Synopsis (Managerial Economics) -I

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Introduction to Managerial Economics

Economics is the science which studies human behavior as a relationship
between ends and scarce means which have alternative uses.
Every country must have a way of determining what commodities to produce,
how to produce these goods, for whom to produce, how to provide for the
growth of the system and how to ration a given quantity of commodity over
time.
A market economy is one in which individuals of goods and services and
private firms make the major decisions about production and consumption.
A command economy is one in which the government makes all-important
decisions about production and distribution. In a mixed economy, private and
public sectors work together.
Each economy has a stock of limited resources land, labor, capital,
technology, factories, tools, energy, etc. However, the size of the production
basically depends on the availability and allocation of resources. Every
economy has to maintain balance between unlimited needs and limited
means.
The central problems of an economy are: what to produce? How to produce?
& whom to produce?

The production possibility curve is basically a menu of choice. It is concave
curve representing the potential output that can be generated in an economy.
It does not show any combination but represents the potential resources
available in an economy

The concave shape of the curve implies there is increasing rate of
substitution between the two goods (capital goods) and (consumer
goods).The logic behind the shape of the production possibility curve is the
principle of Opportunity cost (the next best alternative forgone).

Features of PPC: Any point inside the production possibility curves
indicates underutilization of resources: any point on the production
possibility frontier indicate optimum utilization of resources and any point
over and above the production possibility frontier represents over utilization
of resources.

Production Possibility Curve can be used to explain the problem of how to
produce, which involves the choice of proper techniques and effective use of
optimum available resources.

Alternative economic Systems: Economic systems are classified into three
types: Market Economy; Command Economy and Mixed Economy. The
basis for the classification of economic system is the central problems of an
economy (what, how and whom). In case of Market economy, the central
problems (what, how and whom) are addressed by Demand and Supply
factors (Market forces). Example : USA, Switzerland

In case of Command Economy, the central problems (what, how and whom)
are addressed by government. Example : China, Cuba

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In case of Mixed economy, the central problems (what, how and whom) are
addressed by both market forces and government. Example : India

Economics can be classified into two branches : Micro economics and
Macroeconomics. The basis for study of microeconomics is partial
equilibrium analysis. It is basically study of individual and based on
assumptions. Partial equilibrium is identified when the model assumes other
things remaining constant or ceteris paribus.

Microeconomic Theory studies the behavior of individual decision-making
units such as individual consumers, resource owners, and business firms, etc.

Macro Economic Theory deals with the aggregates. It is based on General
equilibrium analysis or Walrasian analysis. It mainly studies aggregate level
of output and national income. The level of national employment,
consumption, investment and prices in the economy as a whole.
Microeconomics is concerned with the decisions made by small economic
units consumers, workers, investors, owners of resources, and business
firms. It is also concerned with the interaction of consumers and firms to
form markets and industries.
According to economists, the appropriate methodology of economics (and
science in general) is to test a theory not only by its ability to predict
accurately, but also by the internal consistency of those assumptions.
Positive analysis seeks to predict the impact of changes in economic policy
on observable items such as production and income, and then tries to
determine who gains and who loses as a result of the changes. Normative
analysis evaluates the desirability of alternative outcomes according to value
judgments about what is good or bad.

Demand and Supply Analysis
What is demand?
Want + Willingness + Ability = Demand
Law of Demand
Other things being constant, as price falls, the quantity demanded rises and
vice versa
Demand function = Qd = f (P)
Demand Schedule: There are two components in demand schedule. They are
price of the commodity and quantity demanded.. It is the data pertaining to
price and quantity of a commodity.
Demand curve: It is the depicting of the demand schedule in the form of a
graph. Price is represented on Y axis and quantity demanded is represented
on X axis
Exceptions to law of demand

Giffen goods(Staple food)
Veblen effect(Prestigious goods, status symbol)
Snob effect(Collection of rare goods)
Other factors affecting demand

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Prices of related goods
Substitutes
Complementary goods
Population
Tastes and preferences
Income of the consumer
Wealth of the consumer
Expectations
Special influences
Any change in quantity demanded of commodity which results from
variations in its own price is movement along the demand curve
Movement along the demand curve can be extension in demand and
contraction in demand. In case of extension in demand the price of the
commodity falls while the quantity demanded expands. In case of contraction
in demand, the price of the good increases and quantity demanded contracts.
Technically movement along the demand curve is referred to as Change in
quantity demanded
Shift in demand occurs due to change in the value of any variable other than
price(income, tastes and preferences). Shift in demand can be rightward shift
or leftward shift from the original demand curve. Rightward shift in demand
is also known as increase in demand. The outcome of rightward shift in
demand is both price and quantity demanded will increase.
Leftward shift in demand is also known as decrease in demand. The outcome
of leftward shift in demand is both price and quantity demanded will
decrease. Technically shift in demand curve is referred to as Change in
demand
Market demand curve is horizontal summation of all individual demand
curves.
Analysis of Supply

What is supply?
Want + Willingness + Ability = Supply
Law of Supply
Other things being constant, as price increases, the quantity supplied also
increases and vice versa
Supply function = QS = f (P)
Supply Schedule: There are two components in Supply schedule. They are
price of the commodity and quantity supplied.. It is the data pertaining to
price and quantity supplied of a commodity.
Supply curve: It is the depicting of the Supply schedule in the form of a
graph. Price is represented on Y axis and quantity supplied is represented on
X axis
Other factors affecting Supply
Prices of related goods
Factor prices
Technology
Government policy

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Special influences
Any change in quantity supplied of a commodity which results from
variations in its own price is movement along the Supply curve
Movement along the supply curve can be extension in supply and contraction
in supply. In case of extension in supply the price of the commodity increases
while the quantity supplied expands. In case of contraction in supply, the
price of the good decreases and quantity supplied contracts. Technically
movement along the supply curve is referred to as Change in quantity
supplied
Shift in supply occurs due to change in the value of any variable other than
price (factor prices, technology and government policy). Shift in supply can
be rightward shift or leftward shift from the original supply curve. Rightward
shift in supply is also known as increase in supply. The outcome of rightward
shift in supply is price will decrease and quantity supplied will increase.
Leftward shift in supply is also known as decrease in supply. The outcome
of leftward shift in supply is price will increase and quantity supplied will
decrease. Technically shift in supply curve is referred to as Change in supply
Market supply curve is horizontal summation of all firms supply curves.

A market is a mechanism through which buyers and sellers interact to set
prices and exchange goods and services.
Supply demand analysis is a basic tool of microeconomics. In competitive
markets, supply and demand curves tell us how much will be produced by
firms and how much will be demanded by consumers as a function of price.
Market equilibrium is achieved at a point where Qd = QS. At this point
simultaneously equilibrium price and equilibrium quantity can be
determined.
Market Intervention can be of two forms : price ceiling and Price floor
A legally established maximum price. The government is occasionally
inclined to keep the price of one good or another from rising too high.
Examples include apartments and natural gas. While the goal is invariably a
noble one like keeping stuff affordable for poor people. The price is
basically set below the equilibrium price and gives rise to shortages in market
(Qd> QS). The outcome of this type of market intervention results in black
marketing and hoarding
A legally established minimum price. Pressured by special interest groups,
our beloved government is often convinced that the price of a good needs to
be kept at a higher level. The price is basically set above the equilibrium
price and gives rise to inefficient surpluses in market (Qd< QS). The outcome
of this type of market intervention results in adulteration


Elasticity
Elasticity is a measure of the percentage change in one variable brought
about by a 1 percent change in some other variable.
The degrees of elasticity:
Unit Elastic Demand/Constant Elasticity: Price elasticity of demand is unity
when the change in demand is exactly proportionate to the change in the price of

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the good. For example, 10% change in price causes 10% change in demand i.e. e
p

=
10%
10%
=1, q/p = 1.
Relatively Elastic Demand: The change in the price results in more than
proportionate change in the quantity demanded where q/p >1.
Relatively Inelastic Demand: The change in the price results in less than
proportionate change in the quantity, where q/p < 1.
Perfectly Inelastic Demand: Whatever the price change, the demand will remain
constant, q/p = 0.
Perfectly Elastic Demand: A small change in price brings about an infinite
change in demand, q/p = .

Price elasticity of demand is a measure of the responsiveness of quantity
demanded to price changes along a given demand curve. Price elasticity is
calculated by dividing the percentage change in quantity demanded of a good
by the percentage change in price that caused it, other things being equal.
Since, on a typical demand curve, P and Q move in oppositely, e
Q,P
will be
negative.
For example, if e
Q,P
= -2, a 1 percent increase in price leads to a 2 percent
decline in quantity.
The price elasticity of demand is always changing along a straight line
demand curve.
Demand is elastic at prices above the midpoint price.
Demand is unit elastic at the midpoint price.
Demand is inelastic at prices below the midpoint price.
The income elasticity of demand is defined, as the rate of change in the
quantity demanded of a good due to change in the income of the consumer.


For normal goods, e
Q,I
is positive because increases in income lead to
increases in purchases of the good
For inferior goods e
Q,I
is negative.
If e
Q,I
> 1, the purchase of the good increases more rapidly than income
so the good might be called a luxury good
Cross elasticity of demand is defined as the percentage change in the quantity
demanded of a good due to a change in the price of another good, other
things remaining constant.



If the goods are substitutes, an increase in the price of one will cause
buyers to purchase more of the substitute, so the elasticity will be
Positive.
If the goods are complements, an increase in the price of one will cause
buyers to buy less of that good and also less of the good they use with it, so
the elasticity will be negative.
.
I in change Percentage
Q in change Percentage
,

P Q
e
.
P' in change Percentage
Q in change Percentage
,

P Q
e

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The price elasticity of supply is a number used to measure the sensitivity of
changes in quantity supplied to given percentage changes in the price of a
good, other things being equal.

The elasticity of supply refers to the percentage change in quantity supplied
due to one percent change in the price of that good. This implies that the
elasticity of supply
e
s
=
percentage changein the quantity supplied
percentage change in price

=
Q/Q
P/P

=
Q
P

x
P
Q

where,
e
s
= Elasticity of supply of the good;
Q = Original quantity of the good supplied;
Q = Change in the quantity supplied;
P = Original price of the good;
P = Change in the price.




Kinds of Supply Elasticity
Summary of different types of elasticity of supply
When elasticity of supply is It is called
Equal to infinity Perfectly elastic supply
More than one but less than infinity Relatively elastic supply
Equal to one Unitary elastic supply
Less than one but more than zero Relatively inelastic supply
Equal to zero Perfectly inelastic supply