MANAGERIAL ECONOMICS -MB0026

MBA -1 SEM Assignment – Set 1

L. Megha Syam 510925494

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Q1. Define Managerial Economics and discuss its importance and

functions.

Managerial economics is a science that deals with the application of various

economic theories, principles, concepts and techniques to business management
in order to solve business and management problems.

It deals with the practical application of economic theory and methodology to

decision making problems faced by private, public and non profit making
organizations.

The same idea has been expressed by Spencer and Seigelman in the following
words. “Managerial Economics is the integration of economic theory with business practice for
the purpose of facilitating decision making and forward planning by the management”.

According to Mc Nair and Meriam, “Managerial economics is the use of economic modes of
thought to analyze business situation”.

Brighman and Pappas define managerial economics as,” the application of economic
theory and methodology to business administration practice”. Joel dean is of the opinion
that use of economic analysis in formulating business and management policies
is known as managerial economics.

Managerial economics is a highly specialized and new branch of economics

developed in recent years. It highlights on practical application of principles and
concepts of economics in to business decision making process in order to find
out optimal solutions to managerial problems. It fills up the gap between
abstract economic theory and managerial practice. It lies midway between
economic theory and business practice and serves as a connecting link between
the two.

Features of managerial Economics

1. It is a new discipline and of recent origin
2. It is a highly specialized and separate branch by itself.
3. It is basically a branch of microeconomics and as such it studies the
problems of only one firm in detail.
4. It is mainly a normative science and as such it is a goal oriented and
prescriptive science.
5. It is more realistic, pragmatic and highlights on practical application of
various economic theories to solve business and management problems.

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 6. It is a science of decision making. It concentrates on decision making
process, decision models and decision variables and their relationships.
7. It is both conceptual and metrical and it helps the decision maker by
providing measurement of various economic variables and their
interrelationships.
8. It uses various macro-economic concepts like national income, inflation,
deflation, trade cycles etc to understand and adjust its policies to the
environment in which the firm operates.
9. It also gives importance to the study of noneconomic variables having
implications of economic performance of the firm.
10.It uses the services of many other sister sciences like mathematics,
statistics, engineering, accounting, operation research and psychology etc
to find solutions to business and management problems.

Importance of the study of Managerial Economics

Managerial Economics does not give importance to the study of theoretical

economic concepts. Its main concern is to apply theories to find solutions to day
–today practical problems faced by a firm.

Significance of the study Managerial Economics

1. It gives guidance for identification of key variables in decision making
process.
2. It helps the business executives to understand the various intricacies of
business and managerial problems and to take right decision at the right
time.
3. It provides the necessary conceptual, technical skills, toolbox of analysis
and techniques of thinking and other such most modern tools and
instruments like elasticity of demand and supply, cost and revenue,
income and expenditure, profit and volume of production etc to solve
various business problems.

4. It is both a science and an art.

5. It helps the business executives to become much more responsive,
realistic and competent to face the ever changing challenges in the
modern business world.

6. It helps in the optimum use of scarce resources of a firm to maximize its

profits.
7. It also helps in achieving other objectives a firm like attaining industry
leadership, market share expansion and social responsibilities etc.

8. It helps a firm in forecasting the most important economic variables like

demand, supply, cost, revenue, price, sales and profit etc and formulate
sound business polices.
9. It also helps in understanding the various external factors and forces
which affect the decision making of a firm. Thus, it has become a highly
useful and practical discipline in recent years to analyze and find solutions
to various kinds of problems in a systematic and rational manner.

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Functions of a Managerial Economics

A Managerial Economics helps a manager in analyzing and finding answers to

business and managerial problems. It provides in-depth knowledge of the
subject.

The major functions of Managerial Economics are Decision making and forward
planning.

1. Decision making
‘Decision’ suggests a deliberate choice made out of several possible alternative
courses of action after carefully considering them. The act of choice signifying
solution to an economic problem is economic decision making. It involves
choices among a set of alternative courses of action.
Decision making is essentially a process of selecting the best out of many
alternative opportunities or courses of action that are open to a management.

2. Forward planning
The term ‘planning’ implies a consciously directed activity with certain
predetermined goals and means to carry them out. It is a deliberate activity. It
is a programmed action. Basically planning is concerned with tackling future
situations in a systematic manner.

Forward planning implies planning in advance for the future. It is associated with
deciding the future course of action of a firm. It is prepared on the basis of past
and current experience of a firm. It is prepared in the background of uncertain
and unpredictable environment and guess work.

Q2. What is elasticity of demand? Explain the different degree of price

elasticity with suitable examples.

Elasticity of Demand

Elasticity of demand is generally defined as the responsiveness or sensitiveness

of demand to a given change in the price of a commodity. It refers to the
capacity of demand either to stretch or shrink to a given change in price.

Elasticity of demand indicates a ratio of relative changes in two quantities.ie,

price and demand. According to prof. Boulding. “Elasticity of demand measures the
responsiveness of demand to changes in price”. In the words of Marshall,” The elasticity (or
responsiveness) of demand in a market is great or small according to as the amount demanded
much or little for a given fall in price, and diminishes much or little for a given rise in price”

Kinds of elasticity of demand

1. Price Elasticity Of Demand
2. Cross Elasticity Of Demand
3. Income Elasticity Of Demand
4. Promotional Elasticity Of Demand
5. Substitution Elasticity Of Demand

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Price Elasticity of Demand
Elasticity which is used to describe the effect of change in price on quantity
demanded.
Price elasticity of demand is a technical term used by economists to explain the
degree of responsiveness of the demand for a product to a change in its price.
Price elasticity of demand is a ratio of two pure numbers, the numerator is the
percentage change in quantity demanded and the denominator is the percentage
change in price of the commodity. It is measured by using the following formula.

Ep=( Percentage change in quantity demanded )/( Percentage change in price.)

Different Degree of Price Elasticity of Demand

1. Perfectly Elastic Demand: In this case, a very small change in price leads
to an infinite change in demand. The demand cure is a horizontal line and
parallel to OX axis. The numerical coefficient of perfectly elastic demand is
infinity (ED=00)

2. Perfectly Inelastic Demand: In this case, what ever may be the change in
price, quantity demanded will remain perfectly constant. The demand curve is a
vertical straight line and parallel to OY axis. Quantity demanded would be 10
units, irrespective of price changes from Rs. 10.00 to Rs. 2.00. Hence, the
numerical coefficient of perfectly inelastic demand is zero. ED = 0

3. Relative Elastic Demand: In this case, a slight change in price leads to

more than proportionate change in demand. One can notice here that a change
in demand is more than that of change in price. Hence, the elasticity is greater
than one. For e.g., price falls by 3 % and demand rises by 9 %. Hence, the
numerical coefficient of demand is greater than one.

4. Relatively Inelastic Demand In this case, a large change in price, say 8 %

fall price, leads to less than proportionate change in demand, say 4 % rise in
demand. One can notice here that change in demand is less than that of change
in price. This can be represented by a steeper demand curve. Hence, elasticity is
less than one.

5. Unitary elastic demand: In this case, proportionate change in price leads to

equal proportionate change in demand. For e.g., 5 % fall in price leads to
exactly 5 % increase in demand. Hence, elasticity is equal to unity. It is possible
to come across unitary elastic demand but it is a rare phenomenon.

Out of five different degrees, the first two are theoretical and the last one is a
rare possibility. Hence, in all our general discussion, we make reference only to
two terms relatively elastic demand and relatively inelastic demand.

Q3. Suppose your manufacturing company planning to release a new

product into market, Explain the various methods forecasting for a new
product.

When a manufacturing companies planning to release a new product into the

market, it should perform the demand forecasting to check the demand of the
product in the market and also the availability of similar product in the market.

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Demand forecasting for new products is quite different from that for established
products. Here the firms will not have any past experience or past data for this
purpose. An intensive study of the economic and competitive characteristics of
the product should be made to make efficient forecasts.

As per Professor Joel Dean, few guidelines to make forecasting of demand for
new products are:

a. Evolutionary approach
The demand for the new product may be considered as an outgrowth of an
existing product. For e.g.,
Demand for new Tata Indica, which is a modified version of Old Indica can most
effectively be projected based on the sales of the old Indica, the demand for new
Pulsor can be forecasted based on the sales of the old Pulsor. Thus when a new
product is evolved from the old product, the demand conditions of the old
product can be taken as a basis for forecasting the demand for the new product.

b. Substitute approach
If the new product developed serves as substitute for the existing product, the
demand for the new product may be worked out on the basis of a ‘market
share’. The growths of demand for all the products have to be worked out on the
basis of intelligent forecasts for independent variables that influence the demand
for the substitutes. After that, a portion of the market can be sliced out for the
new product. For e.g., A moped as a substitute for a scooter, a cell phone as a
substitute for a land line. In some cases price plays an important role in shaping
future demand for the product.

c. Opinion Poll approach

Under this approach the potential buyers are directly contacted, or through the
use of samples of the new product and their responses are found out. These are
finally blown up to forecast the demand for the new product.

d. Sales experience approach

Offer the new product for sale in a sample market; say supermarkets or big
bazaars in big cities, which are also big marketing centres. The product may be
offered for sale through one super market and the estimate of sales obtained
may be ‘blown up’ to arrive at estimated demand for the product.

e. Growth Curve approach

According to this, the rate of growth and the ultimate level of demand for the
new product are estimated on the basis of the pattern of growth of established
products. For e.g., An Automobile Co., while introducing a new version of a car
will study the level of demand for the existing car.

f. Vicarious approach
A firm will survey consumers’ reactions to a new product indirectly through
getting in touch with some specialized and informed dealers who have good
knowledge about the market, about the different varieties of the product already
available in the market, the consumers’ preferences etc. This helps in making a
more efficient estimation of future demand.

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Q4. Define the term equilibrium. Explain the changes in market
equilibrium and effects to shifts in supply and demand.

Equilibrium means equal balance. It means a state of even balance in which

opposing forces or tendencies neutralize each other.

It is a position of rest characterized by absence of change. It is a state where

there is complete agreement of the economic plans of the various market
participants so that no one has a tendency to revise or alter his decision.
In the words of professor Mehta: “Equilibrium denotes in economics absence of
change in movement.”

There are two approaches to market equilibrium.

1. Partial equilibrium approach: The partial equilibrium approach to pricing
explains price determination of a single commodity keeping the prices of
other commodities constant.
2. General equilibrium approach: This approach explains the mutual and
simultaneous determination of the prices of all goods and factors. Thus it
explains a multi market equilibrium position.

Before Marshall, there was a dispute among economists on whether the force of
demand or the force of supply is more important in determining price. Marshall
gave equal importance to both the demand and supply in the determination of
value or price. He compared supply and demand to a pair of scissors which
explained that neither supply alone, nor demand alone can determine the price
of a commodity, both are equally important in the determination of price. But
the relative importance of the two may vary depending upon the time under
consideration. Thus, the demand of all consumers and the supply of all firms
together determine the price of a commodity in the market.

Effects of shit in demand

Demand changes when there is a change in the determinants of demand like the
income, tastes, prices of substitutes and complements, size of the population
etc. If demand raises due to a change in any one of these conditions the demand
curve shifts upward to the right. If, on the other hand, demand falls, the
demand curve shifts downward to the left. Such rise and fall in demand are
referred to as increase and decrease in demand.
Thus the market equilibrium price and quantity demanded will change when
there is an increase or decrease in demand.

Effects of Shifts in Supply

On assuming the demand to remain constant. An increase in supply is
represented by a shift of the supply curve to the right and a decrease in supply
is represented by a shift to the left. The general rule is, if supply increases, price
falls and if supply decreases price rises.
Thus changes in supply, demand remaining constant will cause changes in the
market equilibrium.

Effects of Changes in both Demand and Supply

Changes can occur in both demand and supply conditions. The effects of such
changes on the market equilibrium depend on the rate of change in the two
variables. If the rate of change in demand is matched with the rate of change in

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supply there will be no change in the market equilibrium, the new equilibrium
shows expanded market with increased quantity of both supply and demand at
the same price.

If the increase in demand is greater than the increase in supply, the new market
equilibrium is at a higher level showing a rise in both the equilibrium price and
the equilibrium quantity demanded and supplied. On the other hand if the
increase in supply is greater than the increase in demand, the new market
equilibrium is at lower level, showing a lower equilibrium price and a higher
quantity of good supplied and demanded.

Similar will be the effects when the decrease in demand is greater than the
decrease in supply on the market equilibrium.

Q5. Give a brief description of

(a) Implicit and Explicit cost

Explicit costs are those costs which are in the nature of contractual payments
and are paid by an entrepreneur to the factors of production [excluding himself]
in the form of rent, wages, interest and profits, utility expenses, and payments
for raw materials etc. They can be estimated and calculated exactly and
recorded in the books of accounts.

Implicit or imputed costs are implied costs. They do not take the form of cash
outlays and as such do not appear in the books of accounts. They are the
earnings of owner employed resources. For example, the factor inputs owned by
the entrepreneur himself like capital can be utilized by him or can be supplied to
others for a contractual sum if he himself does not utilize them in the business.
It is to be remembered that the total cost is a sum of both implicit and explicit
costs.

(b) Actual and opportunity cost

Actual costs are also called as outlay costs, absolute costs and acquisition
costs. They are those costs that involve financial expenditures at some time and
hence are recorded in the books of accounts. They are the actual expenses
incurred for producing or acquiring a commodity or service by a firm. For
example, wages paid to workers, expenses on raw materials, power, fuel and
other types of inputs. They can be exactly calculated and accounted without any
difficulty.

Opportunity cost of a good or service is measured in terms of revenue which

could have been earned by employing that good or service in some other
alternative uses. In other words, opportunity cost of anything is the cost of
displaced alternatives or costs of sacrificed alternatives. It implies that
opportunity cost of anything is the alternative that has been foregone. Hence,
they are also called as alternative costs. Opportunity cost represents only
sacrificed alternatives. Hence, they can never be exactly measured and recorded
in the books of accounts.
The knowledge of opportunity cost is of great importance to management
decision. They help in taking a decision among alternatives. While taking a
decision among several alternatives, a manager selects the best one which is
more profitable or beneficial by sacrificing other alternatives.

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Q6. Critically examine Boumal’s static and dynamic models.

Boumal’s Static And Dynamic Models.

Sales maximization model is an alternative model for profit maximization. This
model is developed by Prof. W.J.Boumal, an American economist. This
alternative goal has assumed greater significance in the context of the growth of
Oligopolistic firms.
The model highlights that the primary objective of a firm is to maximize its sales
rather than profit maximization. It states that the goal of the firm is
maximization of sales revenue subject to a minimum profit constraint. The
minimum profit constraint is determined by the expectations of the share
holders. This is because no company can displease the share holders.
It is to be noted here that maximization of sales does not mean maximization of
physical sales but maximization of total sales revenue. Hence, the managers are
more interested in maximizing sales rather than profit.
The basic philosophy is that when sales are maximized automatically profits of
the company would also go up. Hence, attention is diverted to increase the sales
of the company in recent years in the context of highly competitive markets.

In defence of this model, the following arguments are given.

1. Increase in sales and expansion in its market share is a sign of healthy
growth of a normal company.
2. It increases the competitive ability of the firm and enhances its influence in
the market.
3. The amount of slack earnings and salaries of the top managers are directly
linked to it.
4. It helps in enhancing the prestige and reputation of top management,
distribute more dividends to share holders and increase the wages of workers
and keep them happy.
5. The financial and other lending institutions always keep a watch on the sales
revenues of a firm as it is an indication of financial health of a firm.
6. It helps the managers to pursue a policy of steady performance with
satisfactory levels of profits rather than spectacular profit maximization over
a period of time. Managers are reluctant to take up those kinds of projects
which yield high level of profits having high degree of risks and uncertainties.
The risk averting and avoiding managers prefer to select those projects which
ensure steady and satisfactory levels of profits.

Prof, Boumal has developed two models. The first is static model and the second
one is the dynamic model.

The Static Model

This model is based on the following assumptions.
1. The model is applicable to a particular time period and the model does not
operate at different periods of time.
2. The firm aims at maximizing its sales revenue subject to a minimum profit
constraint.
3. The demand curve of the firm slope downwards from left to right.
4. The average cost curve of the firm is unshaped one.

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Sales maximization/ dynamic model
In the real world many changes takes place which affects business decisions of a
firm. In order to include such changes, Boumal has developed another dynamic
model. This model explains how changes in advertisement expenditure, a major
determinant of demand, would affect the sales revenue of a firm under severe
competitions.

Assumptions
1. Higher advertisement expenditure would certainly increase sales revenue
of a firm.
2. Market price remains constant.
3. Demand and cost curves of the firm are conventional in nature.

- Generally under competitive conditions, a firm in order to increase its

volume of sales and sales revenue would go for aggressive
advertisements. This leads to a shift in the demand curve to the right.
- Forward shift in demand curve implies increased advertisement
expenditure resulting in higher sales and sales revenue. A price cut may
increase sales in general. But increase in sales mainly depends on
whether the demand for a product is elastic or inelastic.
- A price reduction policy may increase its sales only when the demand is
elastic and if the demand is inelastic; such a policy would have adverse
effects on sales. Hence, to promote sales, advertisements become an
effective instrument today. It is the experience of most of the firms that
with an increase in advertisement expenditure, sales of the company
would also go up.
- A sales maximizer would generally incur higher amounts of advertisement
expenditure than a profit maximizer. However, it is to be remembered
that amount allotted for sales promotion should bring more than
proportionate increase in sales and total profits of a firm. Otherwise, it will
have a negative effect on business decisions
- Thus, by introducing, a non-price variable in to his model, Boumal makes
a successful attempt to analyze the behaviour of a competitive firm under
oligopoly market conditions. Under oligopoly conditions as there are only a
few big firms competing with each other either producing similar or
differentiated products, would resort to heavy advertisements as an
effective means to increase their sales and sales revenue. This appears to
be more practical in the present day situations.

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