular price and time duration.
There is clear difference between supply
and stock. Stock is the quantity of a
commodity that will be offered at favorable
condition.