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UNIT-I

INTRODUCTION TO MANAGERIAL ECONOMICS

Imagine for a while that you have finihe! your tu!ie an! have "oine! a an engineer in a manufa#turing organi$ation%&hat !o you !o there' (ou )lan to )ro!u#e ma*imum +uantity of goo! of a given +uality at a reaona,le #ot% On the

other han!- if you are a ale manager- you have to ell a ma*imum amount of goo! with minimum a!vertiement #ot%

In other wor!- you want to minimi$e your #ot an! ma*imi$e your return an! ,y !oing o- you are )ra#ti#ing the

)rin#i)le of managerial e#onomi#%

Manager- in their !ay.to.!ay a#tivitie- are alway #onfronte! with everal iue u#h a how mu#h +uantity i to ,e

u))lie!/ at what )ri#e/ houl! the )ro!u#t ,e ma!e internally/ or whether it houl! ,e ,ought from outi!e/ how mu#h

+uantity i to ,e )ro!u#e! to ma0e a given amount of )rofit an! o on% Managerial e#onomi# )rovi!e u a ,ai#

inight into ee0ing olution for managerial )ro,lem%

Managerial e#onomi#- a the name itelf im)lie- i an offhoot of two !itin#t !i#i)line1 E#onomi# an!

Management% In other wor!- it i ne#eary to un!ertan! what thee !i#i)line are- at leat in ,rief- to un!ertan! the

nature an! #o)e of managerial e#onomi#%

Introduction to Economics

E#onomi# i a tu!y of human a#tivity ,oth at in!ivi!ual an! national level% The e#onomit of early age treate!

e#onomi# merely a the #ien#e of wealth% The reaon for thi i #lear% Every one of u in involve! in effort aime! at

earning money an! )en!ing thi money to atify our want u#h a foo!- Clothing- helter- an! other% Su#h a#tivitie

of earning an! )en!ing money are #alle! 2E#onomi# a#tivitie3% It wa only !uring the eighteenth #entury that A!am

Smith- the 4ather of E#onomi#- !efine! e#onomi# a the tu!y of nature an! ue of national wealth5%

Dr% Alfre! Marhall- one of the greatet e#onomit of the nineteenth #entury- write 2E#onomi# i a tu!y of man5

a#tion in the or!inary ,uine of life1 it en+uire how he get hi in#ome an! how he ue it3% Thu- it i one i!e- a

tu!y of wealth/ an! on the other- an! more im)ortant i!e/ it i the tu!y of man% A Marhall o,erve!- the #hief aim

of e#onomi# i to )romote 6human welfare5- ,ut not wealth% The !efinition given ,y AC 7igou en!ore the o)inion of

Marhall% 7igou !efine E#onomi# a 2the tu!y of e#onomi# welfare that #an ,e ,rought !ire#tly an! in!ire#tly- into

relationhi) with the meauring ro! of money3%

7rof% Lionel Ro,,in !efine! E#onomi# a 2the #ien#e- whi#h tu!ie human ,ehaviour a a relationhi) ,etween en!

an! #ar#e mean whi#h have alternative ue3% &ith thi- the fo#u of e#onomi# hifte! from 6wealth5 to human

,ehaviour5%

Lor! 8eyne !efine! e#onomi# a 6the tu!y of the a!minitration of #ar#e mean an! the !eterminant of

em)loyment an! in#ome3%

Microeconomics

MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS 1

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The tu!y of an in!ivi!ual #onumer or a firm i #alle! mi#roe#onomi# 9alo #alle! the Theory of Firm:% Mi#ro mean

6one millionth5% Mi#roe#onomi# !eal with ,ehavior an! )ro,lem of ingle in!ivi!ual an! of mi#ro organi$ation%

Managerial e#onomi# ha it root in mi#roe#onomi# an! it !eal with the mi#ro or in!ivi!ual enter)rie% It i

#on#erne! with the a))li#ation of the #on#e)t u#h a )ri#e theory- Law of Deman! an! theorie of mar0et tru#ture

an! o on%

Macroeconomics

The tu!y of 6aggregate5 or total level of e#onomi# a#tivity in a #ountry i #alle! macroeconomics% It tu!ie the flow

of e#onomi# reour#e or fa#tor of )ro!u#tion 9u#h a lan!- la,our- #a)ital- organiation an! te#hnology: from the

reour#e owner to the ,uine firm an! then from the ,uine firm to the houehol!% It !eal with total aggregate-

for intan#e- total national in#ome total em)loyment- out)ut an! total invetment% It tu!ie the interrelation among

variou aggregate an! e*amine their nature an! ,ehaviour- their !etermination an! #aue of flu#tuation in the% It

!eal with the )ri#e level in general- intea! of tu!ying the )ri#e of in!ivi!ual #ommo!itie% It i #on#erne! with the

level of em)loyment in the e#onomy% It !i#ue aggregate #onum)tion- aggregate invetment- )ri#e level- an!

)ayment- theorie of em)loyment- an! o on%

Though ma#roe#onomi# )rovi!e the ne#eary framewor0 in term of government )oli#ie et#%- for the firm to a#t u)on

!ealing with analyi of ,uine #on!ition- it ha le !ire#t relevan#e in the tu!y of theory of firm%

Management

Management i the #ien#e an! art of getting thing !one through )eo)le in formally organi$e! grou)% It i ne#eary

that every organiation ,e well manage! to ena,le it to a#hieve it !eire! goal% Management in#lu!e a num,er of

fun#tion1Planning, organizing, staffing, directing, and controlling% The manager while !ire#ting the effort of hi taff

communicates to them the goal- o,"e#tive- )oli#ie- an! )ro#e!ure/ coordinates their effort/ motivates them to

utain their enthuiam/ an! leadsthem to a#hieve the #or)orate goal%

Welfare Economics

&elfare e#onomi# i that ,ran#h of e#onomi#- whi#h )rimarily !eal with ta0ing of )overty- famine an! !itri,ution of

wealth in an e#onomy% Thi i alo #alle! Development Economics% The #entral fo#u of welfare e#onomi# i to ae

how well thing are going for the mem,er of the o#iety% If #ertain thing have gone terri,ly ,a! in ome ituation- it i

ne#eary to e*)lain why thing have gone wrong% 7rof% Amartya Sen wa awar!e! the No,el 7ri$e in E#onomi# in

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&elfare e#onomi# ta0e #are of what managerial e#onomi# ten! to ignore% In other wor!- the growth for an

e#onomi# growth with o#ietal u)liftment i #ountere! )ro!u#tive% In time of #rii- what #ome to the re#ue of )eo)le

i their won litera#y- )u,li# health fa#ilitie- a ytem of foo! !itri,ution- ta,le !emo#ra#y- o#ial afety- 9that i-

ytem or )oli#ie that ta0e #are of )eo)le when thing go wrong for one reaon or other:%

Managerial Economics

Introduction

Managerial E#onomi# a a u,"e#t gaine! )o)ularity in USA after the )u,li#ation of the ,oo0 2Managerial E#onomi#3

,y Boel Dean in ;

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Managerial E#onomi#- therefore- fo#ue on thoe tool an! te#hni+ue- whi#h are ueful in !e#iion.ma0ing%

Nature of Managerial Economics

Managerial e#onomi# i- )erha)- the younget of all the o#ial #ien#e% Sin#e it originate from E#onomi#- it ha the

,ai feature of e#onomi#- u#h a auming that other thing remaining the ame 9or the Latin e+uivalent #eteri

)ari,u:% Thi aum)tion i ma!e to im)lify the #om)le*ity of the managerial )henomenon un!er tu!y in a !ynami#

,uine environment o many thing are #hanging imultaneouly% Thi et a limitation that we #annot really hol! other

thing remaining the ame% In u#h a #ae- the o,ervation ma!e out of u#h a tu!y will have a limite! )ur)oe or

value% Managerial e#onomi# alo ha inherite! thi )ro,lem from e#onomi#%

4urther- it i aume! that the firm or the ,uyer a#t in a rational manner 9whi#h normally !oe not ha))en:% The ,uyer

i #arrie! away ,y the a!vertiement- ,ran! loyaltie- in#entive an! o on- an!- therefore- the innate ,ehaviour of the

#onumer will ,e rational i not a realiti# aum)tion% Unfortunately- there are no other alternative to un!ertan! the

u,"e#t other than ,y ma0ing u#h aum)tion% Thi i ,e#aue the ,ehaviour of a firm or a #onumer i a #om)le*

)henomenon%

The other feature of managerial e#onomi# are e*)laine! a ,elow1

(a) Close to microeconomics1 Managerial e#onomi# i #on#erne! with fin!ing the olution for !ifferent

managerial )ro,lem of a )arti#ular firm% Thu- it i more #loe to mi#roe#onomi#%

(b) Operates against the backdrop of macroeconomics1 The ma#roe#onomi# #on!ition of the e#onomy are alo

een a limiting fa#tor for the firm to o)erate% In other wor!- the managerial e#onomit ha to ,e aware of

the limit et ,y the ma#roe#onomi# #on!ition u#h a government in!utrial )oli#y- inflation an! o on%

(c) Normative statements1 A normative tatement uually in#lu!e or im)lie the wor! 6ought5 or 6houl!5% They

refle#t )eo)le5 moral attitu!e an! are e*)reion of what a team of )eo)le ought to !o% 4or intan#e- it

!eal with tatement u#h a 6Government of In!ia houl! o)en u) the e#onomy% Su#h tatement are ,ae!

on value "u!gment an! e*)re view of what i 6goo!5 or 6,a!5- 6right5 or 6 wrong5% One )ro,lem with

normative tatement i that they #annot to verify ,y loo0ing at the fa#t- ,e#aue they motly !eal with the

future% Diagreement a,out u#h tatement are uually ettle! ,y voting on them%

(d) Prescriptive actions1 7re#ri)tive a#tion i goal oriente!% Given a )ro,lem an! the o,"e#tive of the firm- it

ugget the #oure of a#tion from the availa,le alternative for o)timal olution% If !oe not merely mention

the #on#e)t- it alo e*)lain whether the #on#e)t #an ,e a))lie! in a given #onte*t on not% 4or intan#e- the

fa#t that varia,le #ot are marginal #ot #an ,e ue! to "u!ge the feai,ility of an e*)ort or!er%

(e) pplied in nature1 6Mo!el5 are ,uilt to refle#t the real life #om)le* ,uine ituation an! thee mo!el are

of immene hel) to manager for !e#iion.ma0ing% The !ifferent area where mo!el are e*tenively ue!

in#lu!e inventory #ontrol- o)timi$ation- )ro"e#t management et#% In managerial e#onomi#- we alo em)loy

#ae tu!y metho! to #on#e)tuali$e the )ro,lem- i!entify that alternative an! !etermine the ,et #oure of

a#tion%


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(f) Offers scope to evaluate each alternative1 Managerial e#onomi# )rovi!e an o))ortunity to evaluate ea#h

alternative in term of it #ot an! revenue% The managerial e#onomit #an !e#i!e whi#h i the ,etter

alternative to ma*imi$e the )rofit for the firm%

(g) Interdisciplinar!1 The #ontent- tool an! te#hni+ue of managerial e#onomi# are !rawn from !ifferent

u,"e#t u#h a e#onomi#- management- mathemati#- tatiti#- a##ountan#y- )y#hology- organi$ational,ehavior- o#iology an! et#%

(h) ssumptions and limitations1 Every #on#e)t an! theory of managerial e#onomi# i ,ae! on #ertain

aum)tion an! a u#h their vali!ity i not univeral% &here there i #hange in aum)tion- the theory may

not hol! goo! at all%

Scope of Managerial Economics:

The #o)e of managerial e#onomi# refer to it area of tu!y% Managerial e#onomi# refer to it area of tu!y%

Managerial e#onomi#- 7rovi!e management with a trategi# )lanning tool that #an ,e ue! to get a #lear )er)e#tive

of the way the ,uine worl! wor0 an! what #an ,e !one to maintain )rofita,ility in an ever.#hanging environment%

Managerial e#onomi# i )rimarily #on#erne! with the a))li#ation of e#onomi# )rin#i)le an! theorie to five ty)e of

reour#e !e#iion ma!e ,y all ty)e of ,uine organi$ation%

a% The ele#tion of )ro!u#t or ervi#e to ,e )ro!u#e!%

,% The #hoi#e of )ro!u#tion metho! an! reour#e #om,ination%

#% The !etermination of the ,et )ri#e an! +uantity #om,ination

!% 7romotional trategy an! a#tivitie%

e% The ele#tion of the lo#ation from whi#h to )ro!u#e an! ell goo! or ervi#e to #onumer%

The )ro!u#tion !e)artment- mar0eting an! ale !e)artment an! the finan#e !e)artment uually han!le thee five ty)e

of !e#iion%

The #o)e of managerial e#onomi# #over two area of !e#iion ma0ing

a% O)erational or Internal iue

,% Environmental or E*ternal iue

a. Operational issues:

O)erational iue refer to thoe- whi#h wie within the ,uine organi$ation an! they are un!er the #ontrol of the

management% Thoe are1

;% Theory of !eman! an! Deman! 4ore#ating

% 7ri#ing an! Com)etitive trategy

F% 7ro!u#tion #ot analyi

?% Reour#e allo#ation

% 7rofit analyi

% Ca)ital or Invetment analyi

>% Strategi# )lanning"# Demand nal!ses and $orecasting%


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A firm #an urvive only if it i a,le to the !eman! for it )ro!u#t at the right time- within the right +uantity%

Un!ertan!ing the ,ai# #on#e)t of !eman! i eential for !eman! fore#ating% Deman! analyi houl! ,e a ,ai#

a#tivity of the firm ,e#aue many of the other a#tivitie of the firm !e)en! u)on the out#ome of the !eman! fore #ot%

Deman! analyi )rovi!e1

;% The ,ai for analy$ing mar0et influen#e on the firm/ )ro!u#t an! thu hel) in the a!a)tation to thoe

influen#e%

% Deman! analyi alo highlight for fa#tor- whi#h influen#e the !eman! for a )ro!u#t% Thi hel) to

mani)ulate !eman!% Thu !eman! analyi tu!ie not only the )ri#e elati#ity ,ut alo in#ome elati#ity- #ro

elati#ity a well a the influen#e of a!vertiing e*)en!iture with the a!vent of #om)uter- !eman! fore#ating

ha ,e#ome an in#reaingly im)ortant fun#tion of managerial e#onomi#%

# Pricing and competitive strateg!%

7ri#ing !e#iion have ,een alway within the )review of managerial e#onomi#% 7ri#ing )oli#ie are merely a u,et of

,roa!er #la of managerial e#onomi# )ro,lem% 7ri#e theory hel) to e*)lain how )ri#e are !etermine! un!er !ifferent

ty)e of mar0et #on!ition% Com)etition analyi in#lu!e the anti#i)ation of the re)one of #om)etition the firm5

)ri#ing- a!vertiing an! mar0eting trategie% 7ro!u#t line )ri#ing an! )ri#e fore#ating o##u)y an im)ortant )la#e here%

'# Production and cost anal!sis%

7ro!u#tion analyi i in )hyi#al term% &hile the #ot analyi i in monetary term #ot #on#e)t an! #laifi#ation-

#ot.out.)ut relationhi)- e#onomie an! !ie#onomie of #ale an! )ro!u#tion fun#tion are ome of the )oint

#ontituting #ot an! )ro!u#tion analyi%

# esource llocation%

Managerial E#onomi# i the tra!itional e#onomi# theory that i #on#erne! with the )ro,lem of o)timum allo#ation of

#ar#e reour#e% Marginal analyi i a))lie! to the )ro,lem of !etermining the level of out)ut- whi#h ma*imi$e

)rofit% In thi re)e#t linear )rogramming te#hni+ue ha ,een ue! to olve o)timi$ation )ro,lem% In fa#t line

)rogramming i one of the mot )ra#ti#al an! )owerful managerial !e#iion ma0ing tool #urrently availa,le%

*# Profit anal!sis%

7rofit ma0ing i the ma"or goal of firm% There are everal #ontraint here an a##ount of #om)etition from other

)ro!u#t- #hanging in)ut )ri#e an! #hanging ,uine environment hen#e in )ite of #areful )lanning- there i alway

#ertain ri0 involve!% Managerial e#onomi# !eal with te#hni+ue of averting of minimi$ing ri0% 7rofit theory gui!e

in the meaurement an! management of )rofit- in #al#ulating the )ure return on #a)ital- ,ei!e future )rofit )lanning%

+# Capital or investment anal!ses%


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Ca)ital i the foun!ation of ,uine% La#0 of #a)ital may reult in mall i$e of o)eration% Availa,ility of #a)ital from

variou our#e li0e e+uity #a)ital- intitutional finan#e et#% may hel) to un!erta0e large.#ale o)eration% en#e

effi#ient allo#ation an! management of #a)ital i one of the mot im)ortant ta0 of the manager% The ma"or iue

relate! to #a)ital analyi are1

;% The #hoi#e of invetment )ro"e#t

% Evaluation of the effi#ien#y of #a)ital

F% Mot effi#ient allo#ation of #a)ital

8nowle!ge of #a)ital theory #an hel) very mu#h in ta0ing invetment !e#iion% Thi involve- #a)ital ,u!geting-

feai,ility tu!ie- analyi of #ot of #a)ital et#%

,# -trategic planning%

Strategi# )lanning )rovi!e management with a framewor0 on whi#h long.term !e#iion #an ,e ma!e whi#h ha an

im)a#t on the ,ehavior of the firm% The firm et #ertain long.term goal an! o,"e#tive an! ele#t the trategie to

a#hieve the ame% Strategi# )lanning i now a new a!!ition to the #o)e of managerial e#onomi# with the emergen#e of

multinational #or)oration% The )er)e#tive of trategi# )lanning i glo,al%

It i in #ontrat to )ro"e#t )lanning whi#h fo#ue on a )e#ifi# )ro"e#t or a#tivity% In fa#t the integration of managerial

e#onomi# an! trategi# )lanning ha given rie to ,e new area of tu!y #alle! #or)orate e#onomi#%

B. Environmental or Eternal Issues:

An environmental iue in managerial e#onomi# refer to the general ,uine environment in whi#h the firm o)erate%

They refer to general e#onomi#- o#ial an! )oliti#al atmo)here within whi#h the firm o)erate% A tu!y of e#onomi#

environment houl! in#lu!e1

a% The ty)e of e#onomi# ytem in the #ountry%

,% The general tren! in )ro!u#tion- em)loyment- in#ome- )ri#e- aving an! invetment%

#% Tren! in the wor0ing of finan#ial intitution li0e ,an0- finan#ial #or)oration- inuran#e #om)anie

!% Magnitu!e an! tren! in foreign tra!e/

e% Tren! in la,our an! #a)ital mar0et/

f% Government5 e#onomi# )oli#ie vi$% in!utrial )oli#y monetary )oli#y- fi#al )oli#y- )ri#e )oli#y et#%

The o#ial environment refer to o#ial tru#ture a well a o#ial organi$ation li0e tra!e union- #onumer5 #o.

o)erative et#% The 7oliti#al environment refer to the nature of tate a#tivity- #hiefly tate5 attitu!e towar! )rivate

,uine- )oliti#al ta,ility et#%

The environmental iue highlight the o#ial o,"e#tive of a firm i%e%/ the firm owe a re)oni,ility to the o#iety%

7rivate gain of the firm alone #annot ,e the goal%


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The environmental or e*ternal iue relate managerial e#onomi# to ma#ro e#onomi# theory while o)erational iue

relate the #o)e to mi#ro e#onomi# theory% The #o)e of managerial e#onomi# i ever wi!ening with the !ynami# role

of ,ig firm in a o#iety%

Managerial economics relations!ip "it! ot!er disciplines:

Many new u,"e#t have evolve! in re#ent year !ue to the intera#tion among ,ai# !i#i)line% &hile there are many

u#h new u,"e#t in natural an! o#ial #ien#e- managerial e#onomi# #an ,e ta0en a the ,et e*am)le of u#h a

)henomenon among o#ial #ien#e% en#e it i ne#eary to tra#e it root an! relation hi) with other !i#i)line%

"# elationship .ith economics%

The relationhi) ,etween managerial e#onomi# an! e#onomi# theory may ,e viewe! form the )oint of view of the

two a))roa#he to the u,"e#t Hi$% Mi#ro E#onomi# an! Mar#o E#onomi#% Mi#roe#onomi# i the tu!y of the

e#onomi# ,ehavior of in!ivi!ual- firm an! other u#h mi#ro organi$ation% Managerial e#onomi# i roote! in Mi#ro

E#onomi# theory% Managerial E#onomi# ma0e ue to everal Mi#ro E#onomi# #on#e)t u#h a marginal #ot-

marginal revenue- elati#ity of !eman! a well a )ri#e theory an! theorie of mar0et tru#ture to name only a few%

Ma#ro theory on the other han! i the tu!y of the e#onomy a a whole% It !eal with the analyi of national in#ome-

the level of em)loyment- general )ri#e level- #onum)tion an! invetment in the e#onomy an! even matter relate! to

international tra!e- Money- )u,li# finan#e- et#%

The relationhi) ,etween managerial e#onomi# an! e#onomi# theory i li0e that of engineering #ien#e to )hyi# or

of me!i#ine to ,iology% Managerial e#onomi# ha an a))lie! ,ia an! it wi!er #o)e lie in a))lying e#onomi# theory

to olve real life )ro,lem of enter)rie% @oth managerial e#onomi# an! e#onomi# !eal with )ro,lem of #ar#ity an!

reour#e allo#ation%

# Management theor! and accounting%

Managerial e#onomi# ha ,een influen#e! ,y the !evelo)ment in management theory an! a##ounting te#hni+ue%

A##ounting refer to the re#or!ing of )e#uniary trana#tion of the firm in #ertain ,oo0% A )ro)er 0nowle!ge of

a##ounting te#hni+ue i very eential for the u##e of the firm ,e#aue )rofit ma*imi$ation i the ma"or o,"e#tive of

the firm%

Managerial E#onomi# re+uire a )ro)er 0nowle!ge of #ot an! revenue information an! their #laifi#ation% A tu!ent

of managerial e#onomi# houl! ,e familiar with the generation- inter)retation an! ue of a##ounting !ata% The fo#u of

a##ounting within the firm i fat #hanging from the #on#e)t of tore 0ee)ing to that if managerial !e#iion ma0ing-

thi ha reulte! in a new )e#iali$e! area of tu!y #alle! 2Managerial A##ounting3%

'# Managerial /conomics and mathematics%

The ue of mathemati# i ignifi#ant for managerial e#onomi# in view of it )rofit ma*imi$ation goal long with

o)tional ue of reour#e% The ma"or )ro,lem of the firm i how to minimi$e #ot- hoe to ma*imi$e )rofit or how to


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o)timi$e ale% Mathemati#al #on#e)t an! te#hni+ue are wi!ely ue! in e#onomi# logi# to olve thee )ro,lem% Alo

mathemati#al metho! hel) to etimate an! )re!i#t the e#onomi# fa#tor for !e#iion ma0ing an! forwar! )lanning%

Mathemati#al ym,ol are more #onvenient to han!le an! un!ertan! variou #on#e)t li0e in#remental #ot- elati#ityof !eman! et#%- Geometry- Alge,ra an! #al#ulu are the ma"or ,ran#he of mathemati# whi#h are of ue in managerial

e#onomi#% The main #on#e)t of mathemati# li0e logarithm- an! e*)onential- ve#tor an! !eterminant- in)ut.out)ut

mo!el et#%- are wi!ely ue!% @ei!e thee uual tool- more a!van#e! te#hni+ue !eigne! in the re#ent year vi$%

linear )rogramming- inventory mo!el an! game theory fine wi!e a))li#ation in managerial e#onomi#%

# Managerial /conomics and -tatistics%

Managerial E#onomi# nee! the tool of tatiti# in more than one way% A u##eful ,uineman mut #orre#tly

etimate the !eman! for hi )ro!u#t% e houl! ,e a,le to analye the im)a#t of variation in tate% 4ahion an!

#hange in in#ome on !eman! only then he #an a!"ut hi out)ut% Statiti#al metho! )rovi!e an! ure ,ae for !e#iion.

ma0ing% Thu tatiti#al tool are ue! in #olle#ting !ata an! analy$ing them to hel) in the !e#iion ma0ing )ro#e%

Statiti#al tool li0e the theory of )ro,a,ility an! fore#ating te#hni+ue hel) the firm to )re!i#t the future #oure of

event% Managerial E#onomi# alo ma0e ue of #orrelation an! multi)le regreion in relate! varia,le li0e )ri#e an!

!eman! to etimate the e*tent of !e)en!en#e of one varia,le on the other% The theory of )ro,a,ility i very ueful in

)ro,lem involving un#ertainty%

*# Managerial /conomics and Operations esearch%

Ta0ing effe#tive !e#iion i the ma"or #on#ern of ,oth managerial e#onomi# an! o)eration reear#h% The

!evelo)ment of te#hni+ue an! #on#e)t u#h a linear )rogramming- inventory mo!el an! game theory i !ue to the

!evelo)ment of thi new u,"e#t of o)eration reear#h in the )otwar year% O)eration reear#h i #on#erne! with the

#om)le* )ro,lem ariing out of the management of men- ma#hine- material an! money%

O)eration reear#h )rovi!e a #ientifi# mo!el of the ytem an! it hel) managerial e#onomit in the fiel! of )ro!u#t

!evelo)ment- material management- an! inventory #ontrol- +uality #ontrol- mar0eting an! !eman! analyi% The varie!

tool of o)eration Reear#h are hel)ful to managerial e#onomit in !e#iion.ma0ing%

+# Managerial /conomics and the theor! of Decision0 making%

The Theory of !e#iion.ma0ing i a new fiel! of 0nowle!ge grown in the e#on! half of thi #entury% Mot of the

e#onomi# theorie e*)lain a ingle goal for the #onumer i%e%- 7rofit ma*imi$ation for the firm% @ut the theory of!e#iion.ma0ing i !evelo)e! to e*)lain multi)li#ity of goal an! lot of un#ertainty%


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A u#h thi new ,ran#h of 0nowle!ge i ueful to ,uine firm- whi#h have to ta0e +ui#0 !e#iion in the #ae of

multi)le goal% Hiewe! thi way the theory of !e#iion ma0ing i more )ra#ti#al an! a))li#ation oriente! than the

e#onomi# theorie%

,# Managerial /conomics and Computer -cience%

Com)uter have #hange the way of the worl! fun#tion an! e#onomi# or ,uine a#tivity i no e*#e)tion% Com)uter

are ue! in !ata an! a##ount maintenan#e- inventory an! to#0 #ontrol an! u))ly an! !eman! )re!i#tion% &hat ue!

to ta0e !ay an! month i !one in a few minute or hour ,y the #om)uter% In fa#t #om)uteri$ation of ,uine

a#tivitie on a large #ale ha re!u#e! the wor0loa! of managerial )eronnel% In mot #ountrie a ,ai# 0nowle!ge of

#om)uter #ien#e- i a #om)ulory )rogramme for managerial trainee%

To #on#lu!e- managerial e#onomi#- whi#h i an offhoot tra!itional e#onomi#- ha gaine! trength to ,e a e)arate

,ran#h of 0nowle!ge% It trength lie in it a,ility to integrate i!ea from variou )e#iali$e! u,"e#t to gain a )ro)er

)er)e#tive for !e#iion.ma0ing%

A u##eful managerial e#onomit mut ,e a mathemati#ian- a tatiti#ian an! an e#onomit% e mut ,e alo a,le to

#om,ine )hiloo)hi# metho! with hitori#al metho! to get the right )er)e#tive only then/ he will ,e goo! at

)re!i#tion% In hort managerial )ra#ti#e with the hel) of other allie! #ien#e%

T#E $O%E O& M'N'(E$I'% E)ONOMIST

Ma0ing !e#iion an! )ro#eing information are the two )rimary ta0 of the manager% Managerial e#onomit have

gaine! im)ortan#e in re#ent year with the emergen#e of an organi$ational #ulture in )ro!u#tion an! ale a#tivitie%

A management e#onomit with oun! 0nowle!ge of theory an! analyti#al tool for information ytem o##u)ie a

)retigiou )la#e among the )eronnel% A managerial e#onomit i nearer to the )oli#y.ma0ing% E+ui))e! with

)e#iali$e! 0ill an! mo!ern te#hni+ue he analye the internal an! e*ternal o)eration of the firm% e evaluate an!

hel) in !e#iion ma0ing regar!ing ale- 7ri#ing finan#ial iue- la,our relation an! )rofita,ility% e hel) in

!e#iion.ma0ing 0ee)ing in view the !ifferent goal of the firm%

i role in !e#iion.ma0ing a))lie to routine affair u#h a )ri#e fi*ation- im)rovement in +uality- Lo#ation of )lant-

e*)anion or #ontra#tion of out)ut et#% The role of managerial e#onomit in internal management #over wi!e area of

)ro!u#tion- ale an! inventory #he!ule of the firm%

The mot im)ortant role of the managerial e#onomit relate to !eman! fore#ating ,e#aue an analyi of general

,uine #on!ition i mot vital for the u##e of the firm% e )re)are a hort.term fore#at of general ,uine

a#tivity an! relate general e#onomi# fore#at to )e#ifi# mar0et tren!% Mot firm re+uire two fore#at one #overingthe hort term 9for net three month to one year: an! the other #overing the long term- whi#h re)reent any )erio!


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e*#ee!ing one.year% e ha to ,e ever alert to gauge the #hange in tate an! )referen#e of the #onumer% e houl!

evaluate the mar0et )otential% The nee! to 0now fore#ating te#hni+ue on the )art of the managerial e#onomi# mean-

he houl! ,e a!e)t at mar0et reear#h% The )ur)oe of mar0et reear#h i to )rovi!e a firm with information a,out

#urrent mar0et )oition a well a )reent an! )oi,le future tren! in the in!utry% A managerial e#onomit who i well

e+ui))e! with thi 0nowle!ge #an hel) the firm to )lan )ro!u#t im)rovement- new )ro!u#t )oli#y- )ri#ing- an! ale)romotion trategy%

The fourth fun#tion of the managerial e#onomit i to un!erta0e an e#onomi# analyi of the in!utry% Thi i #on#erne!

with )ro"e#t evaluation an! feai,ility tu!y at the firm level i%e%- he houl! ,e a,le to "u!ge on the ,ai of #ot ,enefit

analyi- whether it i a!via,le an! )rofita,le to go ahea! with the )ro"e#t% The managerial e#onomit houl! ,e a!e)t

at invetment a))raial metho!% At the e*ternal level- e#onomi# analyi involve the 0nowle!ge of #om)etition

involve!- )oi,ility of internal an! foreign ale- the general ,uine #limate et#%

Another fun#tion i e#urity management analyi% Thi i very im)ortant in the #ae of !efene.oriente! in!utrie-

)ower )ro"e#t- an! nu#lear )lant where e#urity i very eential% Se#urity management mean- alo that the

)ro!u#tion an! tra!e e#ret #on#erning te#hnology- +uality an! other u#h relate! fa#t houl! not ,e lea0e! out to

other% Thi e#urity i more ne#eary in trategi# an! !efene.oriente! )ro"e#t of national im)ortan#e/ a managerial

e#onomit houl! ,e a,le to manage thee iue of e#urity management analyi%

The i*th fun#tion i an a!viory fun#tion% ere hi a!vi#e i re+uire! on all matter of )ro!u#tion an! tra!e% In the

hierar#hy of management- a managerial e#onomit ran0 ne*t to the to) e*e#utive or the )oli#y ma0er who may ,e

!oyen of everal )ro"e#t% It i the managerial e#onomit of ea#h firm who ha to a!vie them on all matter of tra!e

in#e they are in the 0now of a#tual fun#tioning of the unit in all a)e#t- ,oth te#hni#al an! finan#ial%

Another fun#tion of im)ortan#e for the managerial e#onomit i a #on#erne! with )ri#ing an! relate! )ro,lem% The

u##e of the firm !e)en! u)on a )ro)er )ri#ing trategy% The )ri#ing !e#iion i one of the mot !iffi#ult !e#iion to

,e ma!e in ,uine ,e#aue the information re+uire! i never fully availa,le% 7ri#ing of eta,lihe! )ro!u#t i

!ifferent from new )ro!u#t% e may have to o)erate in an atmo)here #ontraine! ,y government regulation% e may

have to anti#i)ate the rea#tion of #om)etitor in )ri#ing% The managerial e#onomit ha to ,e very alert an! !ynami# to

ta0e #orre#t )ri#ing !e#iion in #hanging environment%

4inally the )e#ifi# fun#tion of a managerial e#onomit in#lu!e an analyi of environment iue% Mo!ern theory of

managerial e#onomi# re#ogni$e the o#ial re)oni,ility of the firm% It refer to the im)a#t of a firm on environmental

fa#tor% It houl! not have a!vere im)a#t on )ollution an! if )oi,le try to #ontri,ute to environmental )reervation

an! )rote#tion in a )oitive way%

The role of management e#onomit lie not in ta0ing !e#iion ,ut in analy$ing- #on#lu!ing an! re#ommen!ing to the

)oli#y ma0er% e houl! have the free!om to o)erate an! analy$e an! mut )oe full 0nowle!ge of fa#t% e ha to

#olle#t an! )rovi!e the +uantitative !ata from within the firm% e ha to get information on e*ternal ,uine

environment u#h a general mar0et #on!ition- tra!e #y#le- an! ,ehavior )attern of the #onumer% The managerial

e#onomit hel) to #o.or!inate )oli#ie relating to )ro!u#tion- invetment- inventorie an! )ri#e%


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e houl! have e+uanimity to meet #rii% e houl! a#t only after analyi an! !i#uion with relevant !e)artment%

e houl! have !i)loma#y to a#t in a!viory #a)a#ity to the to) e*e#utive a well a getting #o.o)eration from !ifferent

!e)artment for hi e#onomi# analyi% e houl! !o well to have intuitive a,ility to 0now what i goo! or ,a! for the

firm%

e houl! have oun! theoreti#al 0nowle!ge to ta0e u) the #hallenge he ha to fa#e in a#tual !ay to !ay affair%

2@ANMOL3 referring to the role of managerial e#onomit )oint out% 2A managerial e#onomit #an ,e#ome a for more

hel)ful mem,er of a management grou) ,y virtue of tu!ie of e#onomi# analyi- )rimarily ,e#aue there he learn to

,e#ome an effe#tive mo!el ,uil!er an! ,e#aue there he a#+uire a very ri#h ,o!y of tool an! te#hni+ue whi#h #an

hel) to !eal with the )ro,lem of the firm in a far more rigorou- a far more )ro,ing an! a far !ee)er manner3%

*UESTIONS

;% &hat i managerial e#onomi#' E*)lain it fo#u are a% 7oint out the im)ortan#e of managerial e#onomi# in !e#iion ma0ingF% &hat are the #ontri,ution an! limitation of e#onomi# analyi in ,uine !e#iion ma0ing?% Managerial E#onomi# i the !i#i)line whi#h !eal with the a))li#ation of e#onomi# theory to ,uine

management !i#u%% E*)lain the fun!amental #on#e)t of managerial e#onomi#% Di#u the nature S#o)e of Managerial e#onomi#>% Managerial E#onomi# i the tu!y of allo#ation of reour#e availa,le to a firm or other unit of management

among the a#tivitie of that unit e*)lain%=% E*)lain the nature of )ro,lem tu!ie in managerial e#onomi#% &hat i the im)ortan#e of the tu!y of u#h

)ro,lem in ,uine management'

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9#: O)erational Environmental iue 9!: None

>% The relationhi) ,etween Managerial E#onomi# an! E#onomi# Theory i

li0e that of Engineering S#ien#e to 7hyi# 9or: Me!i#ine to JJJJJJJJJJJ% 9 : 9a: Mathemati# 9,: E#onomi# 9#: @iology 9!: A##ountan#y

=% Ma0ing !e#iion an! )ro#eing information are the two 7rimary ta0 of the Manager % It wa e*)laine! ,y the u,"e#t JJJJJJJJJJJJJJJJJJJJJ% 9 :

9a: 7hyi# 9,: Engineering S#ien#e 9#: Managerial E#onomi# 9!: Chemitry

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1EM'N1 'N'%2SIS

Introduction 0 Meaning:

Deman! in #ommon )arlan#e mean the !eire for an o,"e#t% @ut in e#onomi# !eman! i omething more than thi%A##or!ing to Stonier an! ague- 2Deman! in e#onomi# mean !eman! ,a#0e! u) ,y enough money to )ay for the

goo! !eman!e!3% Thi mean that the !eman! ,e#ome effe#tive only it if i ,a#0e! ,y the )ur#haing )ower in

a!!ition to thi there mut ,e willingne to ,uy a #ommo!ity%

Thu !eman! in e#onomi# mean the !eire ,a#0e! ,y the willingne to ,uy a #ommo!ity an! the )ur#haing )ower

to )ay% In the wor! of 2@enham3 2The !eman! for anything at a given )ri#e i the amount of it whi#h will ,e ,ought

)er unit of time at that 7ri#e3% 9Thu !eman! i alway at a )ri#e for a !efinite +uantity at a )e#ifie! time%: Thu

!eman! ha three eential K )ri#e- +uantity !eman!e! an! time% &ithout thee- !eman! ha to ignifi#an#e in

e#onomi#%

%'W of 1emand:

Law of !eman! how the relation ,etween )ri#e an! +uantity !eman!e! of a #ommo!ity in the mar0et% In the wor! of

Marhall- 2the amount !eman! in#reae with a fall in )ri#e an! !iminihe with a rie in )ri#e3%

A rie in the )ri#e of a #ommo!ity i followe! ,y a re!u#tion in !eman! an! a fall in )ri#e i followe! ,y an in#reae in

!eman!- if a #on!ition of !eman! remain #ontant%

The law of !eman! may ,e e*)laine! with the hel) of the following !eman! #he!ule%

Demand -chedule#

7ri#e of A))el 9In% R%: uantity Deman!e!

; ;

=

F

? ?

&hen the )ri#e fall from R% ; to = +uantity !eman!

in#reae from ; to % In the ame way a )ri#e fall-

+uantity !eman! in#reae on the ,ai of the

!eman! #he!ule we #an !raw the !eman!

#urve%


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7ri#e

The !eman! #urve DD how the invere relation ,etween )ri#e an! +uantity !eman! of a))le% It i !ownwar! lo)ing%

ssumptions%

Law i !eman! i ,ae! on #ertain aum)tion1

;% Thi i no #hange in #onumer tate an! )referen#e%

% In#ome houl! remain #ontant%

F% 7ri#e of other goo! houl! not #hange%

?% There houl! ,e no u,titute for the #ommo!ity

% The #ommo!ity houl! not #onfer at any !itin#tion

% The !eman! for the #ommo!ity houl! ,e #ontinuou

>% 7eo)le houl! not e*)e#t any #hange in the )ri#e of the #ommo!ity

/1ceptional demand curve%

Some time the !eman! #urve lo)e u)war! from left to right% In thi #ae the !eman! #urve ha a )oitive lo)e%

7ri#e

&hen )ri#e in#reae from O7 to O); +uantity !eman!e! alo in#reae from to O; an! vi#e vera% The reaon for

e*#e)tional !eman! #urve are a follow%

"# 2iffen parado1%


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The Giffen goo! or inferior goo! i an e*#e)tion to the law of !eman!% &hen the )ri#e of an inferior goo! fall- the

)oor will ,uy le an! vi#e vera% 4or e*am)le- when the )ri#e of mai$e fall- the )oor are willing to )en! more on

u)erior goo! than on mai$e if the )ri#e of mai$e in#reae- he ha to in#reae the +uantity of money )ent on it%

Otherwie he will have to fa#e tarvation% Thu a fall in )ri#e i followe! ,y re!u#tion in +uantity !eman!e! an! vi#evera% 2Giffen3 firt e*)laine! thi an! therefore it i #alle! a Giffen5 )ara!o*%

# 3eblen or Demonstration effect%

6He,lan5 ha e*)laine! the e*#e)tional !eman! #urve through hi !o#trine of #on)i#uou #onum)tion% Ri#h )eo)le

,uy #ertain goo! ,e#aue it give o#ial !itin#tion or )retige for e*am)le !iamon! are ,ought ,y the ri#her #la for

the )retige it )oe% It the )ri#e of !iamon! fall )oor alo will ,uy i hen#e they will not give )retige% Therefore-

ri#h )eo)le may to) ,uying thi #ommo!ity%

'# Ignorance%

Sometime- the +uality of the #ommo!ity i Bu!ge ,y it )ri#e% Conumer thin0 that the )ro!u#t i u)erior if the )ri#e

i high% A u#h they ,uy more at a higher )ri#e%

# -peculative effect%

If the )ri#e of the #ommo!ity i in#reaing the #onumer will ,uy more of it ,e#aue of the fear that it in#reae till

further- Thu- an in#reae in )ri#e may not ,e a##om)lihe! ,y a !e#reae in !eman!%

*# $ear of shortage%

During the time of emergen#y of war 7eo)le may e*)e#t hortage of a #ommo!ity% At that time- they may ,uy more at

a higher )ri#e to 0ee) to#0 for the future%

*# Necessaries%

In the #ae of ne#earie li0e ri#e- vegeta,le et#% )eo)le ,uy more even at a higher )ri#e%

&actors 'ffecting 1emand:

There are fa#tor on whi#h the !eman! for a #ommo!ity !e)en!% Thee fa#tor are e#onomi#- o#ial a well a )oliti#al

fa#tor% The effe#t of all the fa#tor on the amount !eman!e! for the #ommo!ity i #alle! Deman! 4un#tion%

Thee fa#tor are a follow1

"# Price of the Commodit!%


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The mot im)ortant fa#tor.affe#ting amount !eman!e! i the )ri#e of the #ommo!ity% The amount of a #ommo!ity

!eman!e! at a )arti#ular )ri#e i more )ro)erly #alle! )ri#e !eman!% The relation ,etween )ri#e an! !eman! i #alle!

the Law of Deman!% It i not only the e*iting )ri#e ,ut alo the e*)e#te! #hange in )ri#e- whi#h affe#t !eman!%

# Income of the Consumer%

The e#on! mot im)ortant fa#tor influen#ing !eman! i #onumer in#ome% In fa#t- we #an eta,lih a relation ,etween

the #onumer in#ome an! the !eman! at !ifferent level of in#ome- )ri#e an! other thing remaining the ame% The

!eman! for a normal #ommo!ity goe u) when in#ome rie an! fall !own when in#ome fall% @ut in #ae of Giffen

goo! the relationhi) i the o))oite%

'# Prices of related goods1

The !eman! for a #ommo!ity i alo affe#te! ,y the #hange in )ri#e of the relate! goo! alo% Relate! goo! #an ,e of

two ty)e1

9i:% Su,titute whi#h #an re)la#e ea#h other in ue/ for e*am)le- tea an! #offee are

u,titute% The #hange in )ri#e of a u,titute ha effe#t on a #ommo!ity5 !eman!

in the ame !ire#tion in whi#h )ri#e #hange% The rie in )ri#e of #offee hall raie

the !eman! for tea/

9ii:% Com)lementary foo! are thoe whi#h are "ointly !eman!e!- u#h a )en an! in0% In

u#h #ae #om)lementary goo! have o))oite relationhi) ,etween )ri#e of one

#ommo!ity an! the amount !eman!e! for the other% If the )ri#e of )en goe u)-

their !eman! i le a a reult of whi#h the !eman! for in0 i alo le% The )ri#e

an! !eman! go in o))oite !ire#tion% The effe#t of #hange in )ri#e of a #ommo!ity on

amount !eman!e! of relate! #ommo!itie i #alle! Cro Deman!%

# 4astes of the Consumers%

The amount !eman!e! alo !e)en! on #onumer5 tate% Tate in#lu!e fahion- ha,it- #utom- et#% A #onumer5 tate

i alo affe#te! ,y a!vertiement% If the tate for a #ommo!ity goe u)- it amount !eman!e! i more even at the ame

)ri#e% Thi i #alle! in#reae in !eman!% The o))oite i #alle! !e#reae in !eman!%

*# 5ealth%

The amount !eman!e! of #ommo!ity i alo affe#te! ,y the amount of wealth a well a it !itri,ution% The wealthier

are the )eo)le/ higher i the !eman! for normal #ommo!itie% If wealth i more e+ually !itri,ute!- the !eman! for


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ne#earie an! #omfort i more% On the other han!- if ome )eo)le are ri#h- while the ma"oritie are )oor- the !eman!

for lu*urie i generally higher%

+# Population%

In#reae in )o)ulation in#reae !eman! for ne#earie of life% The #om)oition of )o)ulation alo affe#t !eman!%

Com)oition of )o)ulation mean the )ro)ortion of young an! ol! an! #hil!ren a well a the ratio of men to women% A

#hange in #om)oition of )o)ulation ha an effe#t on the nature of !eman! for !ifferent #ommo!itie%

,# 2overnment Polic!%

Government )oli#y affe#t the !eman! for #ommo!itie through ta*ation% Ta*ing a #ommo!ity in#reae it )ri#e an!

the !eman! goe !own% Similarly- finan#ial hel) from the government in#reae the !eman! for a #ommo!ity while

lowering it )ri#e%

6# /1pectations regarding the future%

If #onumer e*)e#t #hange in )ri#e of #ommo!ity in future- they will #hange the !eman! at )reent even when the

)reent )ri#e remain the ame% Similarly- if #onumer e*)e#t their in#ome to rie in the near future they may in#reae

the !eman! for a #ommo!ity "ut now%

7# Climate and .eather%

The #limate of an area an! the weather )revailing there ha a !e#iive effe#t on #onumer5 !eman!% In #ol! area

woolen #loth i !eman!e!% During hot ummer !ay- i#e i very mu#h in !eman!% On a rainy !ay- i#e #ream i not o

mu#h !eman!e!%

"8# -tate of business%

The level of !eman! for !ifferent #ommo!itie alo !e)en! u)on the ,uine #on!ition in the #ountry% If the #ountry

i )aing through ,oom #on!ition- there will ,e a mar0e! in#reae in !eman!% On the other han!- the level of !eman!

goe !own !uring !e)reion%


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UNIT - II

E%'STI)IT2 O& 1EM'N1

Elati#ity of !eman! e*)lain the relationhi) ,etween a #hange in )ri#e an! #one+uent #hange in amount !eman!e!%

2Marhall3 intro!u#e! the #on#e)t of elati#ity of !eman!% Elati#ity of !eman! how the e*tent of #hange in +uantity

!eman!e! to a #hange in )ri#e%

In the wor! of 2Marhall3- 2The elati#ity of !eman! in a mar0et i great or mall a##or!ing a the amount !eman!e!

in#reae mu#h or little for a given fall in the )ri#e an! !iminihe mu#h or little for a given rie in 7ri#e3

Elastic demand:A mall #hange in )ri#e may lea! to a great #hange in +uantity !eman!e!% In thi #ae- !eman! i

elati#%

In-elastic demand:If a ,ig #hange in )ri#e i followe! ,y a mall #hange in !eman!e! then the !eman! in 2inelati#3%


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T3pes of Elasticit3 of 1emand:

There are three ty)e of elati#ity of !eman!1

;% 7ri#e elati#ity of !eman!

% In#ome elati#ity of !eman!

F% Cro elati#ity of !eman!

4. 5rice elasticit3 of demand:

Marhall wa the firt e#onomit to !efine )ri#e elati#ity of !eman!% 7ri#e elati#ity of !eman! meaure #hange in

+uantity !eman! to a #hange in 7ri#e% It i the ratio of )er#entage #hange in +uantity !eman!e! to a )er#entage #hange

in )ri#e%

7ro)ortionate #hange in the +uantity !eman! of #ommo!ity

5rice elasticit3 ..................................................................

7ro)ortionate #hange in the )ri#e of #ommo!ity

There are five #ae of )ri#e elati#ity of !eman!

'. 5erfectl3 elastic demand:

&hen mall #hange in )ri#e lea! to an infinitely large #hange i +uantity !eman!- it i #alle! )erfe#tly or infinitely

elati# !eman!% In thi #ae E

The !eman! #urve DD; i hori$ontal traight line% It how the at 2O73 )ri#e any amount i !eman! an! if )ri#e

in#reae- the #onumer will not )ur#hae the #ommo!ity%

B. 5erfectl3 Inelastic 1emand

In thi #ae- even a large #hange in )ri#e fail to ,ring a,out a #hange in +uantity !eman!e!%


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&hen )ri#e in#reae from 6O75 to 6O75- the +uantity !eman!e! remain the ame% In other wor! the re)one of

!eman! to a #hange in 7ri#e i nil% In thi #ae 6E5%

). $elativel3 elastic demand:

Deman! #hange more than )ro)ortionately to a #hange in )ri#e% i%e% a mall #hange in )ri#e loa! to a very ,ig #hange

in the +uantity !eman!e!% In thi #ae

E ;% Thi !eman! #urve will ,e flatter%

&hen )ri#e fall from 6O75 to 6O75- amount !eman!e! in #reae from 2O5 to 2O;5 whi#h i larger than the #hange in

)ri#e%

1. $elativel3 in-elastic demand.

uantity !eman!e! #hange le than )ro)ortional to a #hange in )ri#e% A large #hange in )ri#e lea! to mall #hange in

amount !eman!e!% ere E P ;% Deman!e! #arve will ,e tee)er%


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&hen )ri#e fall from 2O75 to 6O7; amount !eman!e! in#reae from O to O;- whi#h i maller than the #hange in

)ri#e%

E. Unit elasticit3 of demand:

The #hange in !eman! i e*a#tly e+ual to the #hange in )ri#e% &hen ,oth are e+ual E; an! elati#ity if ai! to ,e

unitary%

&hen )ri#e fall from 6O75 to 6O7;5 +uantity !eman!e! in#reae from 6O75 to 6O7;5- +uantity !eman!e! in#reae

from 6O5 to 6O;5% Thu a #hange in )ri#e ha reulte! in an e+ual #hange in +uantity !eman!e! o )ri#e elati#ity of

!eman! i e+ual to unity%

6. Income elasticit3 of demand:


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In#ome elati#ity of !eman! how the #hange in +uantity !eman!e! a a reult of a #hange in in#ome% In#ome

elati#ity of !eman! may ,e late! in the form of a formula%

7ro)ortionate #hange in the +uantity !eman! of #ommo!ityIncome Elasticit3 ..................................................................

7ro)ortionate #hange in the in#ome of the )eo)le

In#ome elati#ity of !eman! #an ,e #laifie! in to five ty)e%

'. +ero income elasticit3:

uantity !eman!e! remain the ame- even though money in#ome in#reae% Sym,oli#ally- it #an ,e e*)ree! a Ey%

It #an ,e !e)i#te! in the following way1

A in#ome in#reae from O( to O(;-

+uantity !eman!e! never #hange%

B. Negative Income elasticit3:

&hen in#ome in#reae- +uantity !eman!e! fall% In thi #ae- in#ome elati#ity of !eman! i negative% i%e%- Ey P %


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&hen in#ome in#reae from O( to O(;- !eman! fall from O to O;%

c. Unit income elasticit3:

&hen an in#reae in in#ome ,ring a,out a )ro)ortionate in#reae in +uantity !eman!e!- an! then in#ome elati#ity of

!eman! i e+ual to one% Ey ;

&hen in#ome in#reae from O( to O(;- uantity !eman!e! alo in#reae from O to O;%

d. Income elasticit3 greater t!an unit3:

In thi #ae- an in#reae in #ome ,ring a,out a more than )ro)ortionate in#reae in +uantity !eman!e!% Sym,oli#ally it

#an ,e written a Ey ;%

It how high.in#ome elati#ity of !eman!% &hen in#ome in#reae from O(

to O(;- uantity !eman!e! in#reae from O to O;%


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E. Income elasticit3 leas t!an unit3:

&hen in#ome in#reae +uantity !eman!e! alo in#reae ,ut le than )ro)ortionately% In thi #ae E P ;%

An in#reae in in#ome from O( to O(- ,ring what an in#reae in +uantity !eman!e! from O to O;- @ut the

in#reae in +uantity !eman!e! i maller than the in#reae in in#ome% en#e- in#ome elati#ity of !eman! i le than

one%

7. )ross elasticit3 of 1emand:

A #hange in the )ri#e of one #ommo!ity lea! to a #hange in the +uantity !eman!e! of another #ommo!ity% Thi i

#alle! a #ro elati#ity of !eman!% The formula for #ro elati#ity of !eman! i1

7ro)ortionate #hange in the +uantity !eman! of #ommo!ity 28

)ross elasticit3 .......................................................................

7ro)ortionate #hange in the )ri#e of #ommo!ity 22

a.In case of sustitutes- #ro elati#ity of !eman! i )oitive% Eg1 Coffee an! Tea

&hen the )ri#e of #offee in#reae- uantity !eman!e! of tea in#reae% @oth are u,titute%

7ri#e of Coffee


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.Incase of compliments- #ro elati#ity i negative% If in#reae in the )ri#e of one #ommo!ity lea! to a !e#reae in

the +uantity !eman!e! of another an! vi#e vera%

&hen )ri#e of #ar goe u) from O7 to O7Q- the +uantity !eman!e! of )etrol !e#reae from O to OQ% The #ro.

!eman!e! #urve ha negative lo)e%

c.In case of unrelated commodities- #ro elati#ity of !eman!e! i $ero% A #hange in the )ri#e of one #ommo!ity will

not affe#t the +uantity !eman!e! of another%

uantity !eman!e! of #ommo!ity 2,3 remain un#hange! !ue to a #hange in the )ri#e of 6A5- a ,oth are unrelate!

goo!%


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&actors influencing t!e elasticit3 of demand

Elati#ity of !eman! !e)en! on many fa#tor%

"# Nature of commodit!%

Elati#ity or in.elati#ity of !eman! !e)en! on the nature of the #ommo!ity i%e% whether a #ommo!ity i a ne#eity-

#omfort or lu*ury- normally/ the !eman! for Ne#earie li0e alt- ri#e et# i inelati#% On the other ,an!- the !eman!

for #omfort an! lu*urie i elati#%

# vailabilit! of substitutes%

Elati#ity of !eman! !e)en! on availa,ility or non.availa,ility of u,titute% In #ae of #ommo!itie- whi#h have

u,titute- !eman! i elati#- ,ut in #ae of #ommo!itie- whi#h have no u,titute- !eman! i in elati#%

'# 3ariet! of uses%

If a #ommo!ity #an ,e ue! for everal )ur)oe- than it will have elati# !eman!% i%e% ele#tri#ity% On the other han!-

!eman!e! i inelati# for #ommo!itie- whi#h #an ,e )ut to only one ue%

# Postponement of demand%

If the #onum)tion of a #ommo!ity #an ,e )ot)one!- than it will have elati# !eman!% On the #ontrary- if the !eman!

for a #ommo!ity #annot ,e )ot)one- than !eman! i in elati#% The !eman! for ri#e or me!i#ine #annot ,e )ot)one!-

while the !eman! for Cy#le or um,rella #an ,e )ot)one!%

*# mount of mone! spent%

Elati#ity of !eman! !e)en! on the amount of money )ent on the #ommo!ity% If the #onumer )en! a maller for

e*am)le a #onumer )en! a little amount on alt an! mat#h,o*e% Even when )ri#e of alt or mat#h,o* goe u)-

!eman!e! will not fall% Therefore- !eman! i in #ae of #lothing a #onumer )en! a large )ro)ortion of hi in#ome

an! an in#reae in )ri#e will re!u#e hi !eman! for #lothing% So the !eman! i elati#%

+# 4ime%

Elati#ity of !eman! varie with time% Generally- !eman! i inelati# !uring hort )erio! an! elati# !uring the long)erio!% Deman! i inelati# !uring hort )erio! ,e#aue the #onumer !o not have enough time to 0now a,out the


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#hange i )ri#e% Even if they are aware of the )ri#e #hange- they may not imme!iately wit#h over to a new #ommo!ity-

a they are a##utome! to the ol! #ommo!ity%

,# ange of Prices%

Range of )ri#e e*ert an im)ortant influen#e on elati#ity of !eman!% At a very high )ri#e- !eman! i inelati# ,e#aue

a light fall in )ri#e will not in!u#e the )eo)le ,uy more% Similarly at a low )ri#e alo !eman! i inelati#% Thi i

,e#aue at a low )ri#e all thoe who want to ,uy the #ommo!ity woul! have ,ought it an! a further fall in )ri#e will not

in#reae the !eman!% Therefore- elati#ity i low at very him an! very low )ri#e%

Importance of Elasticit3 of 1emand:

The #on#e)t of elati#ity of !eman! i of mu#h )ra#ti#al im)ortan#e%

"# Price fi1ation%

Ea#h eller un!er mono)oly an! im)erfe#t #om)etition ha to ta0e into a##ount elati#ity of !eman! while fi*ing the

)ri#e for hi )ro!u#t% If the !eman! for the )ro!u#t i inelati#- he #an fi* a higher )ri#e%

# Production%

7ro!u#er generally !e#i!e their )ro!u#tion level on the ,ai of !eman! for the )ro!u#t% en#e elati#ity of !eman!

hel) the )ro!u#er to ta0e #orre#t !e#iion regar!ing the level of #ut )ut to ,e )ro!u#e!%

'# Distribution%

Elati#ity of !eman! alo hel) in the !etermination of rewar! for fa#tor of )ro!u#tion% 4or e*am)le- if the !eman!

for la,our i inelati#- tra!e union will ,e u##eful in raiing wage% It i a))li#a,le to other fa#tor of )ro!u#tion%

# International 4rade%

Elati#ity of !eman! hel) in fin!ing out the term of tra!e ,etween two #ountrie% Term of tra!e refer to the rate at

whi#h !ometi# #ommo!ity i e*#hange! for foreign #ommo!itie% Term of tra!e !e)en! u)on the elati#ity of

!eman! of the two #ountrie for ea#h other goo!%

*# Public $inance%


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Elati#ity of !eman! hel) the government in formulating ta* )oli#ie% 4or e*am)le- for im)oing ta* on a #ommo!ity-

the 4inan#e Miniter ha to ta0e into a##ount the elati#ity of !eman!%

+# Nationali9ation%

The #on#e)t of elati#ity of !eman! ena,le the government to !e#i!e a,out nationali$ation of in!utrie%

1emand &orecasting

Introduction:

The information a,out the future i eential for ,oth new firm an! thoe )lanning to e*)an! the #ale of their

)ro!u#tion% Deman! fore#ating refer to an etimate of future !eman! for the )ro!u#t%

It i an 6o,"e#tive aement of the future #oure of !eman!3% In re#ent time- fore#ating )lay an im)ortant role in

,uine !e#iion.ma0ing% Deman! fore#ating ha an im)ortant influen#e on )ro!u#tion )lanning% It i eential for a

firm to )ro!u#e the re+uire! +uantitie at the right time%

It i eential to !itinguih ,etween fore#at of !eman! an! fore#at of ale% Sale fore#at i im)ortant for

etimating revenue #ah re+uirement an! e*)ene% Deman! fore#at relate to )ro!u#tion- inventory #ontrol- timing-

relia,ility of fore#at et#% owever- there i not mu#h !ifferen#e ,etween thee two term%

T3pes of demand &orecasting:

@ae! on the time )an an! )lanning re+uirement of ,uine firm- !eman! fore#ating #an ,e #laifie! in to ;%

Short.term !eman! fore#ating an!

% Long K term !eman! fore#ating%

"# -hort0term demand forecasting%

Short.term !eman! fore#ating i limite! to hort )erio!- uually for one year% It relate to )oli#ie regar!ing ale-

)ur#hae- )ri#e an! finan#e% It refer to e*iting )ro!u#tion #a)a#ity of the firm% Short.term fore#ating i eential for

formulating i eential for formulating a uita,le )ri#e )oli#y% If the ,uine )eo)le e*)e#t of rie in the )ri#e of raw

material of hortage- they may ,uy early% Thi )ri#e fore#ating hel) in ale )oli#y formulation% 7ro!u#tion may ,e

un!erta0en ,ae! on e*)e#te! ale an! not on a#tual ale% 4urther- !eman! fore#ating ait in finan#ial fore#ating

alo% 7rior information a,out )ro!u#tion an! ale i eential to )rovi!e a!!itional fun! on reaona,le term%

# :ong ; term forecasting%

In long.term fore#ating- the ,uinemen houl! now a,out the long.term !eman! for the )ro!u#t% 7lanning of a new

)lant or e*)anion of an e*iting unit !e)en! on long.term !eman!% Similarly a multi )ro!u#t firm mut ta0e intoa##ount the !eman! for !ifferent item% &hen fore#at are mo!e #overing long )erio!- the )ro,a,ility of error i high%


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It i vary !iffi#ult to fore#at the )ro!u#tion- the tren! of )ri#e an! the nature of #om)etition% en#e +uality an!

#om)etent fore#at are eential%

7rof% C% I% Savage an! T%R% Small #laify !eman! fore#ating into time ty)e% They are ;% E#onomi# fore#ating- %

In!utry fore#ating- F% 4irm level fore#ating% E#onomi# fore#ating i #on#erne! with the e#onomi#- while in!utriallevel fore#ating i ue! for inter.in!utry #om)arion an! i ,eing u))lie! ,y tra!e ao#iation or #ham,er of

#ommer#e% 4irm level fore#ating relate to in!ivi!ual firm%

Met!ods of forecasting:

Several metho! are em)loye! for fore#ating !eman!% All thee metho! #an ,e grou)e! un!er urvey metho! an!

tatiti#al metho!% Survey metho! an! tatiti#al metho! are further u,!ivi!e! in to !ifferent #ategorie%

"# -urve! Method%

Un!er thi metho!- information a,out the !eire of the #onumer an! o)inion of e*)ort are #olle#te! ,y interviewing

them% Survey metho! #an ,e !ivi!e! into four ty)e5 vi$%- O)tion urvey metho!/ e*)ert o)inion/ Del)hi metho! an!

#onumer interview metho!%

a# Opinion surve! method%

Thi metho! i alo 0nown a ale.for#e #om)oite metho! 9or: #olle#tive o)inion metho!% Un!er thi metho!- the

#om)any a0 it aleman to u,mit etimate of future ale in their re)e#tive territorie% Sin#e the fore#at of the

alemen are ,iae! !ue to their o)timiti# or )eimiti# attitu!e ignoran#e a,out e#onomi# !evelo)ment et#% thee

etimate are #onoli!ate!- reviewe! an! a!"ute! ,y the to) e*e#utive% In #ae of wi!e !ifferen#e- an average i

tru#0 to ma0e the fore#at realiti#%

Thi metho! i more ueful an! a))ro)riate ,e#aue the alemen are more 0nowle!ge% They #an ,e im)ortant our#e of

information% They are #oo)erative% The im)lementation within un,iae! or their ,ai# #an ,e #orre#te!%

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A variant of the urvey metho! i Del)hi metho!% It i a o)hiti#ate! metho! to arrive at a #onenu% Un!er thi

metho!- a )anel i ele#te! to give uggetion to olve the )ro,lem in han!% @oth internal an! e*ternal e*)ert #an ,e

the mem,er of the )anel% 7anel mem,er one 0e)t a)art from ea#h other an! e*)re their view in an anonymou

manner% There i alo a #oor!inator who a#t a an interme!iary among the )anelit% e )re)are the +uetionnaire an!

en! it to the )anelit% At the en! of ea#h roun!- he )re)are a ummary re)ort% On the ,ai of the ummary re)ort the)anel mem,er have to give uggetion% Thi metho! ha ,een ue! in the area of te#hnologi#al fore#ating% It ha

)rove! more )o)ular in fore#ating% It ha )rovi!e! more )o)ular in fore#ating non.e#onomi# rather than e#onomi#

varia,le%

D# Consumers intervie. method%

In thi metho! the #onumer are #onta#te! )eronally to 0now a,out their )lan an! )referen#e regar!ing the

#onum)tion of the )ro!u#t% A lit of all )otential ,uyer woul! ,e !rawn an! ea#h ,uyer will ,e a))roa#he! an! a0e!

how mu#h he )lan to ,uy the lite! )ro!u#t in future% e woul! ,e a0e! the )ro)ortion in whi#h he inten! to ,uy%

Thi metho! eem to ,e the mot i!eal metho! for fore#ating !eman!%

# -tatistical Methods%

Statiti#al metho! i ue! for long run fore#ating% In thi metho!- tatiti#al an! mathemati#al te#hni+ue are ue! to

fore#at !eman!% Thi metho! relie on )ot !ata%

a# 4ime series anal!sis or trend pro=ection methods%

A well.eta,lihe! firm woul! have a##umulate! !ata% Thee !ata are analy$e! to !etermine the nature of e*iting tren!%

Then- thi tren! i )ro"e#te! in to the future an! the reult are ue! a the ,ai for fore#at% Thi i #alle! a time erie

analyi% Thi !ata #an ,e )reente! either in a ta,ular form or a gra)h% In the time erie )ot !ata of ale are ue! to

fore#at future%

b# ue%

Sim)le tren! )ro"e#tion are not #a)a,le of fore#ating turning )aint% Un!er @arometri# metho!- )reent event are

ue! to )re!i#t the !ire#tion of #hange in future% Thi i !one with the hel) of e#onomi# an! tatiti#al in!i#ator%

Thoe are 9;: Contru#tion Contra#t awar!e! for ,uil!ing material 9: 7eronal in#ome 9F: Agri#ultural In#ome% 9?:

Em)loyment 9: Gro national in#ome 9: In!utrial 7ro!u#tion 9>: @an0 De)oit et#%

c# egression and correlation method%

Regreion an! #orrelation are ue! for fore#ating !eman!% @ae! on )ot !ata the future !ata tren! i fore#ate!% If the

fun#tional relationhi) i analy$e! with the in!e)en!ent varia,le it i im)le #orre#tion% &hen there are everal

in!e)en!ent varia,le it i multi)le #orrelation% In #orrelation we analy$e the nature of relation ,etween the varia,le

while in regreion/ the e*tent of relation ,etween the varia,le i analy$e!% The reult are e*)ree! in mathemati#al


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form% Therefore- it i #alle! a e#onometri# mo!el ,uil!ing% The main a!vantage of thi metho! i that it )rovi!e the

value of the in!e)en!ent varia,le from within the mo!el itelf%

*UESTIONS

;% &hat i meant ,y elati#ity of !eman!' ow !o you meaure it' &hat are !eterminate of elati#ity of!eman!'

% &hat i the utility of !eman! fore#ating' &hat are the #riteria for a goo! fore#ating metho!' 4ore#ating of!eman! for a new )ro!u#t' 6 E#onomi# in!i#ator5

F% &hat i )romotional elati#ity of !eman!' ow !oe if !iffer from #ro elati#ity of !eman!%?% E*)lain in law of !eman!% &hat !o you mean ,y hift in !eman! #urve'

% &hat i #ro elati#ity of !eman!' I it )oitive for u,titute or #om)lement' Show in a !iagram relating tothe !eman! for #offee to the )ri#e of tea'

% In#ome elati#ity of !eman! an! !itinguih it- variou ta)e% ow !oe it !iffer from )ure elati#ity of!eman!'

>% &hat i meant ,y !eman!' Everyone !eire a Maruti = Car K Doe thi mean that the !eman! for Maruti

Car i large'=% Cal#ulate )ri#e elati#ity of !eman!1

; ? 7; 7 ;

C F ?

D ? ?

E ;

Com,ination 6A5 re)reent ; unit of la,our an! ; unit of #a)ital an! )ro!u#e 65 +uintal of a )ro!u#t all other

#om,ination in the ta,le are aume! to yiel! the ame given out)ut of a )ro!u#t ay 65 +uintal ,y em)loying any

one of the alternative

#om,ination of the

two fa#tor la,our an!

#a)ital% If we )lot all thee

#om,ination on a

)a)er an! "oin them- we will get

#ontinue an! mooth #urve

#alle! Io.)ro!u#t #urve a

hown ,elow%


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La,our i on the .a*i an! #a)ital i on the (.a*i% I i the ISO.7ro!u#t #urve whi#h how all the alternative

#om,ination A- @- C- D- E whi#h #an )ro!u#e +uintal of a )ro!u#t%

5roducer9s E/uilirium:

The tem )ro!u#er5 e+uili,rium i the #ounter )art of #onumer5 e+uili,rium% But a the #onumer i in e+uili,rium

when ,e e#ure ma*imum atifa#tion- in the ame manner- the )ro!u#er i in e+uili,rium when he e#ure ma*imum

out)ut- with the leat #ot #om,ination of fa#tor of )ro!u#tion%

The o)timum )oition of the )ro!u#er #an ,e foun! with the hel) of io.)ro!u#t #urve% The Io.)ro!u#t #urve or e+ual

)ro!u#t #urve or )ro!u#tion in!ifferen#e #urve how !ifferent #om,ination of two fa#tor of )ro!u#tion- whi#h yiel!

the ame out)ut% Thi i illutrate! a follow%

Let u u))oe% The )ro!u#er #an )ro!u#e the given out)ut of )a!!y ay ; +uintal ,y em)loying any one of the

following alternative #om,ination of the two fa#tor la,our an! #a)ital #om)utation of leat #ot #om,ination of two

in)ut%

L

Unit

8

Unit

Out)ut

LL7 9FR%:

Cot of la,our

8879?R%:

#ot of #a)ital

Total #ot

; ? ; F ;= ;

= ; ;; ;>

F ; ;

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It i #lear from the a,ove that ; unit of 6L5 #om,ine! with ? unit of 685 woul! #ot the )ro!u#er R% V.% @ut if ;>

unit re!u#e 685 an! ; unit in#reae 6L5- the reulting #ot woul! ,e R% ;>V.% Su,tituting ; more unit of 6L5 for ;

unit of 685 further re!u#e #ot )f R% ;?V.V owever- it will not ,e )rofita,le to #ontinue thi u,titution )ro#e

further at the e*iting )ri#e in#e the rate of u,titution i !iminihing ra)i!ly% In the a,ove ta,le the leat #ot

#om,ination i F unit of 6L5 ue! with ; unit of 685 when the #ot woul! ,e minimum at R% ;?V.% So thi i theytage 2the )ro!u#er i in e+uili,rium3%

%'W O& 5$O1U)TION:

7ro!u#tion analyi in e#onomi# theory #oni!er two ty)e of in)ut.out)ut relationhi)%

;% &hen +uantitie of #ertain in)ut- are fi*e! an! other are varia,le an!

% &hen all in)ut are varia,le%

Thee two ty)e of relationhi) have ,een e*)laine! in the form of law%

i: Law of varia,le )ro)ortion

ii: Law of return to #ale

I. %a" of variale proportions:

The law of varia,le )ro)ortion whi#h i a new name given to ol! #lai#al #on#e)t of 2Law of !iminihing return ha

)laye! a vital role in the mo!ern e#onomi# theory% Aume that a firm )ro!u#tion fun#tion #onit of fi*e! +uantitie

of all in)ut 9lan!- e+ui)ment- et#%: e*#e)t la,our whi#h i a varia,le in)ut when the firm e*)an! out)ut ,y em)loying

more an! more la,our it alter the )ro)ortion ,etween fi*e! an! the varia,le in)ut% The law #an ,e tate! a follow1

2&hen total out)ut or )ro!u#tion of a #ommo!ity i in#reae! ,y a!!ing unit of a varia,le in)ut while the +uantitie of

other in)ut are hel! #ontant- the in#reae in total )ro!u#tion ,e#ome after ome )oint- maller an! maller3%

2If e+ual in#rement of one in)ut are a!!e!- the in)ut of other )ro!u#tion ervi#e ,eing hel! #ontant- ,eyon! a

#ertain )oint the reulting in#rement of )ro!u#t will !e#reae i%e% the marginal )ro!u#t will !iminih3% 9(. Stigler:

2A the )ro)ortion of one fa#tor in a #om,ination of fa#tor i in#reae!- after a )oint- firt the marginal an! then the

average )ro!u#t of that fa#tor will !iminih3% 9&. Ben!am:

The law of varia,le )ro)ortion refer to the ,ehaviour of out)ut a the +uantity of one 4a#tor i in#reae! 8ee)ing the

+uantity of other fa#tor fi*e! an! further it tate that the marginal )ro!u#t an! average )ro!u#t will eventually !o

#line% Thi law tate three ty)e of )ro!u#tivity an in)ut fa#tor K Total- average an! marginal )hyi#al )ro!u#tivity%

ssumptions of the :a.1 The law i ,ae! u)on the following aum)tion1

i: The tate of te#hnology remain #ontant% If there i any im)rovement in te#hnology- the average an!marginal out )ut will not !e#reae ,ut in#reae%


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ii: Only one fa#tor of in)ut i ma!e varia,le an! other fa#tor are 0e)t #ontant% Thi law !oe not a))ly to

thoe #ae where the fa#tor mut ,e ue! in rigi!ly fi*e! )ro)ortion%

iii: All unit of the varia,le fa#tor are homogenou%

T!ree stages of la":

The ,ehavior of the Out)ut when the varying +uantity of one fa#tor i #om,ine with a fi*e! +uantity of the other #an

,e !ivi!e! in to three !itri#t tage% The three tage #an ,e ,etter un!ertoo! ,y following the ta,le%

4i*e! fa#tor Haria,le fa#tor

9La,our:

Total )ro!u#t Average 7ro!u#t Marginal 7ro!u#t

; ; ; ; . Stage I

; ; ;

; F > F Stage II

; F ?

; FF ;

; > FF ?> Stage III

; = F ? .;

A,ove ta,le reveal that ,oth average )ro!u#t an! marginal )ro!u#t in#reae in the ,eginning an! then !e#line of the

two marginal )ro!u#t !ro) of fater than average )ro!u#t% Total )ro!u#t i ma*imum when the farmer em)loy th

wor0er- nothing i )ro!u#e! ,y the >thwor0er an! it marginal )ro!u#tivity i $ero- wherea marginal )ro!u#t of = th

wor0er i 6.;5- ,y "ut #reating #re!it =thwor0er not only fail to ma0e a )oitive #ontri,ution ,ut lea! to a fall in the

total out)ut%

7ro!u#tion fun#tion with one varia,le in)ut an! the remaining fi*e! in)ut i illutrate! a ,elow


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4rom the a,ove gra)h the law of varia,le )ro)ortion o)erate in three tage% In the firt tage- total )ro!u#t in#reae

at an in#reaing rate% The marginal )ro!u#t in thi tage in#reae at an in#reaing rate reulting in a greater in#reae in

total )ro!u#t% The average )ro!u#t alo in#reae% Thi tage #ontinue u) to the )oint where average )ro!u#t i e+ual to

marginal )ro!u#t% The law of in#reaing return i in o)eration at thi tage% The law of !iminihing return tart

o)erating from the e#on! tage awar!% At the e#on! tage total )ro!u#t in#reae only at a !iminihing rate% Theaverage )ro!u#t alo !e#line% The e#on! tage #ome to an en! where total )ro!u#t ,e#ome ma*imum an! marginal

)ro!u#t ,e#ome $ero% The marginal )ro!u#t ,e#ome negative in the thir! tage% So the total )ro!u#t alo !e#line% The

average )ro!u#t #ontinue to !e#line%

&e #an um u) the a,ove relationhi) thu when 6A%7%5 i riing- 2M% 7%5 rie more than 2 A% 7/ &hen 6A% 7%3 i

ma*imum an! #ontant- 6M% 7%5 ,e#ome e+ual to 6A% 7%5 when 6A% 7%5 tart falling- 6M% 7%5 fall fater than 6 A% 7%5%

Thu- the total )ro!u#t- marginal )ro!u#t an! average )ro!u#t )a through three )hae- vi$%- in#reaing !iminihing

an! negative return tage% The law of varia,le )ro)ortion i nothing ,ut the #om,ination of the law of in#reaing an!

!emiing return%

II. %a" of $eturns of Scale:

The law of return to #ale e*)lain the ,ehavior of the total out)ut in re)one to #hange in the #ale of the firm- i%e%- in

re)one to a imultaneou to #hange in the #ale of the firm- i%e%- in re)one to a imultaneou an! )ro)ortional

in#reae in all the in)ut% More )re#iely- the Law of return to #ale e*)lain how a imultaneou an! )ro)ortionate

in#reae in all the in)ut affe#t the total out)ut at it variou level%

The #on#e)t of varia,le )ro)ortion i a hort.run )henomenon a in thee )erio! fi*e! fa#tor #an not ,e #hange! an!

all fa#tor #annot ,e #hange!% On the other han! in the long.term all fa#tor #an ,e #hange! a ma!e varia,le% &hen we

tu!y the #hange in out)ut when all fa#tor or in)ut are #hange!- we tu!y return to #ale% An in#reae in the #ale

mean that all in)ut or fa#tor are in#reae! in the ame )ro)ortion% In varia,le )ro)ortion- the #oo)erating fa#tor

may ,e in#reae! or !e#reae! an! one fater 9E*% Lan! in agri#ulture 9or: ma#hinery in in!utry: remain #ontant o

that the #hange in )ro)ortion among the fa#tor reult in #ertain #hange in out)ut% In return to #ale all the ne#eary

fa#tor or )ro!u#tion are in#reae! or !e#reae! to the ame e*tent o that whatever the #ale of )ro!u#tion- the

)ro)ortion among the fa#tor remain the ame%

&hen a firm e*)an!- it #ale in#reae all it in)ut )ro)ortionally- then te#hni#ally there are three )oi,ilitie% 9i:

The total out)ut may in#reae )ro)ortionately 9ii: The total out)ut may in#reae more than )ro)ortionately an! 9iii: The

total out)ut may in#reae le than )ro)ortionately% If in#reae in the total out)ut i )ro)ortional to the in#reae in in)ut-

it mean #ontant return to #ale% If in#reae in the out)ut i greater than the )ro)ortional in#reae in the in)ut- it

mean in#reaing return to #ale% If in#reae in the out)ut i le than )ro)ortional in#reae in the in)ut- it mean

!iminihing return to #ale%


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Let u now e*)lain the law of return to #ale with the hel) of io+uant for a two.in)ut an! ingle out)ut )ro!u#tion

ytem%

E)ONOMIES O& S)'%E

7ro!u#tion may ,e #arrie! on a mall #ale or o a large #ale ,y a firm% &hen a firm e*)an! it i$e of )ro!u#tion ,y

in#reaing all the fa#tor- it e#ure #ertain a!vantage 0nown a e#onomie of )ro!u#tion% Marhall ha #laifie! thee

e#onomie of large.#ale )ro!u#tion into internal e#onomie an! e*ternal e#onomie%

Internal e#onomie are thoe- whi#h are o)ene! to a ingle fa#tory or a ingle firm in!e)en!ently of the a#tion of other

firm% They reult from an in#reae in the #ale of out)ut of a firm an! #annot ,e a#hieve! unle out)ut in#reae%

en#e internal e#onomie !e)en! olely u)on the i$e of the firm an! are !ifferent for !ifferent firm%

E*ternal e#onomie are thoe ,enefit- whi#h are hare! in ,y a num,er of firm or in!utrie when the #ale of

)ro!u#tion in an in!utry or grou) of in!utrie in#reae% en#e e*ternal e#onomie ,enefit all firm within the

in!utry a the i$e of the in!utry e*)an!%

)auses of internal economies:

Internal e#onomie are generally #aue! ,y two fa#tor

;% In!ivii,ilitie % S)e#iali$ation%

4. Indivisiilities

Many fi*e! fa#tor of )ro!u#tion are in!ivii,le in the ene that they mut ,e ue! in a fi*e! minimum i$e% 4or

intan#e- if a wor0er wor0 half the time- he may ,e )ai! half the alary% @ut he #annot ,e #ho))e! into half an! a0e!

to )ro!u#e half the #urrent out)ut% Thu a out)ut in#reae the in!ivii,le fa#tor whi#h were ,eing ue! ,elow

#a)a#ity #an ,e utili$e! to their full #a)a#ity there,y re!u#ing #ot% Su#h in!ivii,ilitie arie in the #ae of la,our-

ma#hine- mar0eting- finan#e an! reear#h%

6. Specialiation.

Diviion of la,our- whi#h lea! to )e#iali$ation- i another #aue of internal e#onomie% S)e#iali$ation refer to the

limitation of a#tivitie within a )arti#ular fiel! of )ro!u#tion% S)e#iali$ation may ,e in la,our- #a)ital- ma#hinery an!

)la#e% 4or e*am)le- the )ro!u#tion )ro#e may ,e )lit into four !e)artment relation to manufa#turing- aem,ling-

)a#0ing an! mar0eting un!er the #harge of e)arate manager who may wor0 un!er the overall #harge of the general

manger an! #oor!inate the a#tivitie of the for !e)artment% Thu )e#iali$ation will lea! to greater )ro!u#tive

effi#ien#y an! to re!u#tion in #ot%

Internal Economies:

Internal e#onomie may ,e of the following ty)e%

)# 4echnical /conomies#


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Te#hni#al e#onomie arie to a firm from the ue of ,etter ma#hine an! u)erior te#hni+ue of )ro!u#tion% A a reult-

)ro!u#tion in#reae an! )er unit #ot of )ro!u#tion fall% A large firm- whi#h em)loy #otly an! u)erior )lant an!

e+ui)ment- en"oy a te#hni#al u)eriority over a mall firm% Another te#hni#al e#onomy lie in the me#hani#al

a!vantage of uing large ma#hine% The #ot of o)erating large ma#hine i le than that of o)erating mall ma#hine%More over a larger firm i a,le to re!u#e it5 )er unit #ot of )ro!u#tion ,y lin0ing the variou )ro#ee of )ro!u#tion%

Te#hni#al e#onomie may alo ,e ao#iate! when the large firm i a,le to utili$e all it wate material for the

!evelo)ment of ,y.)ro!u#t in!utry% S#o)e for )e#iali$ation i alo availa,le in a large firm% Thi in#reae the

)ro!u#tive #a)a#ity of the firm an! re!u#e the unit #ot of )ro!u#tion%

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2)# /conomies of .elfare%

A large firm #an )rovi!e ,etter wor0ing #on!ition in.an! out.i!e the fa#tory% 4a#ilitie li0e u,i!i$e! #anteen-

#rW#he for the infant- re#reation room- #hea) houe- e!u#ational an! me!i#al fa#ilitie ten! to in#reae the )ro!u#tiveeffi#ien#y of the wor0er- whi#h hel) in raiing )ro!u#tion an! re!u#ing #ot%

Eternal Economies.

@uine firm en"oy a num,er of e*ternal e#onomie- whi#h are !i#ue! ,elow1

)# /conomies of Concentration%

&hen an in!utry i #on#entrate! in a )arti#ular area- all the mem,er firm rea) ome #ommon e#onomie li0e 0ille!

la,our- im)rove! mean of tran)ort an! #ommuni#ation- ,an0ing an! finan#ial ervi#e- u))ly of )ower an! ,enefit

from u,i!iarie% All thee fa#ilitie ten! to lower the unit #ot of )ro!u#tion of all the firm in the in!utry%

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Internal an! e*ternal !ie#onomie are the limit to large.#ale )ro!u#tion% It i )oi,le that e*)anion of a firm5

out)ut may lea! to rie in #ot an! thu reult !ie#onomie intea! of e#onomie% &hen a firm e*)an! ,eyon! )ro)er

limit- it i ,eyon! the #a)a#ity of the manager to manage it effi#iently% Thi i an e*am)le of an internal !ie#onomy% In

the ame manner- the e*)anion of an in!utry may reult in !ie#onomie- whi#h may ,e #alle! e*ternal !ie#onomie%Em)loyment of a!!itional fa#tor of )ro!u#tion ,e#ome le effi#ient an! they are o,taine! at a higher #ot% It i in thi

way that e*ternal !ie#onomie reult a an in!utry e*)an!%

The ma"or !ie#onomie of large.#ale )ro!u#tion are !i#ue! ,elow1

Internal 1iseconomies:

)# $inancial Diseconomies%

4or e*)an!ing ,uine- the entre)reneur nee! finan#e% @ut finan#e may not ,e eaily availa,le in the re+uire! amount

at the a))ro)riate time% La#0 of finan#e retar! the )ro!u#tion )lan there,y in#reaing #ot of the firm%

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Eternal 1iseconomies:

&hen many firm get lo#ate! at a )arti#ular )la#e- the #ot of tran)ortation in#reae !ue to #ongetion% The firm have

to fa#e #oni!era,le !elay in getting raw material an! en!ing finihe! )ro!u#t to the mar0eting #enter% Thelo#ali$ation of in!utrie may lea! to #ar#ity of raw material- hortage of variou fa#tor of )ro!u#tion li0e la,our an!

#a)ital- hortage of )ower- finan#e an! e+ui)ment% All u#h e*ternal !ie#onomie ten! to raie #ot )er unit%

*UESTIONS

;% &hy !oe the law of !iminihing return o)erate' E*)lain with the hel) of a !iagram%% E*)lain the nature an! ue of )ro!u#tion fun#tion%F% E*)lain an! illutrate low of return to #ale%

?% a% E*)lain how )ro!u#tion fun#tion #an ,e mo!e ue of to re!u#e #ot of

7ro!u#tion%,% E*)lain low of #ontant return' Illutrate%

% E*)lain the following 9i: Internal E#onomi# 9ii: E*ternal E#onomi# 9or:E*)lain E#onomi# of #ale% E*)lain the fa#tor- whi#h #aue in#reaing return to #ale%

% E*)lain the following with referen#e to )ro!u#tion fun#tion

9a: MRTS9,: Haria,le )ro)ortion of fa#tor

>% Define )ro!u#tion fun#tion- e*)lain i e+uate an! i #ot #urve%=% E*)lain the im)ortan#e an! ue of )ro!u#tion fun#tion in ,rea0.even analyi%

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9a: Conumer5 E+uili,rium 9,: 7ri#e E+uili,rium9#: 7ro!u#er5 E+uili,rium 9!: 4irm5 E+uili,rium

% The 6Law of Haria,le 7ro)ortion5 i alo #alle! a JJJJJJJJJJJJ% 9 :9a: Law of fi*e! )ro)ortion 9,: Law of return to #ale9#: Law of varia,le )ro)ortion 9!: None

>% JJJJJJJJJ I a 6grou) of firm )ro!u#ing the ame are lightly

Different )ro!u#t for the ame mar0et or uing ame raw material5% 9 :9a: 7lant 9,: 4irm

9#: In!utry 9!: Si$e

=% &hen )ro)ortionate in#reae in all in)ut reult in an e+ual7ro)ortionate in#reae in out)ut- then we #allJJJJJJJJJJJJ% 9 :

9a: In#reaing Return to S#ale 9,: De#reaing Return to S#ale9#: Contant Return to S#ale 9!: None

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)OST 'N'%2SIS

7rofit i the ultimate aim of any ,uine an! the long.run )ro)erity of a firm !e)en! u)on it a,ility to earn utaine!

)rofit% 7rofit are the !ifferen#e ,etween elling )ri#e an! #ot of )ro!u#tion% In general the elling )ri#e i not within

the #ontrol of a firm ,ut many #ot are un!er it #ontrol% The firm houl! therefore aim at #ontrolling an! minimi$ing#ot% Sin#e every ,uine !e#iion involve #ot #oni!eration- it i ne#eary to un!ertan! the meaning of variou

#on#e)t for #lear ,uine thin0ing an! a))li#ation of right 0in! of #ot%

)OST )ON)E5TS:

A managerial e#onomit mut have a #lear un!ertan!ing of the !ifferent #ot #on#e)t for #lear ,uine thin0ing an!

)ro)er a))li#ation% The everal alternative ,ae of #laifying #ot an! the relevan#e of ea#h for !ifferent 0in! of

)ro,lem are to ,e tu!ie!% The variou relevant #on#e)t of #ot are1

"# Opportunit! costs and outla! costs%

Out lay #ot alo 0nown a a#tual #ot o,olete #ot are thoe e*)en! whi#h are a#tually in#urre! ,y the firm thee

are the )ayment ma!e for la,our- material- )lant- ,uil!ing- ma#hinery traveling- tran)orting et#%- Thee are all thoe

e*)ene item a))earing in the ,oo0 of a##ount- hen#e ,ae! on a##ounting #ot #on#e)t%

On the other han! o))ortunity #ot im)lie the earning foregone on the ne*t ,et alternative- ha the )reent o)tion i

un!erta0en% Thi #ot i often meaure! ,y aeing the alternative- whi#h ha to ,e #arifie! if the )arti#ular line i

followe!%

The o))ortunity #ot #on#e)t i ma!e ue for long.run !e#iion% Thi #on#e)t i very im)ortant in #a)ital e*)en!iture

,u!geting% Thi #on#e)t i very im)ortant in #a)ital e*)en!iture ,u!geting% The #on#e)t i alo ueful for ta0ing hort.

run !e#iion o))ortunity #ot i the #ot #on#e)t to ue when the u))ly of in)ut i tri#tly limite! an! when there i

an alternative% If there i no alternative- O))ortunity #ot i $ero% The o))ortunity #ot of any a#tion i therefore

meaure! ,y the value of the mot favora,le alternative #oure- whi#h ha! to ,e foregoing if that a#tion i ta0en%

# /1plicit and implicit costs%

E*)li#it #ot are thoe e*)ene that involve #ah )ayment% Thee are the a#tual or ,uine #ot that a))ear in the

,oo0 of a##ount% Thee #ot in#lu!e )ayment of wage an! alarie- )ayment for raw.material- interet on ,orrowe!

#a)ital fun!- rent on hire! lan!- Ta*e )ai! et#%

Im)li#it #ot are the #ot of the fa#tor unit that are owne! ,y the em)loyer himelf% Thee #ot are not a#tually

in#urre! ,ut woul! have ,een in#urre! in the a,en#e of em)loyment of elf K owne! fa#tor% The two normal im)li#it

#ot are !e)re#iation- interet on #a)ital et#% A !e#iion ma0er mut #oni!er im)li#it #ot too to fin! out a))ro)riate

)rofita,ility of alternative%

'# ?istorical and eplacement costs%


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itori#al #ot i the original #ot of an aet% itori#al #ot valuation how the #ot of an aet a the original )ri#e

)ai! for the aet a#+uire! in the )at% itori#al valuation i the ,ai for finan#ial a##ount%

A re)la#ement #ot i the )ri#e that woul! have to ,e )ai! #urrently to re)la#e the ame aet% During )erio! of

u,tantial #hange in the )ri#e level- hitori#al valuation give a )oor )ro"e#tion of the future #ot inten!e! formanagerial !e#iion% A re)la#ement #ot i a relevant #ot #on#e)t when finan#ial tatement have to ,e a!"ute! for

inflation%

# -hort ; run and long ; run costs%

Short.run i a )erio! !uring whi#h the )hyi#al #a)a#ity of the firm remain fi*e!% Any in#reae in out)ut !uring thi

)erio! i )oi,le only ,y uing the e*iting )hyi#al #a)a#ity more e*tenively% So hort run #ot i that whi#h varie

with out)ut when the )lant an! #a)ital e+ui)ment in #ontant%

Long run #ot are thoe- whi#h vary with out)ut when all in)ut are varia,le in#lu!ing )lant an! #a)ital e+ui)ment%

Long.run #ot analyi hel) to ta0e invetment !e#iion%

*# Out0of pocket and books costs%

Out.of )o#0et #ot alo 0nown a e*)li#it #ot are thoe #ot that involve #urrent #ah )ayment% @oo0 #ot alo

#alle! im)li#it #ot !o not re+uire #urrent #ah )ayment% De)re#iation- un)ai! interet- alary of the owner i

e*am)le of ,a#0 #ot%

@ut the ,oo0 #ot are ta0en into a##ount in !etermining the level !ivi!en! )aya,le !uring a )erio!% @oth ,oo0 #ot

an! out.of.)o#0et #ot are #oni!ere! for all !e#iion% @oo0 #ot i the #ot of elf.owne! fa#tor of )ro!u#tion%

+# $i1ed and variable costs%

4i*e! #ot i that #ot whi#h remain #ontant for a #ertain level to out)ut% It i not affe#te! ,y the #hange in the

volume of )ro!u#tion% @ut fi*e! #ot )er unit !e#reae- when the )ro!u#tion i in#reae!% 4i*e! #ot in#lu!e alarie-

Rent- A!minitrative e*)ene !e)re#iation et#%

Haria,le i that whi#h varie !ire#tly with the variation i out)ut% An in#reae in total out)ut reult in an in#reae in

total varia,le #ot an! !e#reae in total out)ut reult in a )ro)ortionate !e#line in the total varia,le #ot% The

varia,le #ot )er unit will ,e #ontant% E*1 Raw material- la,our- !ire#t e*)ene- et#%

,# Post and $uture costs%

7ot #ot alo #alle! hitori#al #ot are the a#tual #ot in#urre! an! re#or!e! in the ,oo0 of a##ount thee #ot are

ueful only for valuation an! not for !e#iion ma0ing%


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4uture #ot are #ot that are e*)e#te! to ,e in#urre! in the future% They are not a#tual #ot% They are the #ot

fore#ate! or etimate! with rational metho!% 4uture #ot etimate i ueful for !e#iion ma0ing ,e#aue !e#iion are

meant for future%

6# 4raceable and common costs%

Tra#ea,le #ot otherwie #alle! !ire#t #ot- i one- whi#h #an ,e i!entifie! with a )ro!u#t )ro#e or )ro!u#t% Raw

material- la,our involve! in )ro!u#tion i e*am)le of tra#ea,le #ot%

Common #ot are the one that #ommon are attri,ute! to a )arti#ular )ro#e or )ro!u#t% They are in#urre! #olle#tively

for !ifferent )ro#ee or !ifferent ty)e of )ro!u#t% It #annot ,e !ire#tly i!entifie! with any )arti#ular )ro#e or ty)e

of )ro!u#t%

7# voidable and unavoidable costs%

Avoi!a,le #ot are the #ot- whi#h #an ,e re!u#e! if the ,uine a#tivitie of a #on#ern are #urtaile!% 4or e*am)le- if

ome wor0er #an ,e retren#he! with a !ro) in a )ro!u#t K line- or volume or )ro!u#tion the wage of the retren#he!

wor0er are e#a)a,le #ot%

The unavoi!a,le #ot are otherwie #alle! un0 #ot% There will not ,e any re!u#tion in thi #ot even if re!u#tion in

,uine a#tivity i ma!e% 4or e*am)le #ot of the i!eal ma#hine #a)a#ity i unavoi!a,le #ot%

"8# Controllable and uncontrollable costs%

Controlla,le #ot are one- whi#h #an ,e regulate! ,y the e*e#utive who i in #hange of it% The #on#e)t of

#ontrolla,ility of #ot varie with level of management% Dire#t e*)ene li0e material- la,our et#% are #ontrolla,le #ot%

Some #ot are not !ire#tly i!entifia,le with a )ro#e of )ro!u#t% They are a))ointe! to variou )ro#ee or )ro!u#t

in ome )ro)ortion% Thi #ot varie with the variation in the ,ai of allo#ation an! i in!e)en!ent of the a#tion of the

e*e#utive of that !e)artment% Thee a))ortione! #ot are #alle! un#ontrolla,le #ot%

""# Incremental and sunk costs%

In#remental #ot alo 0nown a !ifferent #ot i the a!!itional #ot !ue to a #hange in the level or nature of ,uine

a#tivity% The #hange may ,e #aue! ,y a!!ing a new )ro!u#t- a!!ing new ma#hinery- re)la#ing a ma#hine ,y a ,etter

one et#%

Sun0 #ot are thoe whi#h are not altere! ,y any #hange K They are the #ot in#urre! in the )at% Thi #ot i the reult

of )at !e#iion- an! #annot ,e #hange! ,y future !e#iion% Invetment in fi*e! aet are e*am)le of un0 #ot%

"# 4otal@ average and marginal costs%


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Total #ot i the total #ah )ayment ma!e for the in)ut nee!e! for )ro!u#tion% It may ,e e*)li#it or im)li#it% It i the um

total of the fi*e! an! varia,le #ot% Average #ot i the #ot )er unit of out)ut% If i o,taine! ,y !ivi!ing the total #ot

9TC: ,y the total +uantity )ro!u#e! 9:

TC

Average #ot ......

Marginal #ot i the a!!itional #ot in#urre! to )ro!u#e an! a!!itional unit of out)ut or it i the #ot of the marginal unit

)ro!u#e!%

"'# ccounting and /conomics costs%

A##ounting #ot are the #ot re#or!e! for the )ur)oe of )re)aring the ,alan#e heet an! )rofit an! ton tatement to

meet the legal- finan#ial an! ta* )ur)oe of the #om)any% The a##ounting #on#e)t i a hitori#al #on#e)t an! re#or!

what ha ha))ene! in the )ot%

E#onomi# #on#e)t #oni!er future #ot an! future revenue- whi#h hel) future )lanning- an! #hoi#e- while the

a##ountant !e#ri,e what ha ha))ene!- the e#onomi# aim at )ro"e#ting what will ha))en%

)OST-OUT5UT $E%'TIONS#I5

A )ro)er un!ertan!ing of the nature an! ,ehavior of #ot i a mut for regulation an! #ontrol of #ot of )ro!u#tion%

The #ot of )ro!u#tion !e)en! on money for#e an! an un!ertan!ing of the fun#tional relationhi) of #ot to variou

for#e will hel) u to ta0e variou !e#iion% Out)ut i an im)ortant fa#tor- whi#h influen#e the #ot%

The #ot.out)ut relationhi) )lay an im)ortant role in !etermining the o)timum level of )ro!u#tion% 8nowle!ge of the

#ot.out)ut relation hel) the manager in #ot #ontrol- )rofit )re!i#tion- )ri#ing- )romotion et#% The relation ,etween

#ot an! it !eterminant i te#hni#ally !e#ri,e! a the #ot fun#tion%

C f 9S- O- 7- T X%:

&here/

C Cot 9Unit or total #ot:

S Si$e of )lantV#ale of )ro!u#tion

O Out)ut level

7 7ri#e of in)ut

T Te#hnology

Coni!ering the )erio! the #ot fun#tion #an ,e #laifie! a 9a: hort.run #ot fun#tion an! 9,: long.run #ot fun#tion%

In e#onomi# theo

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