MANAGERIAL

ECONOMICS

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 Course Outline
Unit 1 Introduction
Micro versus Macroeconomics; Theory of consumer behavior and demand; Consumer
preferences; Indifference curve; Consumer equilibrium; Demand function; Income and
substitution effects;
Unit 2 Production Function
The Slutsky equation; Market demand; Elasticities; Average and marginal revenue; Revealed
preference theory of firm; Production functions; Law of variable proportions; Laws of return
to scale;
Unit 3 Cost Function
Isoquants; Input substitution; Equilibrium of the firm; Expansion path; Cost function; Theory
of costs; Short Run and long run costs; Shape of LAC; Economies and diseconomies of scale;

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Unit 4 Theory of Pricing
Market equilibrium under perfect competition; Equilibrium under alternative forms of market;
Monopoly- pure and discriminating; Monopolistic competition; Oligopoly. Pricing practices
and strategies
Unit 5 National Indicators ( GDP, GNP, WPI, CPI )
National Income Accounting and Economic Indicators, Business Cycle-Inflation,-Fiscal and
Monetary Policies.
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 Reference Books
• Hal R. Varian, Intermediate Microeconomics : A
Modern Approach
• A. Koutsoyiannis, Modern Microeconomics
• Doane P.David Seward E.Lori Applied Statistics in
Business and Economics, Tata McGraw Hill 2007
• Nordhaus & Samuelson , Economics, 18th Edition
Tata McGraw Hill 2007
• Suma Damodaran , Managerial Economics Oxford
University Press 2006

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 Economics
• The term economics comes from the Ancient
Greek word oikonomia which means
"management of a household”.

• Oikos means house + nomo means custom or

rules, hence rules of the house.

• Economics is the social science that analyzes the

production, distribution, and consumption of
goods and services. 5
 Different Views on Economics
• According to Adam Smith: Economics is the
study of wealth- How wealth is produced and
distributed.

• According to Alfred Marshall: Economics is a

study of man in the ordinary business of life. It
enquires how he gets his income and how he uses
it.

• According to L. Robbins: Economics is a

scientific study of human behaviour in relation to
the use of scarce resources 6
Managerial + Economics

• Managerial Economics is
economics applied in
decision-making
• Link between abstract theory
and managerial practice.
• Analysis for identifying
problems, organizing
information and evaluating
alternatives.

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 Managerial Economics

Spencer and Siegelman point to the fact

that “Managerial Economics.. is the
integration of economic theory and business
practice for the purpose of facilitating
decision-making and forward planning by
management.”

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 Chief Characteristics of
Managerial Economics/Nature
• Managerial economics is micro-economic in character
as it concentrates only on the study of the firm and not
on the working of the economy.

• Managerial economics takes the help of macro-

economics to understand and adjust to the
environment in which the firm operates.

• It is both conceptual (theory) and metrical

(quantitative techniques).

• The contents of managerial economics are based mainly

on the “theory-of firm’.

• Knowledge of managerial economics helps in making

wise choices.
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Theory of Demand

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 What is Demand
• A product or service is said to have demand when
three conditions are satisfied
• Desire on the part of the buyers to buy
• Willingness to pay for it
• Ability to pay the specified price for it

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 Factors determining demand
 Price of the product (P)
 Income level of the consumer (I)
 Tastes and preferences of the consumer (T)
 Prices of related goods which may be substitutes/
complementary (PR)
 Expectations about the prices in future (EP)
 Expectations about the incomes in future (EI)
 Size of the population (SP)
 Distributions of consumers over different regions(Dc)
 Advertising efforts (A)
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 Demand Function

Mathematically, the demand function for a product A can be

expressed as follows:

Qd = f (P,I,T,PR,EP,EI,SP,DC,A,O)

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 Law of Demand
As PRICE increases, DEMAND decreases

Demand goes down

Price goes up
THEN

As PRICE decreases, DEMAND increases

Price goes down

THEN Demand goes up

 Demand Curve
• A graph that illustrates the demand for a
product

• It shows how much consumer desire for a

product changes as the price changes
 Demand Curve: This curve illustrates the quantities of
apple juice demanded at each price ay all consumers in the
market.
Price of a Quantity
$3 bottle of demanded per
Price per bottle (in dollars)

Apple Juice week

$2
$0.75 800
$2 $1.00 650
Demand
Curve $1.25 500
$1
$1.50 350
$1
$1.75 200
$0 $2.00 50
50 200 350 500 650 800
Bottles of Apple Juice per
week
 Exceptions of law of demand
• Where there is shortage of necessities feared
• Where the product is such that it confers
distinction (Veblen goods)
• Giffen’s paradox
• In case of ignorance of price changes
 Elasticity of demand
• The term ‘elasticity’ is defined as the rate of
responsiveness in the demand of a commodity
for a given change in price or any other
determinants of demand.
 Elastic Demand
• If Demand for a good is very sensitive to
changes in price, the demand is ELASTIC
Or
• If prices changes a little bit, demand will change
a lot!
 Elastic Demand for Pizza
Curve is FLAT

$16
$15
Price per Pizza

$14
$13 Demand for Pizza
$12
$11
$10
0

0
10

20

30

40

50

60
Number Purchased per Week
 Inelastic Demand
• Demand for a good that consumers will
continue to buy despite a price increase is
INELASTIC
OR
• Even if price changes a lot, demand changes
very little
 Inelastic Demand for Soap
Curve is STEEP
$3.50
Price per Bar of Soap

$3.00
$2.50
$2.00
Soap
$1.50
$1.00
$0.50
$0.00
0 10 20 30 40 50
Quantity Demanded (In
Thousands)
 Types of Elasticity
• Price elasticity of demand
• Income elasticity of demand
• Cross elasticity demand
Theory of Consumer’s Behaviour
Consumer Behaviour is the study of individual
customers or groups’ behaviour while selecting,
purchasing, using, and disposing of goods, ideas,
and services so they can meet their wants and
needs. In simple terms, consumer behaviour is the study
of consumers’ actions and reactions in the marketplace and
the reason behind their actions.
 Consumer?
• A consumer is a person who purchases goods and
services for the satisfaction of needs and wants.

• For example, if a consumer has ₹2,000 and has

different options to spend the money, like movies,
clothes and food, there are different ways in which he
can spend the money. He can either spend the whole
amount on one option or distribute the amount among
two or more options. The way in which the consumer
uses his money will show his behaviour or consumer
behaviour.
 Utility?
• Utility is the want satisfying power of a
consumer for a specific commodity. A consumer
decides the demand for a good based on the
utility he/ she derives from the consumption of
that good.
 Cardinal Utility Approach

• Under the cardinal utility approach, we assume

that the utility level can be measured and
expressed in numbers.
 Ordinal Utility Approach

• Even though the cardinal utility approach is

simple, it has a major drawback, as in real-life,
we cannot measure their satisfaction level in
numbers. However, we can rank our preferences
amongst the alternatives by expressing which
commodity gives less or more utility.
• Total Utility: The total utility of a commodity’s
fixed quantity is the total satisfaction level
derived by a consumer from the consumption of
a given commodity.
• Marginal Utility: The marginal utility of a
commodity is the change in its total utility
because of the consumption of one
additional unit of the commodity.
• MUn = TUn – TUn-1
Where,
MUn = Marginal utility from nth unit
TUn = Total utility from n units
TUn-1 = Total utility from n-1 units
n = Number of units of consumption
• Law of diminishing marginal utility: The law
of diminishing marginal utility states that as a
consumer consumes more of a commodity, the
marginal utility derived from every
additional unit consumed will decrease. The
law of demand is based on the law of
diminishing marginal utility.
 Ordinal Utility Theory
• The utility analysis suffers from a defect of
subjective nature of utility i.e., utility cannot be
measured precisely in quantitative terms.

• The consumer can at best compare the

satisfaction derived from different goods or
from different unit of same good.

• In order to overcome this difficulty, the

economists have evolved an alternative
approach based on indifference curves.
 Indifference Curve
• An indifference curve represents all
combinations of two commodities that provided
the same level of satisfaction to a person
 Marginal Rate of Substitution
• MRS is rate at which the consumer can
substitute one good for another without
changing the level of satisfaction. (slope of IC)
• Constant
• Increasing
• Diminishing
 Assumptions of IC
• Rational Consumer
• Ordinal Utility
• Diminishing Marginal Rate of Substitution
• Consistency in selection
• Transitivity
 Properties of IC
• Slopes Downward
• Convex to the origin
• Higher IC gives higher level of satisfaction
• Two IC never intersect
 Some Exceptional Shapes
• Perfect Substitutes
• Perfect Complement
• Zero satisfaction
 Budget line
• The budget line is different combination of two
commodities that a consumer can purchase
given his income and price of two commodity.

• Slope of Budget line=P1/P2

 Properties of Budget line
• Straight line
• Negative slope
• Slope of budget line= P1/P2
 Shift of Budget line
• Change in Income
• Change in all commodity price
• Change in one commodity price
 Consumer’s Equilibrium
• Consumer is in equilibrium when he maximizes
his satisfaction given his income and market
price level.

• Condition: budget line should be tangent to IC