1.

1 Economics for Managers Syllabus:

Module 1: Introduction 8 Hours:

1.1 Introduction to Managerial Economics-
1.2 Economic Systems-Principles of managerial economics,
1.3 Integration with other managerial decision-making process-
1.4 Tools and analysis of optimization-role of Government and private sector, Competition Vs
Cooperation.
1.5 Relationship with other management subject.
1.6 Production possibility frontiers (PPF)
1.7 Productive efficiency Vs economic efficiency
1.8 economic growth & stability
1.9 Micro economies and Macro economies – the role of markets and government –
1.10 Positive Vs negative externalities

Module 2: Demand and Supply Analysis 10 Hours:

2.1 Definition of demand,
2.2 Law of demand and its determinants and exceptions,
2.3 elasticity of demand and supply,
2.4 movement along the demand curve and shift in demand curve,
2.5 Demand and supply relationship
2.6 Definition of supply, Law of supply,
2.7 Movement along the supply curve and shift in supply curve.
2.8 Relationship of Revenue and elasticity of demand,
2.9 Methods of Demand forecasting and its use in demand.
2.10 Interpretation of Quantitative and Qualitative demand techniques-
2.11 model specification using regression and OLS.

Module 3: Consumer and Producer Behaviour 12 Hours

3.1 Introduction to Consumer behaviour,
3.2 Utility, Cardinal approach, Ordinal approach,
3.3 Consumer’s equilibrium using Indifference curve analysis and Consumer surplus,
3.4 Application of Indifference curve analyses Market,
3.5 Production – Short-run and long-run Production Function
3.6 Returns to scale – economies Vs diseconomies of scale,
3.7 ISO-Quants & ISO-Cost line,
3.8 Analysis of cost – Short-run and long-run cost function
3.9 Relation between Production and cost function,
3.10 Break Even Analysis – Meaning, Assumptions, Determination of BEA, Limitations, Uses of BEA
in Managerial decisions (with simple Problems).
Module 4 Market Structure and Pricing Practices: 12 Hours
4.1 Different Market structure, features,
4.2 determination of price under perfect competition and equilibrium in the short run and the long
run,
4.3 Monopoly - features, equilibrium condition, Price discrimination.
4.4. Monopolistic Competition: Features, Pricing Under monopolistic competition
4.5 Oligopoly: Features, Kinked demand Curve, Cartels, Price leadership.,
4.6 Game theory-types, static and dynamic games
4.7 Pricing Approaches: Full cost pricing, Product line pricing,
4.8 Pricing Strategies: Price Skimming, Penetration Pricing, Loss leader pricing, Peak Load pricing.

Module 5: Business Environment and Economy Performance 10

Hours
5.1 Nature, Scope, Structure of Indian Business Environment – Internal and External Environment.
5.2 Political and Legal Environment, Economic Environment,
5.3 Socio – Cultural Environment, Global Environment Macro-economic aggregates –
5.4 circular flow of macroeconomic activity – National income determination – Aggregate demand
and supply – Macroeconomic equilibrium – Components of aggregate demand and national
income – multiplier effect.

Module 6: Industrial Policies 8 hours

6.1 Industrial Policies of India,
6.2 New Industrial Policy 1991;
6.3 Private Sector- Growth, Problems and Prospects,
6.4 SMEs –Significance in Indian economy-problems and prospects.
6.5 Fiscal policy and Monetary Policy. Foreign Trade: Trends in India’s Foreign Trade,
6.6. Impact of WTO on India’s Foreign Trade.

Skill Development Activities: (Frame Skill Development Activities for each module) 1. Assessment
of Demand Elasticity – Price, Income, Cross, Advertising. 2. Demand Forecasting: Application of
qualitative and quantitative methods of demand forecasting to various sectors (Automobile,
Service, Pharmaceutical, Information Technology, FMCG, Hospitality etc.) in India. 3.Preparing a
Project proposal for a Business Venture. (Compulsory).
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Module 1: Introduction 8 Hours:
1.1 Introduction to Managerial Economics:
Introduction to Economics,

Basic facts of Economics:

1. Human Beings have unlimited wants, and

2. The means of satisfying these wants are relatively scarce.

The above two fundamental facts form the subject matter of Economics.

Therefore-

Economics is concerned with the study of how effectively an individual and society uses
limited (i.e. Scarce) resources, to satisfy infinite wants.

Economics is the study of how individuals and society, work together to transform scarce
resources into goods and services to satisfy the most important of infinite human wants, and
how these goods and services are distributed among different sections of the society.

Economics deals with-

(a) How a nation allocates its scarce productive resources to various uses

(b) The process by which the productive capacity of these resources is increased

(c) The factors which have led to sharp fluctuations in the rate of utilization of resources.

1.1.2 Introduction to Managerial Economics

Definitions of managerial economics

According to Mansfield, "Managerial economics provides a link between economic

theory and decision sciences in the analysis of managerial decision making?

Brigham and Poppas believe that managerial economics is "the application of economic

theory and methodology to business administration practice."
Hague on the other hand, considers managerial economics as "a fundamental academic
subject which seeks to understand and to analyse the problems of business decision-
making."
According to McNair and Meriam, “Managerial economics is the use of economic modes of
thought to analyse business situations.”
According to Prof. Evan J Douglas, ‘Managerial economics’ is concerned with the application
of economic principles and methodologies to the decision making process within the firm or
organisation under the conditions of uncertainty”. Spencer and Siegelman define it as “The
integration of
economic theory with business practices for the purpose of facilitating decision making and
forward planning by management.”

1.1.3 Nature of Managerial Economics

Nature of Managerial Economics

To know more about managerial economics, we must know about its various characteristics.
Let us read about the nature of this concept in the following points:

Art and Science: Managerial economics requires a lot of logical thinking and creative skills
for decision making or problem-solving. It is also considered to be a stream of science by
some economist claiming that it involves the application of different economic principles,
techniques and methods, to solve business problems.
Micro Economics: In managerial economics, managers generally deal with the problems
related to a particular organisation instead of the whole economy. Therefore it is considered
to be a part of microeconomics.

Uses Macro Economics: A business functions in an external environment, i.e. it serves the
market, which is a part of the economy as a whole.

Therefore, it is essential for managers to analyse the different factors of macroeconomics

such as market conditions, economic reforms, government policies, etc. and their impact on
the organisation.

Multi-disciplinary: It uses many tools and principles belonging to various disciplines such as
accounting, finance, statistics, mathematics, production, operation research, human
resource, marketing, etc.

Prescriptive / Normative Discipline: It aims at goal achievement and deals with practical
situations or problems by implementing corrective measures.

Management Oriented: It acts as a tool in the hands of managers to deal with business-
related problems and uncertainties appropriately. It also provides for goal establishment,
policy formulation and effective decision making.

Pragmatic: It is a practical and logical approach towards the day to day business problems.

Scope of Managerial Economics:

The scope of managerial economics refers to its area of study. Managerial economics refers
to its area of study. Managerial economics, Provides management with a strategic planning
tool that can be used to get a clear perspective of the way the business world works and
what can be done to maintain profitability in an ever-changing environment.

Managerial economics is primarily concerned with the application of economic principles

and theories to five types of resource decisions made by all types of business organizations.

a. The selection of product or service to be produced.

b. The choice of production methods and resource combinations.

c. The determination of the best price and quantity combination d. Promotional strategy
and activities.

e. The selection of the location from which to produce and sell goods or service to
consumer. The production department, marketing and sales department and the finance
department usually handle these five types of decisions.

The scope of managerial economics covers two areas of decision making

a. Operational or Internal issues

b. Environmental or External issues a.

Operational issues:

Operational issues refer to those, which wise within the business organization and they are
under the control of the management.

Those are: 1. Theory of demand and Demand Forecasting

2. Pricing and Competitive strategy

3. Production cost analysis

4. Resource allocation

5. Profit analysis

6. Capital or Investment analysis

7. Strategic planning

1. Demand Analyses and Forecasting: A firm can survive only if it is able

to the demand for its product at the right time, within the right quantity. Understanding the
basic concepts of demand is essential for demand forecasting. Demand analysis should be a
basic activity of the firm because many of the other activities of the firms depend upon the
outcome of the demand fore cost.

Demand analysis provides:

A. The basis for analyzing market influences on the firms; products and thus helps in the
adaptation to those influences.

B. Demand analysis also highlights for factors, which influence the demand for a product.
This helps to manipulate demand. Thus demand analysis studies not only the price elasticity
but also income elasticity, cross elasticity as well as the influence of advertising expenditure
with the advent of computers, demand forecasting has become an increasingly important
function of managerial economics.

2. Pricing and competitive strategy:

Pricing decisions have been always within the preview of managerial economics. Pricing
policies are merely a subset of broader class of managerial economic problems. Price theory
helps to explain how prices are determined under different types of market conditions.
Competitions analysis includes the anticipation of the response of competitions the firm’s
pricing, advertising and marketing strategies. Product line pricing and price forecasting
occupy an important place here.
3.Production and cost analysis: Production analysis is in physical terms. While the cost
analysis is in monetary terms cost concepts and classifications, cost-out-put relationships,
economies and diseconomies of scale and production functions are some of the points
constituting cost and production analysis.

4. Resource Allocation: Managerial Economics is the traditional economic theory that is

concerned with the problem of optimum allocation of scarce resources. Marginal analysis is
applied to the problem of determining the level of output, which maximizes profit. In this
respect linear programming techniques has been used to solve optimization problems. In
fact lines programming is one of the most practical and powerful managerial decision
making tools currently available.

5. Profit analysis: Profit making is the major goal of firms. There are several constraints
here an account of competition from other products, changing input prices and changing
business environment hence in spite of careful planning, there is always certain risk
involved. Managerial economics deals with techniques of averting of minimizing risks. Profit
theory guides in the measurement and management of profit, in calculating the pure return
on capital, besides future profit planning.

6. Capital or investment analyses: Capital is the foundation of business. Lack of capital may
result in small size of operations. Availability of capital from various sources like equity
capital, institutional finance etc. may help to undertake large-scale operations. Hence
efficient allocation and management of capital is one of the most important tasks of the
managers. The major issues related to capital analysis are:

a) The choice of investment project

b) Evaluation of the efficiency of capital

c) Most efficient allocation of capital Knowledge of capital theory can help very much in
taking investment decisions.

This involves, capital budgeting, feasibility studies, analysis of cost of capital etc.

7. Strategic planning: Strategic planning provides management with a framework on which

long-term decisions can be made which has an impact on the behavior of the firm. The firm
sets certain longterm goals and objectives and selects the strategies to achieve the same.
Strategic planning is now a new addition to the scope of managerial economics with the
emergence of multinational corporations. The perspective of strategic planning is global. It is
in contrast to project planning which focuses on a specific project or activity. In fact the
integration of managerial economics and strategic planning has given rise to be new area of
study called corporate economics. B. Environmental or External Issues: An environmental
issue in managerial economics refers to the general business environment in which the firm
operates. They refer to general economic, social and political atmosphere within which the
firm operates.

A study of economic environment should include:

a. The type of economic system in the country.

b. The general trends in production, employment, income, prices, saving and investment.

c. Trends in the working of financial institutions like banks, financial corporations, insurance
companies.

d. Magnitude and trends in foreign trade;

e. Trends in labour and capital markets;

f. Government’s economic policies viz. industrial policy monetary policy, fiscal policy, price
policy etc. The social environment refers to social structure as well as social organization like
trade unions, consumer’s co-operative etc. The Political environment refers to the nature of
state activity, chiefly states’ attitude towards private business, political stability etc. The
environmental issues highlight the social objective of a firm i.e.; the firm owes a
responsibility to the society. Private gains of the firm alone cannot be the goal. The
environmental or external issues relate managerial economics to macro economic theory
while operational issues relate the scope to micro economic theory. The scope of
managerial economics is ever widening with the dynamic role of big firms in a society.

1.2 Economic Systems-Principles of managerial economics,

1.2.1: Economic Systems:

Meaning of Economic System

An economic system is a mechanism with the help of which the government

plans and allocates accessible services, resources, and commodities across
the country. Economic systems manage elements of production, combining
wealth, labour, physical resources, and business people. An economic system
incorporates many companies, agencies, objects, models, and deciding
procedures.

Types of Economic Systems

Capitalist economy: In a capitalist system, the products manufactured are

divided among people, not according to what they want but on the basis of
purchasing power, which is the ability to buy products and services. This
means an individual needs to have the money with him to buy the goods and
services. The low-cost housing for the underprivileged is much required but
will not include demand in the market because the needy do not have the
buying power to back the demand. Therefore, the commodities will not be
manufactured and provided as per market forces.

Socialist economy: This economy system acknowledges the three inquiries in

a different way. In a socialist society, the government determines what
products are to be manufactured in accordance with the requirements of the
society. It is believed that the government understands what is appropriate
for the citizens of the country. Therefore, the passions of individual buyers
are not given much attention. The government concludes how products are
to be created and how the product should be disposed of. In principle,
sharing under socialism is assumed to be based on what an individual needs
and not what they can buy. A socialist system does not have a separate estate
because everything is controlled by the government.

Mixed economy: Mixed systems have characteristics of both the command

and the market economic system. For this purpose, the mixed economic
systems are also known as dual economic systems. However, there is no
sincere method to determine a mixed system. Sometimes, the word
represents a market system beneath the strict administrative control in
certain sections of the economy.
Economic Sector

The economic sector is divided into three economic sectors. They are as
follows:

Primary sector: It is that sector which relies on the environment for any
production or manufacturing. A few examples of the primary sector are
mining, farming, agriculture, fishing, etc.

Secondary sector: In this sector, the raw material is transferred to a valuable

product. A few examples are construction industries and manufacturing of
steel, etc.

Tertiary sector: It is also known as service sector, and it includes production

and exchange of services. A few examples are banking, insurance,
transportation, communication, etc.
Differences between Capitalist, Socialist, and Mixed
Economies
Parameters Capitalist economy Socialist economy Mixed economy

Ownership of Private ownership Public ownership Both public and private

property ownerships

Price Prices are determined by Prices are determined by Prices are determined by the
determination the market forces of the central planning central planning authority,
demand and supply. authority. and demand and supply.

Motive of Profit motive Social welfare Profit motive in the private

production sector and welfare motive in
the public sector

Role of No role Complete role Full role in the public sector

government and limited role in the
private sector

Competition Exists No competition Exists only in the private

sector

Distribution of Very unequal Quite equal Considerable inequalities

income exist

Economic principles relevant to managerial decision making:

 Marginal and Incremental Principle. ...

 Equi-marginal Principle. ...
 Opportunity Cost Principle. ...
 Time Perspective Principle. ...
 Discounting Principle.
Economic principles assist in rational reasoning and defined thinking. They
develop logical ability and strength of a manager. Some important principles of
managerial economics are:

1. Marginal and Incremental Principle

This principle states that a decision is said to be rational and sound if

given the firm’s objective of profit maximization, it leads to increase in
profit, which is in either of two scenarios-

 If total revenue increases more than total cost.

 If total revenue declines less than total cost.
 Marginal analysis implies judging the impact of a unit change in one
variable on the other. Marginal generally refers to small changes.
Marginal revenue is change in total revenue per unit change in output
sold. Marginal cost refers to change in total costs per unit change in
output produced (While incremental cost refers to change in total costs
due to change in total output). The decision of a firm to change the price
would depend upon the resulting impact/change in marginal revenue
and marginal cost. If the marginal revenue is greater than the marginal
cost, then the firm should bring about the change in price.

Incremental analysis differs from marginal analysis only in that it analysis

the change in the firm's performance for a given managerial decision,
whereas marginal analysis often is generated by a change in outputs or
inputs. Incremental analysis is generalization of marginal concept. It
refers to changes in cost and revenue due to a policy change. For
example - adding a new business, buying new inputs, processing
products, etc. Change in output due to change in process, product or
investment is considered as incremental change. Incremental principle
states that a decision is profitable if revenue increases more than costs;
if costs reduce more than revenues; if increase in some revenues is more
than decrease in others; and if decrease in some costs is greater than
increase in others.

2. Equi-marginal Principle

Marginal Utility is the utility derived from the additional unit of a

commodity consumed. The laws of equi-marginal utility states that a
consumer will reach the stage of equilibrium when the marginal utilities
of various commodities he consumes are equal. According to the
modern economists, this law has been formulated in form of law of
proportional marginal utility. It states that the consumer will spend his
money-income on different goods in such a way that the marginal utility
of each good is proportional to its price, i.e.,

MUx / Px = MUy / Py = MUz / Pz

Where, MU represents marginal utility and P is the price of good.

Similarly, a producer who wants to maximize profit (or reach

equilibrium) will use the technique of production which satisfies the
following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

 Where, MRP is marginal revenue product of inputs and MC represents
marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources

in a manner which equalizes the ratio of marginal returns and marginal
costs of various use of resources in a specific use.

3. Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of

alternatives required by that decision. If there are no sacrifices, there is
no cost. According to Opportunity cost principle, a firm can hire a factor
of production if and only if that factor earns a reward in that
occupation/job equal or greater than it’s opportunity cost. Opportunity
cost is the minimum price that would be necessary to retain a factor-
service in it’s given use. It is also defined as the cost of sacrificed
alternatives. For instance, a person chooses to forgo his present
lucrative job which offers him Rs.50000 per month, and organizes his
own business. The opportunity lost (earning Rs. 50,000) will be the
opportunity cost of running his own business.

4. Time Perspective Principle

According to this principle, a manger/decision maker should give due

emphasis, both to short-term and long-term impact of his decisions,
giving apt significance to the different time periods before reaching any
decision. Short-run refers to a time period in which some factors are
fixed while others are variable. The production can be increased by
increasing the quantity of variable factors. While long-run is a time
period in which all factors of production can become variable. Entry and
exit of seller firms can take place easily. From consumers point of view,
short-run refers to a period in which they respond to the changes in
price, given the taste and preferences of the consumers, while long-run
is a time period in which the consumers have enough time to respond to
price changes by varying their tastes and preferences.

5. Discounting Principle

According to this principle, if a decision affects costs and revenues in

long-run, all those costs and revenues must be discounted to present
values before valid comparison of alternatives is possible. This is
essential because a rupee worth of money at a future date is not worth a
rupee today. Money actually has time value. Discounting can be defined
 as a process used to transform future dollars into an equivalent number
of present dollars. For instance, $1 invested today at 10% interest is
equivalent to $1.10 next year.

FV = PV*(1+r)t

Where, FV is the future value (time at some future time), PV is the

present value (value at t0, r is the discount (interest) rate, and t is the
time between the future value and present value.

1.3 Integration with other managerial decision-making process:

Managerial Economics in Relation with other Disciplines / Branches of Knowledge

Managerial economics has a close linkage with other disciplines and fields of study. The
subject has gained by the interaction with Economics, Mathematics and Statistics and has drawn
upon Management theory and Accounting concepts. Managerial economics integrates concepts
and methods from these disciplines and brings them to bear on managerial problems.

Managerial Economics & Other Disciplines

Managerial Economics and Economics:

Managerial Economics is economics applied to decision making. It is a special branch of
economics, bridging the gap between pure economic theory and managerial practice. Economics
has two main branches—micro-economics and macro-economics.

Micro-economics:

‘Micro’ means small. It studies the behaviour of the individual units and small groups of
units. It is a study of particular firms, particular households, individual prices, wages, incomes,
individual industries and particular commodities. Thus micro-economics gives a microscopic view
of the economy.

The roots of managerial economics spring from micro-economic theory. In price theory,
demand concepts, elasticity of demand, marginal cost marginal revenue, the short and long runs
and theories of market structure are sources of the elements of micro-economics which
managerial economics draws upon. It makes use of well known models in price theory such as
the model for monopoly price, the kinked demand theory and the model of price discrimination.

Macro-economics:

‘Macro’ means large. It deals with the behaviour of the large aggregates in the
economy. The large aggregates are total saving, total consumption, total income, total
employment, general price level, wage level, cost structure, etc. Thus macro-economics is
aggregative economics.
 It examines the interrelations among the various aggregates, and causes of fluctuations
in them. Problems of determination of total income, total employment and general price level
are the central problems in macro-economics.

Macro-economies is also related to managerial economics. The environment, in which a

business operates, fluctuations in national income, changes in fiscal and monetary measures and
variations in the level of business activity have relevance to business decisions. The
understanding of the overall operation of the economic system is very useful to the managerial
economist in the formulation of his policies.

Macro-economics contributes to business forecasting. The most widely used model in

modern forecasting is the gross national product model.

Managerial Economics and Theory of Decision Making:

The theory of decision making is relatively a new subject that has a significance for
managerial economics. In the process of management such as planning, organising, leading and
controlling, decision making is always essential. Decision making is an integral part of today’s
business management. A manager faces a number of problems connected with his/her business
such as production, inventory, cost, marketing, pricing, investment and personnel.

Economist are interested in the efficient use of scarce resources hence they are
naturally interested in business decision problems and they apply economics in management of
business problems. Hence managerial economics is economics applied in decision making.

Managerial Economics and Operations Research:

Mathematicians, statisticians, engineers and others join together and developed
models and analytical tools which have grown into a specialised subject known as operation
research. The basic purpose of the approach is to develop a scientific model of the system which
may be utilised for policy making.

The development of techniques and concepts such as Linear Programming, Dynamic

Programming, Input-output Analysis, Inventory Theory, Information Theory, Probability Theory,
Queuing Theory, Game Theory, Decision Theory and Symbolic Logic.

Managerial Economics and Statistics:

Statistics is important to managerial economics. It provides the basis for the empirical
testing of theory. It provides the individual firm with measures of appropriate functional
relationship involved in decision making. Statistics is a very useful science for business executives
because a business runs on estimates and probabilities.

Statistics supplies many tools to managerial economics. Suppose forecasting has to be

done. For this purpose, trend projections are used. Similarly, multiple regression technique is
used. In managerial economics, measures of central tendency like the mean, median, mode, and
measures of dispersion, correlation, regression, least square, estimators are widely used.

Statistical tools are widely used in the solution of managerial problems. For eg.
sampling is very useful in data collection. Managerial economics makes use of correlation and
multiple regression in business problems involving some kind of cause and effect relationship.
 Managerial Economics and Accounting:
Managerial economics is closely related to accounting. It is recording the finan cial
operation of a business firm. A business is started with the main aim of earning profit. Capital is
invested / employed for purchasing properties such as building, furniture, etc and for meeting
the current expenses of the business.

Goods are bought and sold for cash as well as credit. Cash is paid to credit sellers. It is
received from credit buyers. Expenses are met and incomes derived. This goes on the daily
routine work of the business. The buying of goods, sale of goods, payment of cash, receipt of
cash and similar dealings are called business transactions.

The business transactions are varied and multifarious. This has given rise to the
necessity of recording business transaction in books. They are written in a set of books in a
systematic manner so as to facilitate proper study of their results.

There are three classes of accounts:

(i) Personal account,

(ii) Property accounts, and

(iii) Nominal accounts.

Management accounting provides the accounting data for taking business decisions.
The accounting techniques are very essential for the success of the firm because profit
maximisation is the major objective of the firm.

Managerial Economics and Mathematics:

Mathematics is another important subject closely related to managerial economics. For
the derivation and exposition of economic analysis, we require a set of mathematical tools.
Mathematics has helped in the development of economic theories and now mathematical
economics has become a very important branch of economics.

Mathematical approach to economic theories makes them more precise and logical. For
the estimation and prediction of economic factors for decision making and forward planning,
mathematical method is very helpful. The important branches of mathematics generally used by
a managerial economist are geometry, algebra and calculus.

The mathematical concepts used by the managerial economists are the logarithms and
exponential, vectors and determinants, input-out tables. Operations research which is closely
related to managerial economics is mathematical in character.

1.4 Tools and analysis of optimization-role of Government and private sector, Competition Vs
Cooperation.
 Some specific analytical tools are applied to analyse economic problems to find the optimum
level of business activities. Managerial economics is essentially the application of economic
theories and tools of analysis in business decision making.

The tools of economic analysis generally applied to business decision making, as listed below:

i) Functional relationship between economic variables

ii) Concept of slope and its application
iii) Optimization techniques
iv) Constrained optimization, and
v) Regression analysis

First, lets understand the analytical tools by explaining the meaning and kinds of economic
variables generally used in economic analysis and also in most business decision issues.

1.4.1 Meaning of economic variables:

Variable: Anything that is subject to change is called variable. In economic sense, any
quantity, value, price and rate of any thing which changes on its own or due to change in
its
determinants is called economic variable.

Most of the above said variables are interrelated and interdependent. The
interrelatedness and interdependence of the variables means that change in other related

For Example: The terms like demand, supply, price, cost, sales, revenue, profit,
capital, labour, money demand and supply, interest rate, advertisement spending,
etc., are all economic variables.

variable(s).

Consider the interrelationship between and interdependence of some of the important

economic variables:

 Demand depends on price and price depends on demand,

 Supply depends of price and price depends on supply
 Production depends on cost of procuction and production on cost.
 Market price depends on both demand and supply and vice versa
 Borrowing depends on the rate of interest and interest rate on borrowing
 Profit depends on price, cost and sales.
 Kinds of Economic Variables:

Economic variables are generally classified under two broad categories depending on their
role in economic analysis:

i) Dependent and independent variables and

ii) Endogenous and Exogenous variables.

i) Dependent and Independent Variables: depending on the purpose of analysis,

andy of the economic variables can be treated as dependent variable or as
independent variable.
A dependent variable is one whose value depends on the value of other
variables
A independent variable is one whose value changes on its own, or is assumed
to change due to certain exogenous factors- the factors outside the model.

For example:

1. If demand for computers is assumed to depend on its price, then ‘demand for
computer’ is the dependent variable and computer price is the independent
variable.
2. Petrol price in India has been increasing due to increase in import oil price. In this
Case, domestic oil price is a dependent variable and international oil price is and
independent variable.

ii) Endogenous and Exogenous variables:

Economic variables are also classified as endogenous variables and exogenous
variables.
An endogenous variable is one whose value is determined within the model or
framework of the analysis and an exogenous variable is one whose value is
determined outside the model,
In out petrol-price example, domestic oil price is endogenous variable and
international oil price as exogenous variable. Endogenous and exogenous
categories of variables will be explained further and illustrated in the following
section.

1.4.2 Methods of Showing Relationships Between Variables

A variety of functions are used in economic theory and many of them are applied to
analyse business problems and in business decisions making e.g., demand function, supply
function production function, cost function, total revenue function, profit function, and so
 on. These functions are used to explain various economic theories which constitute
managerial economics.
Now, let us understand the concept of functions and shoe the use of functions in economic
analysis.

Most of the economic variable are interrelated and interdependent. In most cases,
economic variables have cause-and-effect relationship. The relationship between any two
or more related economic variables can be expressed in a tabular, a graphical and a
functional form. Tabular and graphical forms serve the purpose only when the number of
variables and the number of observation are small.

1)Tabular method: When the relationship between two variables in expressed by sequential
data in a table, it is called a tabular form.

For example, consider a simple case of relationship between price of pizza and the number of
pizzas sold per week in your college canteen. Suppose weekly sale of pizza by the canteen is given
in table 1.1:

Table 1.1 Price of Pizza and weekly Pizza Sale:

Pizza Price No. of pizzas sole

100 00
80 100
60 200
40 300
20 400
00 500

The data given in table 1.1 shows that there exists a relationship between the price of
pizza and its quantity demanded per week. It shows that as price of pizza decreases, its
demand increases, demand for it decreases. A little deeper observation shows that each
fall in pizza price by Rs.20, per piece results in increase in sale by 5 pizzas. This is tabular
presentation of relationship between two economic variables – Price and Demand. One
can imagine a number of other such relationships between consumer goods and their
prices.

2)Graphical method: the data given in table 1.1 can be presented graphically as shown in
 Fig 1.1 Price of Pizza and weekly Pizza Sale

120

100
Pizza Price (Per Unit)

80

60

40

20

0
0 100 200 300 400 500 600
Demand for Pizza
Fig.1.1

By plotting the data, we get a line marked PQ . A curve or line so generated is called
demand curve. The line PQ shows the nature of relationship between the price of pizza
and its quantity demanded, graphically.

Both Table 1.1 and graph 1.1 show that as the price of pizza decreases, its demand
increases and vice versa, all things remaining the same. One can easily find the
relationship between pizza price and its quantity demanded per week in the canteen. This
gives the law of demand. The relationship between the price and its weekly demand in the
college canteen can be stated as follows:
i) There is an inverse relationship between the pizza price and demand for it, and
ii) For each fall in pizza price by Rs.20, weekly demand increases by 100 or for each one-
rupee fall in the price of pizza, its weekly demand increases by 5.

1.5 Relationship with other management subject:

Macro Economics, Statistics, Mathematics, Accounts etc., have contributed

a lot in the growth of Managerial Economics. D.C. Hague has stated,
"Managerial Economics uses the logic of Economics, Mathematics and
Statistics to provide effective ways of thinking about business decision
problems."
Economics has two main branches: micro-economics and macro-
economics. Micro-economics has been defined as branch of economics
where deals with the unit of study, an individual behavior or a firm. Macro-
economics, on the other hand, is aggregate in character and deals with
entire economy as a unit of study or deals with entire society behavior.

MANAGERIAL ECONOMICS AND TRADITIONAL ECONOMICS -

Relationship

Another useful method throwing light upon the nature and scope of
managerial economics is to examine its relationship with other subjects. In
this connection, Economics, Statistics, Mathematics and Accounting
deserve special mention. Prof. D.C. Hague has described managerial
Economics uses the logic of Economics, Mathematics and Statistics to provide
effective ways of thinking about business decision problems."

1. Managerial Economics and Traditional Economics:

Managerial Economics has been described as economics applied to

decision-making. It may be viewed as a special branch of economics
bridging the gulf between pure economic theory and managerial practice.
The relation between Managerial Economics and Economics is as close as
is Engineering to Physics and Medicines to Biology.
Economics Introduction
 Economics Introduction
 Economics Definitions
 Macro Economics
 Micro Economics
 Managerial Economics
 M E Definitions
 Scope of Managerial Economics
 Application of M E
 Relationship with other subjects
Traditional Economics has two main divisions: microeconomics and
macroeconomics. Microeconomics; also known as price theory, is the
main source of concepts and analytical tools for managerial economics. To
illustrate, various microeconomic concepts such as elasticity of demand,
marginal cost, the short and long runs, opportunity cost, various market
forms, etc., are all of great significance to managerial economics. The chief
contribution of macroeconomics is in the area of forecasting. The modern
theory of income, employment, trade cycles, etc. has implications for
forecasting general business conditions. As the prospects of an individual
firm often depend greedy on general business conditions, individual firm
forecasts depend on general business forecasts.

2.Managerial Economics and Accounting:

Managerial economics and accounting are closely interrelated. Accounting

can be defined as the recording of financial operations of a business firm.
A business manager needs a lot of accounting information data for logical
analysis in decision-making and policy formulation at the level of firm. The
accounting data and information has to be presented in a methodological
manner worthy of analysis and interpretation for decision-making and
future planning. This is why a new branch of accounting known as
'management accounting' has developed to help correct managerial
decision-making. The main task of management accounting is to provide
the sort of data which managers need to solve some business problems
accurately.

3. Managerial Economics and Operational Research:

Operational Research is closely related to managerial economics.

Operational research is the application of mathematical techniques to
solving business problems. It provides all the data required for business
decisions and forward planning. Techniques such as linear programming,
game theory, etc. are due to the works of operational research, linear
programming is extensively used in decision-making. Managerial
economics is concerned with efficient use of scarce resources. Operational
research is also concerned with efficient use of scarce resources. There is
close affinity between managerial economics and operational research.
Managerial economics gives special emphasis to the problems involving
maximisation of profits and minimisation of costs, while operational
research focuses attention on the concept of optimisation. Managerial
economics has made much use of optimisation concept but initially
started with marginal analysis taken from economics. Managerial
economics uses the logic of Economics, Mathematics and Statistics for
undertaking effective decisions, while operational research techniques
based on these ways of thinking are being used to solve decision-making
problems in business. Again, both operational research and managerial
economics are concerned with taking effective decisions.

Operational research is a tool in the hands of managerial economics to

solve day-to-day business problems. Managerial economics is an
academic subject which aims at understanding and analysing problems
and decision-making by a firm. Thus, operational research is a functional
activity pursued by specialists within the firm. Though it is expensive and a
slow process, it helps managers make accurate solutions by means of
providing necessary data.

4. Managerial Economics and Marketing:

Managerial Economics helps marketing in two ways. First, as a basic

discipline, providing tools and concepts of analysis and second, as an
integrating area, providing its judgement on the optimum sales volume
under the given cost function of a firm, market structure, and the objective
function to be optimized. How much to sell under given circumstances is
answered by an economist and how to sell the desired amount of output
is the domain of the marketing manager. Sometimes, selling more than
what is desired may harm the interest of the firm. It has, however, the
sanction neither of Economics nor of marketing principles as both stresses
on the protection of long run interests of the firm.

Economics is of a great help to marketing in the sphere of pricing. Of the

three basic aspects of pricing viz. value theory, price theory, and pricing
techniques, the first two are the exclusive domain of Economics, while the
third one forms part of both Managerial Economics and marketing. In the
case of pricing techniques, there are varying practices in different
organizations. In many pricing is handled by the accounts staff such as
chartered accountants and company secretaries. There are several areas
of marketing which are totally or heavily dependent on economic theory.
These are:
 Theory of the Firm
 Concepts of goals and goal formulation
 Market structures
 Pricing

5. Managerial Economics and Production Management:

Production is defined as the creation of utility by transforming input into
output. It usually refers to manufacturing activity and the term operations
are used to denote a wider meaning, encompassing all economic activity
which creates economic utility. Operations personnel have four basic
responsibilities to fulfill while producing a firm's products or services:
[Raymond R. Mayor, 1975 p. 3]
 Supply of quantities,
 Maintenance of time-bound deliveries,
 Fulfillment of quality requirement, and
 Economizing production operations.

For this, the personnel have to deal with a number of inter-related areas
including production planning, production control, quality control,
methods analysis, materials handling, plant layout, inventory control, work
management, and wage incentives. A knowledge of Economics would help
operations personnel not only to economize their production operations
but also help them
 To monitor and analyse the input market,
 To monitor market maturity, technical maturity, and
competitive maturity of products being produced,
 To have better coordination with the R & D department with
respect to product and process innovation, and
 To take decisions on production targets.
6. Managerial Economics and Personnel Management:

A human resource manager has to concern himself with two types of

problems: (i) an effective utilization of human resources in terms of costs
and productivity and (ii) improvement in the terms and conditions of
employment as an adjunct to employee satisfaction. Manpower planning,
at the micro level, is another important function of an HRD manager
wherein a firm ensures that it has the right number and the right kind of
people, at the right places, at the right time, doing work for which they are
economically most useful.

Managerial economics can help personnel management by analysing the

economic and financial aspects of personnel problems both in relation to
the economic welfare of the firm and to the prevailing environment of the
economy as a whole. It explains the economic implications of policies and
strategies and judges their consistency with respect to organizational
objectives as well as internal and external constraints. It can provide a
safety range for wage negotiations with trade unions. Business forecasting
could provide information for devising employment norms of the sales
force

1.6 Production possibility frontiers (PPF) –

Production possibility frontier (PPF) is referred to as a graph that shows the maximum possible
output that can be achieved by two goods when the input is maintained constant or fixed.

The factors that are included in the input are natural resources, capital goods, labour and
entrepreneurship.

The production of one good can be increased when the production of the other good is
sacrificed. The Production Possibility Frontier (PPF) is also known as the Production Possibility
Curve.

The production possibility frontier represents the concepts of scarcity, tradeoffs and choice and
the shape of the curve will change based on whether the price costs are constant, increasing or
decreasing.

The slope of the PPF is indicative of the opportunity cost of producing a good in comparison to
another good. The same can be used for comparing the opportunity costs of another producer
for determining the comparative advantage.

Interpreting the PPF Curve

The shape of the PPF curve is like a bow in an outward position. The highest point on the graph
will be when a good is produced on the y-axis and the second good is not produced at all on the
x-axis.

The widest part of the curve will be represented by the point where no good is produced on y-axis
whereas maximum production is happening on the x-axis.

All other points in the graph are regarded as tradeoff points, which means both the goods are
produced in varying degrees in these points.

The points on the PPF curve are said to be efficient and indicates that the resources of the
economy are utilised fully. This is known as the Pareto Efficiency, which refers to the idea that an
economy is operating at its full potential and there is no possibility of getting more output from
the available resources.

The points inside a PPF curve are known as inefficient points as the output from these points
could be greater than the economy’s current resources. Conversely, the points outside the PPF
curve represents production of two goods at its maximum level, which is not possible due to
limited or fixed resources.

Impact on Economy
It helps in letting the businesses understand how much quantity of good must be given up in
order to make space for producing another type of good.

Productive
Productive efficiency Vs economic efficiency –

Efficiency – definition and diagrams

Definition of Productive efficiency
Productive efficiency is concerned with producing goods and services with
the optimal combination of inputs to produce maximum output for the
minimum cost.

To be productively efficient means the economy must be producing on

its production possibility frontier. (i.e. it is impossible to produce more of
one good without producing less of another).
  Points A and B are productively efficient.
 Point D is inefficient because you could produce more goods
or services with no opportunity cost
 Point C is currently impossible.
Productive efficiency and short-run average cost curve

A firm is said to be productively efficient when it is producing at the lowest

point on the short run average cost curve (this is the point where marginal
cost meets average cost).
Productive efficiency is closely related to the concept of technical
efficiency. A firm is technically efficient when it combines the optimal
combination of labour and capital to produce a good. i.e. cannot produce
more of a good, without more inputs.

Note: An economy can be productively efficient but have very

poor allocative efficiency.
Allocative efficiency is concerned with the optimal distribution of
resources. For example, if you devoted 90% of GDP to defence, you could
be productively efficient, but, this would be a very unbalanced economy.

1.7 economic growth & stability –

1.8 Micro economies and Macro economies – the role of markets and government –
1.9 Positive Vs negative externalities