SCOPE OF MANAGERIAL ECONOMICS The scope of managerial economics is very wide as it involves the application of economic concepts and

analysis to all the problems and areas of the manager and the firm. Managerial Economics deals with four problems in both decision making and forward planning. These problems are: 1.Resource allocation for optimal results, 2. Inventory and queuing problem, 3. Pricing problems i.e. fixing prices for the products of the firm, 4. Investment problems i.e. forward planning regarding allocation of scarce recourses over time. Thus the scope of Managerial Economics covers the following areas• Theory of Demand Analysis and Forecasting. • Theory of Production and Production Decisions. • Analysis of Market-Structure and Pricing Theory. • Cost Analysis. • Profit Analysis and Profit Management. • Theory of Capital and Investment Decisions. • Inventory Management.

Demand analysis is essential for a business firm in the following ways. 1. 2. 3. 4. 5. 6. 7. Demand analysis is required to identify and measure the forces that determine sales. Extent of production and cost allocation depend upon demand analysis. Demand analysis is essential for pricing and inventory holdings. Demand analysis helps in sales forecasting and profit planning. New product policy and advertisement policy cannot be drawn without the analysis of demand. Research and development strategy cannot be framed without demand analysis. Demand analysis is the basis of tracing the trend of the firm’s competitive analysis.

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Price of the commodity. Price expectations. Price of related goods. Income of the consumer. Population. Tastes and Preferences. Distribution of Income. Discoveries-polythene bags. Trade activity-business cycle, trade agreements. Climate and weather. Money supply. Savings. Reduction in Taxes.

“The elasticity of demand measures the responsiveness of the quantity demanded of a good, to change in its price, price of other goods and changes in consumer’s income.” Elasticity of Demand are of three types. 1.Price elasticity of demand. a. Perfectly elastic demand. (Infinite) b. Perfectly inelastic demand ( Zero) c. Unitary elastic demand (One) d. Highly elastic demand e. Less elastic demand. 2.Income elasticity of demand. 3.Cross elasticity of demand. 4.Advertisement elasticity of sales.

The diagram shows the effect of a shift in supply with two different demand curves (D & D1). Curve D1 is more elastic than D. Initially the supply curve is S1 and it intersects the both demand curves at point a, at a price of P1 and a quantity of Q1. Now supply shifts to S2.
P r i c e

P2 P3 P1


b a


D1 D o
Q 3 Q 2 Q1 Quantity

In the case of the elastic demand curve D, there is relatively rise in price and relatively fall in quantity, equilibrium is at point b. In the case of the more elastic demand curve, there is a relatively small rise in price but a relatively larger fall in quantity. Thus, equilibrium is at point c.

1. 2. 3. 4. Availability of Substitutes-the higher the degree of closeness of the substitutes, the greater the elasticity of demand for the commodity. Nature of Commodity-luxuries, comforts and necessities. Weightage in the total consumption-if proportion of income spent on a commodity is large, its demand will be more elastic and vice versa. Time factor in adjustment of consumption pattern-the time consumers need to adjust their consumption pattern to a new price: the longer the time allowed, the greater the elasticity. Range of commodity use-the wider the range of the uses of a product, the higher the elasticity of demand for the decrease in price. Proportion of market supplied-if less than half of the market is supplied at the ruling price, price elasticity of demand will be higher than 1 and if more than half of the market is supplied then elasticity will be less than 1.

5. 6.

1. Determination of Price Under Monopoly-a) If the demand for his product is elastic he will earn more profit by fixing a low price. Low price means large sales and hence, large total revenue. b) If the demand is inelastic, he will be in a position to fix up high price. Basis of Price Discrimination- When a monopolist sells his product at different prices, it is called price discrimination. On the basis of elasticity he can charge various prices from the customers. Determination of Wages-If the demand for labour in an industry is elastic, strikes and other trade union tactics will not be of any avail in raising wages. Advantage to Finance Minister-a) Taxes on goods having elastic demand will yield less revenue. It is because of the fact that taxes will raise their prices and thus bring down their demand and finally it means less revenue, b) Goods having inelastic demand are taxed at a higher rate. No doubt the price of the goods will rise on account of these taxes but there will be little fall in their demand.





6. 7.


Determination of Prices of Public Utilities-Where the demand for services is inelastic, a high price is charged, while in the case of elastic demand a lower price is charged. That is why, household consumers are charged a high rate of electricity than industrial or agricultural customers. International Trade-Those exports with inelastic demand will fetch high price. The knowledge of income elasticity can be useful in forecasting demand, when a change in personal incomes is expected. It thus helps in avoiding over production or under production. The concept of cross elasticity is of vital importance in changing price of products having substitutes and complementary goods. If cross elasticity in response to the price of substitutes is greater than 1, it would be inadvisable to increase the price; rather, reducing the price may prove more benecial.

Demand estimation is defined as the process of determining the demand equation to calculate the demand elasticities of the products under the given assumptions, through the application of statistical tools to the data set developed by the managers. STEPS IN DEMAND ESTIMATION: In some cases demand estimates are easy to find, while in others, it is highly difficult. Data set developed by the managers Application of statistical tools to data set Estimation of demand equation Use of demand equation for prediction of future demand under constant prices, income etc.

Following methods are used for demand estimation: 1. Market Experiment Method. 2. Survey of Consumer’s Intentions. 3. Regression Analysis. Market Experiment Method: Market experimentation involves the estimation of demand on the basis of market behaviour of consumers. These are of two kinds. 1. Actual Market Method: Under this method first sales outlets are opened in different localities chosen with a mix of consumers with different levels of income, sex, age, education level etc. Then the reactions of consumers are observed by varying controllable variables affecting demand such as prices, advertisement, quality of products etc. 2. Market Simulation Method: This method is also known as Laboratory Experiment method. In this method each consumer is given a sum of money and he is asked to shop around in a simulated market. Then the consumer behaviour is studied by varying the price and quality of good, its packaging, advertisement etc.

Survey of Consumer’s Intention: In this method consumers are contacted personally to disclose their future purchase plans. For survey of consumer’s intentions, these methods are used. 1. Census Survey Method: This is also known as Complete Enumeration Method. In this method interviews are conducted either orally or through questionnaire. The probable demand so collected from all the consumers is summed up. 2. Sample Survey Method: In this method only a few consumers out of the population are selected for study through interviews which are conducted either orally or through questionnaire. Test Marketing: This is done mainly for estimating demand of new products or estimating sales potential of existing products in new geographical areas. In this method a test area is selected which truly represents the market. The product is launched in this area exactly in the manner in which it is intended to be launched in the market.


Regression Analysis : It is a statistical technique by which demand is estimated with the help of certain independent variables such as income, price of the commodity, price of related goods, advertisement etc. Regression analysis can be of two types: 1. Simple Regression Analysis: It is used when the quantity demanded is taken as a function of a single independent variable such as income of the consumers. Multiple Regression Analysis: Multiple regression analysis is used to estimate demand as a function of two or more independent variables that may vary simultaneously.


Demand forecasting for a product is the technique of estimating its demand in the immediate or distant future. Demand forecast is important basis for formulating inventory policy, production policy, marketing policy, sales strategy etc. by a production unit or a selling organization. Demand forecasts are also used to plan personnel requirements of a firm. Purposes of Demand Forecasting: a) Purposes of Short-term Forecasting: It is difficult to define short-run for a firm because its duration may differ according to the nature of the commodity. Time duration may be set for demand forecasting depending upon how frequent the fluctuations in demand are.
ii) iii) iv) v) vi) For evolving appropriate production policy to avoid problems of overproduction and underproduction. Proper management of inventories, i.e. purchasing raw materials at appropriate time, when their prices are low, and avoid over stocking. To set up reasonable sales targets. Formulating a suitable sales strategy in accordance with the changing pattern of demand and extent of competition among the firms. Forecasting financial requirements for the short run.

b) Purposes of Short-term Forecasting: The concept of demand forecasting is more relevant to the long run than the short run. It is comparatively easy to forecast the immediate future than to forecast the distant future.
i) ii) iii) iv) Planning for a new project, expansion and modernization of an existing unit, diversification and technology up gradation. Assessing long term financial needs. Arranging suitable manpower. Arranging a suitable strategy for changing pattern of consumption. The emerging pattern of industrialization, urbanization, education, degree of contact with the rest of the world could be closely studied by a firm for forecasting demand.

Steps Involved in Demand Forecasting:
1. 2. 3. Setting the objective-rise of output, fixation of price, allocation of funds for sales promotion, mode of raising capital resources, inventory control change in product mix, up gradation of technology etc. Selection of goods-consumer and capital goods, existing and new goods. Selection of method-the scope and success of a particular method depends upon the area of investigation, resources-monetary and time available with the firms, degree of accuracy required, availability of data, availability of trained personnel etc. Interpreting the results-this is the most important step in demand forecasting. The results should be very carefully analyzed before any inference is drawn out of them. Forecasting is based on a number of assumptions. If these assumptions change due to changes in political, economic, social and international factors, the revision of forecast may become inevitable.


Methods of Forecasting
A. Opinion Polling Methods B. Statistical Methods

Consumers Survey Method

Collective Opinion Method

Experts Opinion Method

Trend Projection Method

Barometric Techniques

Regression Simultaneous Method Equation Method

Complete Enumeration Survey

Sample Survey and Test Marketing

End-Use Survey

Leading, Lagging And Coincident Indicators Diffusion Indices

Index Number

Composite Indicators

Fitting Trend Line by Observation or Graphic Method

Least Squares Linear Regression

Time Series Analysis

Moving Average and Annual Difference

Exponential Smoothing

ARIMA Method

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