RBMI

Meaning Of Economics
Economics as a science is concerned with the problem of
allocation of scarce resources among competing ends.
Economic behavior is related to choice by individuals and
others.
Individuals and others have to decide how to allocate
scarce resources in the most effective ways.
Economics provide optimum utilization of scarce resources
to achieve the desired result. It provides the basis for
decision making.
Definitions
Managerial economics is an offshoot of two disciplines
economics and management


Definitions
Dr Alfred Marshall Economics is a study of mans
actions in the ordinary business of life: it enquires how
he gets his income and how he uses it
He says, the main aim of economics is to promote
Human Welfare then wealth
Promote Human Welfare than wealth

Management
Management is the art of getting the work done
through and with the people
It entails the co-ordination of human efforts and
material resources towards the achievement of
organizational objectives.
Managerial Economics
Edurin Mansfield Managerial Economics is
concerned with the application of economic concepts
and economic analysis to the problem of formulating
rational managerial decisions
Spencer and Siegel man Business economics is the
integration of economics theory with business practice
for the purpose of facilitating decision-making and
forward planning for management

Introduction
Managerial Economics is economics applied
in decision-making.
Decision making is the process to select a
particular course of action from among a
number of alternatives.
It is the study of managing maximum gains
out of scarce resources.
Definition
Managerial economics is concerned with the
application of economic principles and
methodologies to the decision process with
in the organization. It seeks to establish rules
and principles to facilitate the attainment of
the desired economic goals of management.
-- By Edwin Mansfield
Economics
Micro Economics
when something is concerned with individual
(person, firm or household)

Macro Economics
something related to the environment as a
whole
Micro Economics
It has been defined as that branch where the unit of study
is an individual, firm or household.
It studies how individual make their choices about,
what to produce?
How to produce?
For whom to produce?, and
What price to charge?
It is also known as the price theory.
It is the main source of concepts and analytical tools for
managerial decision making
Micro economic theories
Theory of production;
Theory of price determination;
Theory of profit;
Theory of demand.
Macro Economics
It studies the economics as a whole.
It is aggregative in character and takes the entire economic
as a unit of study.
Macro economics helps in the area of forecasting.
It includes National Income, aggregate consumption,
investments, employment etc.
It facilitates government in taking policy decisions such as,
How much to spend on health?
How much to spend on services?
How much should go in to providing social security benefits?
Macro economic theories
Environment or external issues;
Theories of government policies;
Theory of capital and Investment.



Managerial
Economics
Analytical Tools:
Mathematical Economics
Econometrics
Study of Functional Areas:
Accounting
Personnel
Finance
Production
Marketing
Economic Theory:
Microeconomics
Macroeconomics
Economic Methodology:
Descriptive Models
Prescriptive Models
Optimal
Decisions
Management
Problems
16
Role of Managerial Economics in Managerial Decision
Making
Traditional
Economics: Theory &
Methodology
Business Management
Decision Problems
Decision Sciences
Tools
& Techniques of
analysis
Optimal Solution to
Business Problems
Managerial
Economics

Application of
Economic theory &
Methodology to
solve business
problems
Role of Managerial Economics in Managerial Decision Making
CHARACTERISTICS OF
MANAGERIAL ECONOMICS
Microeconomics
Normative economics:
Pragmatic
Prescriptive rather than descriptive
Takes the help of macroeconomics
Multidiscilinary


DIFFERENCE BETWEEN
ECONOMICS AND MANAGERIAL
ECONOMICS
ECONOMICS TELLS US ABOUT BODY OF
PRINCIPLE WHILE THE MANAGERIAL
ECONOMICS TELLS DEALS WITH THE
APPLICATION OF ECONOMIC PRINCIPLES TO THE
PROBLEM OF THE FIRM
DIFFERENCE BETWEEN
ECONOMICS AND MANAGERIAL
ECONOMICS
ECONOMICS HAS BOTH CHARACTERSTICS OF
MICRO AND MACRO
MANAGERIAL ECONOMICS HAS MAJOR
CHARACTERSTICS OF MICRO
DIFFERNCE BETWEEN ECONOMICS
AND MANAGERIAL ECONOMICS
MICRO ECONOMICS AS A PART OF ECONOMICS
DEALS WITH INDIVIDUALS AND FIRMS
WHILE MANAGERIAL ECONOMICS DEALS ONLY
WITH FIRMS AND NOT WITH INDIVIDUALS
DIFFERENCE BETWEEN
ECONOMICS AND MANAGERIAL
ECONOMICS
MICRO ECONOMICS BEING PART OF ECONOMICS
DEALS WITH DISRIBUTION THEORY OF
RENT,INTEREST,PROFIT.WAGES
WHILE MANAGERIAL ECONOMICS DEALS ONLY IN
PROFITS.
Nature of managerial
economics
It is a science.
It is an art.
It is a micro economics.
It is a normative science.
Concept of ME
Concepts of Micro-Economics
Elasticity of demand
Marginal cost
Marginal revenue
Market structures and their significance in pricing
policies.
Concepts of Macro-Economics
The magnitude of investment and the level of national
income,
The level of national income and the level of
employment,
The level of consumption and the level of national
income
In ME emphasis is laid on those prepositions which are
likely to be useful to management

Scope of ME
Demand analysis and Forecasting,
Production function,
Cost analysis,
Inventory Management,
Advertising,
Market structure and Pricing System,
Profit Analysis,
Resource allocation etc
ME and Other Disciplines

Mathematics
Statistics
Operations Research
Management Theory
Accounting
Computers
Importance of managerial
economics:

Decision making
Knowledge of concepts
Promotion of sales
Understanding significant external forces
Ideal from other subject
Helpful to new age manager
Revenue to the government
Social benefits

Role of Managerial
Economist
Making decisions and processing information are the
two primary tasks of managers. The task of organizing
and processing information and then making an
intelligent decision based upon this information and
the basic theory can take two general form:

Specific decision
General task
Specific decision
Production scheduling
Demand forecasting,
Market research,
Economic analysis of industry,
Investment appraisal,
Advice on trade
Security management analysis,
Pricing and related decision,
Analyzing and forecasting environmental factors.
General task
External factors
General economic
conditions
Demand for the product
Input cost of the firm.
Market conditions.
Firms share in the
market.
Economic policies.
Internal factors
Determination of pricing
policies.
Decision of expansion of
business activities .
Determination of level of
efficiency and operation.
Determination of wages
policy.
Responsibilities of Managerial
Economist
To measure the increase in earning capacity of the firm.
To make successful forecasting.
To contact the sources of Economic information and
Experts.
To keep the management informed of all the possible
economic trends.
To achieve economic respectable status in the firm.
To perform functions sincerely.
Decision Making
Decision making is the central objective of Managerial
Economics
Decision making may be defined as the process of selecting
the suitable action from among several alternative courses
of action
The problem of decision making arises whenever a number
of alternatives are available. Such as,
What should be the price of the product?
What should be the size of the plant to be installed?
How many workers should be employed?
What kind of training should be imparted to them?
What is the optimal level of inventories of finished
products, raw material, spare parts, etc.?
Decision
Making Areas
Demand
forecasti
ng
Producti
on
plannin
g and
cost
revenue
decision
Study
of
econo
mic
enviro
nment
Pricing
and
related
decisio
ns
Invest
ment
decisio
ns
DEMAND FORECASTING
QUALITATIVE
CONSUMER
SURVEY
JURY OF
EXPERT
OPINION
SALESFORCE
COMPOSITE
METHOD
DELPHI
METHOD
NOMINAL
GROUP
METHOD
QUANTITATIVE
TIMESERIES
METHODS
CAUSAL
METHODS
PRODUCTION PLANNING AND COST
REVENUE DECISIONS
Production Function :
The production function is a technological
relationship between output and various inputs used
in production viz., land, labour, capital and
technology.
The output depends on the increasing function of
all the factor inputs
Q=f(S,L,K,T)

The following types of cost are useful in the
decision areas
Average, Marginal and Total Costs
Fixed and Variable Cost
Direct and Indirect Cost
Replacement and Original Cost
Opportunity and Industrial Cost
Sunk Cost and Outlay Cost
STUDY OF ECONOMIC ENVIORNMENT
Economic environment is the most significant
component of the business environment. It affects the
survival and success of a business organization.


Economic
environment
General
conditions
Industrial
conditions
Stage of supply
of resources of
production
PRICING AND RELATED DECISIONS
The Price-output decisions are taken under various market
structures. The structure of the market refers to the degree
of competition in the market for the firms goods and
services.
Market
Perfect competition
Monopoly market
Monopolistic
market
Oligopoly market
INVESTMENT DECISION

Forward planning involves investment
problems. These are problems of allocating
scarce resources over time.
For example, investing in new
plants, how much to invest, sources of funds,
etc..
STEPS IN DECISION MAKING
Various steps in the decision making by a business firm
are as fallows :
Defining business
problem
Determining objective
Exploring available
alternatives
Assessing consequences of
various alternatives
Choosing best alternative
Performing sensitive analysis
Why Problems of Decision Making Arises?
Due to the scarcity of resources.
We have unlimited wants and the means to satisfy those
wants are limited,
With the satisfaction of one want, another arises, and here
arises the problem of decision making.
While performing his function manager has to take a lot of
decisions in conformity with the goal of the firm.
Most of the decisions are taken under the condition of
uncertainty, and involves risks.
The main reasons behind uncertainty and risks are
uncertain behavior of the market forces.
Factors Influencing Managerial Decision Making
Besides economic variables managerial decision
making is also influenced by other significant
variables, such as
Human and Behavioral Considerations
Technological Forces
Environmental Forces



Principles of Managerial Economics /Tools of
Decision Making
Opportunity cost
Incremental principle (Cost & Revenue)
Principle of the time perspective
Discounting principle
Equi-marginal principle

Opportunity cost
The opportunity cost of anything is the return that can
be had from the next best alternative use.
A farmer who is producing wheat can also produce
potatoes with the same factors. Therefore, the
opportunity cost of a quintal of wheat is the amount of
the output of potatoes given up.
The opportunity costs are the costs of sacrificed
alternatives.



Incremental principle (Cost &
Revenue)
Incremental cost - change in total cost as a result of
change in the level of output, investment etc.
Incremental revenue- change in total revenue
resulting from a change in the level of output, prices
etc.
A manager always determines the worth of a decision
on the basis of the criterion that IR>IC.
For Example:
Principle of the time
perspective
Decision maker must give due consideration to time
element in his decision maker exercise. General
distinction is made between short-run and long-run.
Short-run- volume of output cannot be changed by
altering the sixe of the firm and the scale of plant. The
output can be increase or decrease only by changing
the variable input.
Long-run- time period in which all factors are variable
and that the size of the firm and the scale of plant can
be changed to change the volume of output.
Discounting principle
Time value of money

Examples:
Equi-marginal principle
According to this principle, different courses of action
should be pursued up to the point where all the
courses provide equal marginal benefit per unit of
cost. It states that a rational decision-maker would
allocate or hire his resources in such a way that the
ratio of marginal returns and marginal costs of various
uses of a given resource or of various resources in a
given use is the same. For example, a consumer
seeking maximum utility (satisfaction) from his
consumption basket, will allocate his consumption
budget on goods and services such that


MU1/MC = MU2 / MC2 =..= MUn / MCn
Where MU1 = marginal utility from good one,
MC1 = marginal cost of good one and so on.
Example:
Activity

1. Make a list in your own words of some of the
economic decision that
you are facing
your family has to take
your country has to take
2. Take any quality newspaper, go through it and
make notes on the following:
Micro economic
Macro economic (problems and issues you find)

3. Suppose there is a firm with a temporary idle capacity.
An order for 5000 units comes to managements attention.
The customer is willing to pay Rs 4/- unit or
Rs.20000/- for the whole lot but not more. The short run
incremental cost (ignoring the fixed cost) is only Rs.3/-.
There fore the contribution to overhead and profit is Rs.1/-
per unit (Rs.5000/- for the lot)

What long run repercussion of the order is to be taken into
account?
REFERENCES

1. MANAGERIAL ECONOMICS --
D.N.DWIVEDI
2. BUSINESS ECONOMICS --
D.D. CHATURVEDI
S.L. GUPTA
SUMITRA PAUL
3. MICRO ECONOMICS --
JHON KENNADY
4. MANGERIAL ECONOMICS
MITHANI

THANK YOU
References
Google search engine.
Wikipedia
Scribd.com
Slideshare.com
Why does a Demand Curve
Slope downward?
The demand varies inversely to changes in price.
Dx = f(Px). The demand curve is downward
sloping indicating an inverse relationship between
price and demand.
The price is measured on the Y axis and Demand
on the X- axis. When the price falls, demand
increases. The downward slope of demand curve
implies that the consumer tends to buy more when
the price falls. Thus the demand curve is shown as
downward sloping.
What are the assumptions underlying law of
demand?

No change in Consumers income.
No change in consumers preferences.
No change in the Fashion.
No change in the Price of Related Goods.
No expectation of Future price changes of shortages.
No change in size, age composition, sex ratio of the population.
No change in the range of goods available to the consumers.
No change in the distribution of income and wealth of the community.
No change in government policy.
No change in weather conditions.
What are the exceptions to the
Law of Demand?
Sometimes it may be observed, that with a fall in price,
demand also falls and with a rise in price, demand also
rises. This is apparently contrary to the law of demand.
The demand curve in such cases will be typically
unusual and will be upward sloping.
What are the exceptions to the
Law of Demand?
Giffen Goods: In the case of certain Giffen goods,
when price falls, quite often less quantity will be
purchased because of the negative income effect
and peoples increasing preference for a superior
commodity with rise in their real income. E.g.
staple foods such as cheap potatoes, cheap bread,
pucca rice, vegetable ghee, etc. as against good
potatoes, cake, basmati rice and pure ghee.
What are the exceptions to the
Law of Demand?
Articles of Snob appeal (Veblen effect) :
Sometimes, certain commodities are demanded
just because they happen to be expensive or
prestige goods and have a snob appeal. They
satisfy the aristocratic desire to preserve the
exclusiveness for unique goods. These goods are
purchased by few rich people who use them as
status symbol. When prices of articles like
diamonds rise, their demand rises. Rolls Royce car
is another example.
What are the exceptions to the
Law of Demand?
Speculation: When people are convinced that the
price of a particular commodity will rise further,
they will not contract their demand; on the
contrary they may purchase more for profiteering.
In the stock exchange, people tend to buy more and
more when prices are rising and unload heavily
when prices start falling.
What are the exceptions to the
Law of Demand?
Consumers phychological bias or illusion:
When the consumer is wrongly biased against the
quality of a commodity with reduction in the price
such as in the case of a stock clearance sale and
does not buy at reduced prices, thinking that these
goods on sale are of inferior quality.
Reasons for change (increase or
decrease) in demand:
Change in income.
Changes in taste, habits and preference.
Change in fashions and customs
Change in distributioin of wealth.
Change in substitutes.
Change in demand of position of complementary goods.
Change in population.
Advertisement and publicity persuasion.
Change in the value of money.
Change in the level of taxation.
Expectation of future changes in price.

Examples of change in Demand
Increase in Advertising Easy loans for housing
Recession in the Economy Cut in Incometax Rates
Elasticity of Demand

Elasticity of Demand is the degree of
responsiveness of quantity demanded to a
change in price.

Any elasticity is simply a ratio between cause and an
effect always in percentage terms. The cause goes
to the denominator of the ratio, while the effect
goes to the numerator of the ratio.
Demand Analysis

Demand
Desire
Willing
ness
Ability
Deman
d
What is Demand?
Demand means effective desire or want for a commodity
which is backed up by the ability (purchasing power) and
willingness to pay for it.

Demand = Desire + Ability to pay + Willingness to spend

Demand is a relative concept not absolute
It is related to price , time and place.

The demand for a commodity refers to the amount of it
which will be bought per unit of time at a particular price
( in a particular market).



DEMAND

Demand is the effective desire or want for a
commodity, which is backed up by the ability (i.e.
money or purchasing power) and willingness to pay
for it.
Demand = Desire + Ability to pay + will to spend
The demand for a product refers to the amount of it
which will be bought per unit of time at a particular
price.
Essentials of Demand
An Effective Need,
A Specific Price,
A Specific Time,
A Specific Place.
Consumer Demand
Two levels: Individual Demand
Market Demand

Market Demand is the sum total of all individual
demands.
Prices are determined based on Market Demand.
Individual and Market demand
Individual Demand : Individual demand for a product is
the quantity of it a consumer would buy at a given price,
during a given period of time.
Market demand : Market demand for a product is the
total demand of all the buyers in the market taken
together at a given price during a given period of time.
Demand Schedule: A tabular statement of price
quantity (demanded) relationship at a given period of
time
Individual demand schedule
Market demand schedule.

Types of demand
Price Demand
Income Demand
Cross Demand
Joint and complementary demand
Composite demand
Direct an derived demand
Individual demand & Market demand
Demand for capital goods and demand for
consumer goods
Autonomous demand & Derived demand
Direct & indirect demand
Demand for durable & non-durable goods





Determinants of Demand
Price of the product
Price of the related goods
Consumers income level
Distribution pattern of national income
Consumers taste and preferences
Advertisement of the product
Consumers expectation about future price and supply position
Consumer credit facility
Demography and growth rate of population
General std. of living and spending habits
Climatic and weather conditions
Savings

Demand Function: It states the (functional/mathematical)
relationship between the demand for the product ( dependent
variable) and its determinants ( independent variables).
Factors influencing individual demands:
Price of the products.
Income of the buyer.
Tastes, Habits and Preferences.
Relative prices of other goods.
Relative prices of substitute and complementary
products.
Consumers expectations about future price of
the commodity.
Advertisement effect.
Factors influencing Market Demand



Price of the product.
Distribution of Income and Wealth.
Communitys common habits and scale of preferences.
General standards of living and spending habits of the people.
Number of buyers in the market and the growth of population.
Age structure and sex ratio of the population.
Future expecations.
Level of taxation and Tax structure.
Inventions and Innovations.
Fashions
Climate and weather conditions.
Customs
Advertisement and Sales propaganda.
Important factors (key variables)affecting
demand:
own price of the product (P)
Price of substitute or (Ps)
Price of complimentary product (Pc)
Level of disposable income (Yd)
(income left with buyers after paying tax)
Change in the buyers Taste (T)
Advertisement effect (level of ad. Exp) (A)
Changes in population (or number of buyers) (N)

Thus, Demand Function, Dx = f(Px, Ps, Pc, Yd, T, A, N, u)
Commodity = x Hence, price = Px, Demand = Dx

Law of demand
Statement of Law : Other things being equal,
the higher the price of a commodity, the smaller
is the quantity demanded and lower the price,
larger the quantity demanded.
Assumptions to the Law of Demand:
(1) Income level should remain constant,
(2) Tastes of the buyer should not change,
(3) Prices of other goods should remain constant,
(4) No new substitutes for the commodity,
(5) Price rise in future should not be expected and
(6) Advertising expenditure should remain the same.
Why Demand Curve Slopes Downwards:


Factors behind Law of demand
Substitution effect
Income effect
Utility Maximising behaviour

Exceptions to Law of demand
Expectation regarding future prices
Giffen goods
Articles of snob appeal / Veblen effect
Consumers psychological bias ( about quality and price relationship)


Changes in quantity demanded & Changes in demand
Changes in quantity demanded is related to
law of demand i.e. due to changes in price.
When with a fall in price more of a commodity is
demanded, there is EXTENSION of demand & when
with a rise in price less of a commodity is purchased,
there is CONTRACTION of demand.
Changes in demand is caused by changes in
various other determinants of demand, the
price remaining unchanged.
When more of a commodity is bought than before at
any given price there is INCREASE in demand &
when less of a commodity is bought than before at any
given price there is DECREASE in demand.

Elasticity of demand
Elasticity of demand is the degree of responsiveness
of demand to the changes in its determinants.

(A) PRICE ELASTICITY O DEMAND
The extent of response of demand for a
commodity to the changes in its price, other
determinants of demand remaining constant
is called price elasticity of demand.
e
p = Proportional changes in quantity demanded

Proportional changes in price


e
p = Q /Q P /P


e
p = Q / Q X P / P


e
p = Q / P X P / Q
Types of Price Elasticity
1. Perfectly elastic
2. Perfectly Inelastic
3. Unity Elasticity
4. Relatively Elastic
5. Relatively Inelastic.
Measurement of elasticity of demand
Graphical Method
Point Method
Expenditure Method
Graphical Method
Perfectly Elastic Demand (ep= infinity)

P
D
O
X
Y
Q
Q1
Quantity Demanded
p
r
i
c
e





Where no reduction in price is
needed to cause an increase
in demand.
The firm can sell the quantity in
wants to sell at the prevailing
price but none at all at even
slightly higher price.
The shape of the demand
curve is horizontal.
The elasticity is = infinite.
Perfectly inelastic demand (ep = 0)


Y
X O
Q
D
P
P1
Quantity Demanded
p
r
i
c
e
Less Elastic Demand (ep<1)




Y
X
O
D
D
P1
P
Q1 Q
Quantity Demanded
p
r
i
c
e
Relative/ unitary Elastic Demand

O X
Y
D
D
P
P1
Q1
Q
Quantity Demanded
p
r
i
c
e
Highly Elastic Demand (ep>1)


Y
X
O
D
D
P
P1
Q1 Q
Quantity Demanded
p
r
i
c
e
Point Elasticity of Demand
ep=1
ep=0
ep<1
ep=infinity
ep>1
Formula :
ep=lower segment
upper segment
Expenditure Method
Elastic Demand ( ep>1)

P
(Rs.)
Q
(Nos.)
TE
(Rs.)
6 10 60
5 13 65
P
(Rs.)
Q
(Nos.)
TE
(Rs.)
6 10 60
5 11 55
Inelastic Demand (ep<1)







Unitary Elastic Demand (ep=1)

P
(Rs.)
Q
(Nos.)
TE
(Rs.)
6 10 60
5 12 60
Factors determining Price Elasticity of Demand
1. Nature of the commodity
Extent of use
Range of substitutes
Income level
Proportion of income spent on the commodity
Urgency of demand
Durability
Purchase frequency
Perfectly inelastic demand
Where no reduction in price is needed to cause an
increase in demand.
The firm can sell the quantity in wants to sell at the
prevailing price but none at all at even slightly higher
price.
The shape of the demand curve is horizontal.
The elasticity is = infinite.
Perfectly inelastic demand
Even a large change in price, does not change the
quantity demanded.

Here the shape of the curve is vertical.

Elasticity = 0
Unity elasticity
A proportionate change in price results in exactly the
same proportional change in quantity demanded.

Shape of the demand curve is a rectangular hyperbola.

Elasticity = 1
Relatively elastic demand
A reduction in price leads to more than proportionate
change in demand.

Shape of the demand curve is flat.

Elasticity > 1
Relatively inelastic demand
A decline in price leads to less than proportionate
increase in demand.

Shape of the demand curve is steep.

Elasticity < 1



Change in Demand Vs.
Elasticity of Demand
Change in demand occurs when
price does not change but
demand changes due to other factors.

Elasticity of demand refer to that change in
demand which occurs due to change in price, other
factors remaining the same.

Determinants of price elasticity of demand
- Nature of commodity - Uses of commodity
- Availability of substitutes - Durability of
commodity
- Possibility of postponement - Income level of
consumers
- Price range of the product - Complementary
relationship
- Knowledge level of consumers - Frequency of purchase
- Proportion of expenditure on the product - Time period
Practical application
- Pricing decisions - Factor rewarding
- Terms of trade - Foreign exchange rates
- Tax rates - Public utilities


(B) INCOME ELASTICITY OF DEMAND
The degree of responsiveness of demand for a
commodity to the changes in the consumers income is
known as income elasticity of demand
e
y

= Q / Y X Y / Q
Types of income elasticity
1. Unitary income elasticity 2.Income elasticity grater
than one
3. Income elasticity less than one 4.Zero income elasticity
5. Negative income elasticity
Practical application

- Growth rate of firm - Demand forecasting
- Production planning - Marketing plan



Income Elasticity
Income Elasticity may be defined as the degree of responsiveness of
quantities demanded to a given change in income.
Income Elasticity of Demand is defined as the ratio of the percentage
or proportionate quantity demanded to the percentage or
proportionate change in income.
OR
Q2 Q1 (effect)
Q2 + Q1
e
y = ---------------------


Y2 Y1 (cause)
Y2 + Y1
Q1 Original Quantity demanded before Income change
Q2 - Quantity demanded after Income changed
Y1 - Original Income
Y2 - Changed new income.
Illustration
Suppose a consumer's income is Rs.1000 and he purchases
10 kgs. of sugar. If income goes up to Rs.1100 he is
prepared to buy 12 kgs. Calculate income elasticity of
sugar.
Q2-Q1 12 - 10
Q2+Q1 12 + 10
e
y
= ---------- = --------------------
Y2-Y1 1100 - 1000
Y2+Y1 1100 + 1000
= 2 -:- 100 = 1 x 21
22 2100 11 1
= 21 = 1.99
11 Demand for sugar is income elastic

(C) CROSS ELASTICITY OF DEMAND

The degree of responsiveness of demand for a
commodity to a given change in the price of some other
related commodity is known as cross elasticity of
demand.

e
xy = Proportional change in demand for X
Proportional change in the price of Y

e
xy = Qx Py X Py Qx

Cross Elasticity
Cross elasticity of demand
Cross elasticity of Demand refers to the degree of
responsiveness of demand for a commodity to a
change in the price of some related commodity.

Cross elasticity of demand is the ratio of
proportionate or percentage change in demand of
one commodity to proportionate or percentage
change in the price of another related commodity.




Cross elasticity of Demand
Proportionate or %ge change Qx2 - Qx1
e
c =
in the quantity demanded of X
=
Qx2 + Qx1


Proportionate or %ge change Px2 Px1
in the quantity demanded of Y Py2 + Py1

If commodities are inter-related, a change in price of
one may cause a change in the price of the other.
This is known as Price elasticity of demand.
Py2 Py1
Py2 + Py1
PxEpy = --------------------
Px2 Px1
Px2 + Px1

ADVERTISING / PROMOTIONAL
ELASTICITY OF DEMAND
The degree of responsiveness of demand for a
commodity to given change in the advertising or
promotional expenses is known as cross
elasticity of demand.
e
a= Proportional change in demand for X
Proportional change in the advertisement
expenditure
e
a = Qx ad.exp X ad.exp Qx



Advertising
Advertising consists of those activities by which visual or oral messages are
addressed to selected respondents for the purpose of informing and
influencing them to buy products or services or to act or be inclined
favourably towards ideas, persons, trade marks, institutions or
associations featured.
Two important functions of advertising are
(a) To shift the demand curve to the right
(b) To reduce the elasticity of demand.
(c) However, advertising has a cost payable to the media.
1. A certain amount of sales is possible without advertising.
2. Other things being equal, there is a direct relationship between extent of
advertisement and volume of sales.
3. Upto a point an increase in advertisement will lead to more than
proportionate increase in sales.Beyond this point, an increase will lead to
leass than proportionate increase in sales till the saturation point, when
no further increase in sales is possible.
Promotional or Advertising Elasticity of
Demand
Advertising elasticity of demand is the degree of responsiveness
of demand to changes in advertising expenditure.
Q2-Q1 Q
Q2+Q1 Q Q A
e
A = ------------------------------- = -------------------------- = ------- x -----


A2-A1 A A Q
A2+A1 A

Q = Quantity of sales A = Advertisement expenditure.

Illustration:
At initial advertisement expenditure of Rs.50,000 the demand
For the firms product is 80,000 units. When the advertisement
Budget is increased to Rs.60,000 the sales volume increased
to 90,000 units. What is the advertising elasticity?

A1 = Rs. 50000 A2 = Rs.60000 A = Rs.10000
Q1 = 80000 units Q2 = 90000 units Q = 10000 units

e
A
= Q x A = 10000 x 50000 = 0.625

A Q 10000 80000
Note: When price-quantity changes are very small, point
Elasticity is used.
When there is substantial change, arc elasticity is used.

If Arc elasticity is found for the above example,
e
A
arc = Q x A1 + A2 = 10000 x 50000 + 60000 = 0.647
A Q1 + Q2 10000 80000 + 90000

Point Elasticity of Demand
Point Elasticity of Demand at any point on the Linear Demand Curve is
measured as under :
Lower segment of the Demand Curve
e
p
= --------------------------------------------------
Upper Segment of the Demand Curve

ep < 1 Inelastic range
ep > 1 Elastic range
ep =
Infinite
elasticity


(E) SUBSTITUTION ELASTICITY OF DEMAND
The degree of responsiveness of demand ratio between
X & Y
to a given change in their price ratio is known as
substitution
elasticity of demand.
e
s
= Proportional change in the ratio of demand for X & demand for Y
Proportional change in the ratio of price of X & price of Y
e
s =
(Qx / Qy) (Px / Py)

(Qx / Qy) (Px / Py)
Factors influencing
elasticity of demand
1. Nature of the commodity.
2. Availability of Substitutes
3. Number of Uses
4. Consumers Income.
5. Height of Price and Range of Price Change.
6. Proportion of Expenditure.
7. Durability of the Commodity.
8. Habit.
9. Complementary Goods.
10. Time.
11. Recurrence of Demand.
12. Possibility of Postponement.


Measuring price elasticity of demand

- Total Expenditure Method
- Point Method
- Arc Method

Demand forecasting
Demand forecasting is predicting or anticipating the
future demand for a product.
Micro level Industry level Macro level
USES OF DEMAND FORECASTING DATA
Short term demand forecasting
1) Evolving production policy
2) Determining price policy
3) Evolving purchase policy
4) Fixation of sales targets
5) Short term financial policy
Long term demand forecasting
1) Business planning
2) Man power planning
3) Long term financial planning
Basis of Individual demand
Utility
- From the commodity point of view
- From Consumers point of view

Approaches to Consumer Demand Analysis

o Cardinal Utility approach
- Total utility
- Marginal utility
LAW OF DIMINISHING MARGINALUTILITY

Assumptions underlying cardinality approach

- Rationality
- Limited money income
- maximisation of satisfaction
- Utility is cardinally measurable
- Diminishing marginal utility
- Constant marginal utility of money




Consumers equilibrium
- One commodity model
- Multiple commodity model THE LAW OF EQUIMARGINAL
UTILITY

Ordinal Utility Approach
Assumptions underlying ordinal approach
- Rationality
- Ordinal utility
- Transitivity & consistency in choice
- Nonsatiety
- Diminishing marginal rate of substitution

Marginal rate of substitution - MRS is the rate at which one commodity can be
substituted for another, the level of satisfaction remaining the same.

Diminishing MRS The quantity of a commodity that the quantity of a
commodity that a consumer is willing to sacrifice for an additional unit of
another goes on decreasing when he goes on substituting one commodity for
another.

Indifference Curve - Indifference curve is a locus of points, each representing a
different combination of two substitute goods, which yield the same level of
utility or satisfaction to the consumer.
Indifferent Map




Properties of Indifference curve

- Indifference curves have a negative slope
- Indifference curves are convex to the origin
- Indifference curves do not intersect with each other
- Indifference curves are not tangent to one another
- Upper indifference curve always indicate a higher level of satisfaction

Budgetary constraint & The Budget Line
The limitedness of the income acts as a constraint on how high a consumer
can ride on his/her indifference map.

Consumers Equilibrium

Price Elasticity of Demand
Formula:

e
p
= Proportionate change in the Quantity demanded
Proportionate change in price

change in the quantity demanded
Quantity demanded
= ----------------------------------------------------------------
change in price
price

Price Elasticity of Demand
Law of demand tells us that as the price of a
commodity falls, the quantity demanded
increases, and vice versa.
It does not tell us by how much the quantity
demanded increases, as a result of a certain fall
in price or vice versa.
Law of demand tells us only the direction of
change in demand but not the rate at which
the change takes place.
To know this, we should know the elasticity
of demand or Price elasticity of demand.
Price elasticity of demand
(Q2 Q1)
Q1
e
p
= -------------------------------
P2 P1
P1
Q1 = Original Quantity before price change.
Q2 = Quantity demanded at the changed price.
P1 = Original price.
P2 = Changed price.


Illustration:
If Q1 = 2000 Q2 = 2500
P1 = 10 and P2 = 9

(2500 2000)
2000
e
p = ----------------------------------------------------- = -- 2.5


9 10
10
Price elasticity is negative showing inverse
relationship.

Price elasticity of demand
(modified Formula)
___ Q2 Q1)__
Q1 + Q2
2
e
p
= --------------------------------------
___P2 P1___
P1+ P2
2
Q1 = Original Quantity before price change.
Q2 = Quantity demanded at the changed price.
P1 = Original price.
P2 = Changed price.
Illustration:
If Q1 = 2000 Q2 = 2500
P1 = 10 and P2 = 9

_____(2500 2000)____
2000 + 2500
2
e
p = ----------------------------------------------------- = -- 2.11

9 10
10 + 9
2
Price elasticity is negative showing inverse
relationship.

Modified Formula:
While computing elasticity, instead of taking Q1 and P1 in
the denominator, we take the average of Q1 + Q2 and
P1 + P2. 2
2
The price elasticity e
p
when worked out using the
modified formula = - 2.11
A 1% reduction in price, will result in 2.5% increase in
demand as per the first formula and 2.11% increase as
per modified formula.
Modification in formula is done to ensure reversibility
and consistency when eleasticity = unity.
This is called Arc Elasticity of Demand
And is used when the changes in price and quantity
are quite large.
Types of Price Elasticity
1. Perfectly elastic
2. Perfectly Inelastic
3. Unity Elasticity
4. Relatively Elastic
5. Relatively Inelastic.
Factors determining Price Elasticity of Demand
1. Nature of the commodity
Extent of use
Range of substitutes
Income level
Proportion of income spent on the commodity
Urgency of demand
Durability
Purchase frequency
Perfectly inelastic demand
Where no reduction in price is needed to cause an
increase in demand.
The firm can sell the quantity in wants to sell at the
prevailing price but none at all at even slightly higher
price.
The shape of the demand curve is horizontal.
The elasticity is = infinite.
Perfectly inelastic demand
Even a large change in price, does not change the
quantity demanded.

Here the shape of the curve is vertical.

Elasticity = 0
Unity elasticity
A proportionate change in price results in exactly the
same proportional change in quantity demanded.

Shape of the demand curve is a rectangular hyperbola.

Elasticity = 1
Relatively elastic demand
A reduction in price leads to more than proportionate
change in demand.

Shape of the demand curve is flat.

Elasticity > 1
Relatively inelastic demand
A decline in price leads to less than proportionate
increase in demand.

Shape of the demand curve is steep.

Elasticity < 1



Change in Demand Vs.
Elasticity of Demand
Change in demand occurs when
price does not change but
demand changes due to other factors.

Elasticity of demand refer to that change in
demand which occurs due to change in price, other
factors remaining the same.
Income Elasticity
Income Elasticity may be defined as the degree of responsiveness of
quantities demanded to a given change in income.
Income Elasticity of Demand is defined as the ratio of the percentage
or proportionate quantity demanded to the percentage or
proportionate change in income.
OR
Q2 Q1 (effect)
Q2 + Q1
e
y = ---------------------


Y2 Y1 (cause)
Y2 + Y1
Q1 Original Quantity demanded before Income change
Q2 - Quantity demanded after Income changed
Y1 - Original Income
Y2 - Changed new income.
Illustration
Suppose a consumer's income is Rs.1000 and he purchases
10 kgs. of sugar. If income goes up to Rs.1100 he is
prepared to buy 12 kgs. Calculate income elasticity of
sugar.
Q2-Q1 12 - 10
Q2+Q1 12 + 10
e
y
= ---------- = --------------------
Y2-Y1 1100 - 1000
Y2+Y1 1100 + 1000
= 2 -:- 100 = 1 x 21
22 2100 11 1
= 21 = 1.99
11 Demand for sugar is income elastic
Cross Elasticity
Cross elasticity of demand
Cross elasticity of Demand refers to the degree of
responsiveness of demand for a commodity to a
change in the price of some related commodity.

Cross elasticity of demand is the ratio of
proportionate or percentage change in demand of
one commodity to proportionate or percentage
change in the price of another related commodity.




Cross elasticity of Demand
Proportionate or %ge change Qx2 - Qx1
e
c =
in the quantity demanded of X
=
Qx2 + Qx1


Proportionate or %ge change Px2 Px1
in the quantity demanded of Y Py2 + Py1

If commodities are inter-related, a change in price of
one may cause a change in the price of the other.
This is known as Price elasticity of demand.
Py2 Py1
Py2 + Py1
PxEpy = --------------------
Px2 Px1
Px2 + Px1

Advertising
Advertising consists of those activities by which visual or oral messages are
addressed to selected respondents for the purpose of informing and
influencing them to buy products or services or to act or be inclined
favourably towards ideas, persons, trade marks, institutions or
associations featured.
Two important functions of advertising are
(a) To shift the demand curve to the right
(b) To reduce the elasticity of demand.
(c) However, advertising has a cost payable to the media.
1. A certain amount of sales is possible without advertising.
2. Other things being equal, there is a direct relationship between extent of
advertisement and volume of sales.
3. Upto a point an increase in advertisement will lead to more than
proportionate increase in sales.Beyond this point, an increase will lead to
leass than proportionate increase in sales till the saturation point, when
no further increase in sales is possible.
Promotional or Advertising Elasticity of
Demand
Advertising elasticity of demand is the degree of responsiveness
of demand to changes in advertising expenditure.
Q2-Q1 Q
Q2+Q1 Q Q A
e
A = ------------------------------- = -------------------------- = ------- x -----


A2-A1 A A Q
A2+A1 A

Q = Quantity of sales A = Advertisement expenditure.

Illustration:
At initial advertisement expenditure of Rs.50,000 the demand
For the firms product is 80,000 units. When the advertisement
Budget is increased to Rs.60,000 the sales volume increased
to 90,000 units. What is the advertising elasticity?

A1 = Rs. 50000 A2 = Rs.60000 A = Rs.10000
Q1 = 80000 units Q2 = 90000 units Q = 10000 units

e
A
= Q x A = 10000 x 50000 = 0.625

A Q 10000 80000
Note: When price-quantity changes are very small, point
Elasticity is used.
When there is substantial change, arc elasticity is used.

If Arc elasticity is found for the above example,
e
A
arc = Q x A1 + A2 = 10000 x 50000 + 60000 = 0.647
A Q1 + Q2 10000 80000 + 90000

Point Elasticity of Demand
Point Elasticity of Demand at any point on the Linear Demand Curve is
measured as under :
Lower segment of the Demand Curve
e
p
= --------------------------------------------------
Upper Segment of the Demand Curve

ep < 1 Inelastic range
ep > 1 Elastic range
ep =
Infinite
elasticity
Uses of Elasticity of Demand for Managerial
Decision Making
For taking decisions on a pricing policy, the businessman has to know the likely effects
of price changes on the demand for his product in the market. He can calculate if the
demand will increase by lowering of the price and to what extent, and whether it will
result in substantial increase in revenue and profits. Some businessmen do not pay
any attention to the aspect of elasticity of demand, and suffer heavy losses by wrong
decisions. In scientific management decision making, on has to have as precise an
idea as possible of the degree of elasticity of demand.
By knowing the type of elasticity, it is possible to fix the precise price of the product in
a very profitable way. Unitary elastic demand will not bring in more revenue. Demand
elasticity being more than unity, a price cut would lead to increase in revenue.
If the product has inelastic demand, raising price will fetch better revenue and profits.
A monopolist can have a rational price discrimination policy. E.g., BSES, BWSSB.
In items which are highly responsive to change in income, such as TV sets, when per
capita income rises, larger number of TV sets are sold even at slightly higher prices.
Cross elasticity helps businessmen to mould their business policies. Demand for oil
increases when ghee price rises. Sugar prices has a relationship to changes in price
of gur. Rise in umbrella prices may push demand for raincoats. So businessmen can
fix their prices appropriately in such cases.
Factors influencing
elasticity of demand
1. Nature of the commodity.
2. Availability of Substitutes
3. Number of Uses
4. Consumers Income.
5. Height of Price and Range of Price Change.
6. Proportion of Expenditure.
7. Durability of the Commodity.
8. Habit.
9. Complementary Goods.
10. Time.
11. Recurrence of Demand.
12. Possibility of Postponement.
Factors influencing
elasticity of demand
1. Nature of Commodity: Luxury and comfort goods are
price elastic while necessaries are price inelastic.

2. Availability of substitutes: Where there are close
substitutes in the same price range, demand will be
elastic. E.g., beverages, coffee-tea. Where there are
no effective substitutes, demand is inelastic. E.g.salt.

3. Number of uses: Demand for a multi-use commodity
in those uses where marginal utility is high, will be
inelastic, while in those uses where marginal utility is
low, the demand will be elastic.
Factors influencing
elasticity of demand
4. Consumers Income: Larger the income, demand is relatively
inelastic. Low income tends to make the demand for some
goods relatively elastic.

5. Height of price and range of price: If the change in price in
highly priced commodities is substantial, the demand
will be elastic.

6. Proportion of Expenditure: The demand for Items which are
a small percentage of the family budget is relatively
inelastic.


Factors influencing
elasticity of demand
7. Durability of the commodity: In the case of durable goods
the demand is relatively inelastic.

8. Habit: Demand of habituated products is inelastic.
e.g., cigarettes.

9. Complementary goods: Goods which are jointly demanded
have less elasticity. E.g., ink, petrol.
Factors influencing
elasticity of demand
10. Time : Demand in the short period is generally
inelastic and become elastic in the long period.

11. Recurrence of Demand: If the demand is recurring,
it will be elastic. (FMCG).

12. Possibility of postponement: Consumption goods
which cannot be postponed, the demand is
inelastic. Demand is elastic if it is postponable.