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UNIT - I
MANAGERIAL ECONOMICS
Introduction to Management

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It’s a group of people
It’s a Profession
It’s a Discipline
It’s a Process
Introduction to Management

Management is concerned with Ideas, Things, People of an
organization

Management has deals with human behavior under dynamic
conditions
Definition
“Management is science and art of getting things done
through people formally organized groups.”
According to lousis allen Management is “what managers
do” is called management.
Introduction to Economics



It’s a study of human activity both at Individual & National level
It’s also called as “Science of wealth”
Its satisfying human needs such as food, clothing and shelter
Meaning & Definition
According to Adam smith- Economics as the “study of nature
and uses of national wealth”
According to A. Marshal- Economics is a “study of man’s
actions in the ordinary business life, its enquires how he gets his
income and how he uses it”.
According to Robbins- “Economics as the science which
studies human behavior as a relationship b/w ends and scarce
means which have alternative uses”.
Types of Economics
Micro Economics


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
The study of individual consumer or a firm is called micro economics
It is also called as “Theory of firm”.
It deals with behavior & Problems of individual persons & small
organizations
Its includes price theory, law of demand and theory of market
Types of Economics (contd.)
Macro Economics




Its means the study of aggregate or total level of economic activities in a
country
It studies flow of economic resource or factors of production
Factors of production includes L,L,C,O,T
Its capital structure
Welfare economics
welfare economics is that branch of economics which
primary deals with talking of poverty, famine and distribution of
wealth in an economy. This is also called as “developmental
economics.”
Managerial Economics
Spencer and Siegel man- “Managerial economics as the
integration of economic theory and methodology to business
administration practice.”
Brigham- “Managerial economics as the application of
economic theory with business practice or business administrative
practices.”
Huger- “Managerial economics is a fundamental academic
subject which seeks to understand and to analyze the problems of
business decision making.”
Scope of ME
Managerial decisions areas
o
o
o
Concepts
& Techniques
of ME
o
o
o
o
o
Production
Reduction or control of costs
Price of a product
Make or buy decisions
Inventory decisions
Capital management
Profit planning Management
Investment decisions
Optimum
solutions
Main areas of ME

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Demand decisions
Input-Output decisions
Price-Output decisions
Profit related decisions
Investment decisions
Forecasting & Forward decisions
Linkages with other discipline of ME
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Economics
Operation research
Mathematics
Statistics
Accountancy
Psychology
HRM
Organizational behavior
Nature of ME
Economic
Theory
Decision
Science
ME
Solutions
To Business
Problems
Role of ME in decision making process
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Objectives of the firm
Allocation of resources
Demand analysis and forecasting
Competitive analysis
Strategic planning
Production planning
Cost analysis
Pricing strategies
Market structure analysis
Capital budgeting decisions
Marketing strategies
Achieving economic scale
Introduction to Demand

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Asking with authority
Popularity
Good will of a product
Claim
Need
Want
Request
Call for authority
Introduction to Demand
Basically 3 concepts included in Demand



Consumer’s desire to purchase the product
Consumer’s willingness to purchase the product
Sufficient purchasing power or ability to pay
Types Demand



Individual Demand
when demand arises from an individual consumer, it is called as
individual demand. Individual consumers usually demand for product
like clothes, foot wares
House hold Demand
when demand arises from a house hold, it is called house hold
demand, house hold demand generally demand for refrigerator, TV,
washing machine
Market Demand
when demand arises of all individual and house hold for a product
in given a market is considered, it is called market demand.
Demand analysis
Y
In above diagrams Q1,Q2 are
quantities of the commodities at the
prices of P1,P2 respectively., i.e
Price is P1 (Low) the quantity
demanded is Q2 (High) and it the
price is P2 (High) the quantity
demanded
is
Q2
(Low)
D
P2
P1
D
O
Q1 Q2
X
Price
Demand
Increase
Decrease
Decrease
Increase
Demand function
Basically 2 types of functions
1.Individual function
Qx = f {Px, I, P1…Pn, T, A, Ep, Ei, U}
Qx = Quantity demanded of the commodity ‘X’
Px = Price of the commodity
I = Consumer’s income
P1..Pn = Prices of the other related goods
T = Consumer’s tastes and preferences
A = Advertisement
Ep = Consumer’s expectations about future prices
Ei = Consumer’s expectations about future income
U = Other determinants
F = Function
Demand function
2. Market Demand Function
Qx = f {Px, I, P1…Pn, T, A, Ep, Ei, U}
Qx = Quantity demanded of the commodity ‘X’
Px = Price of the commodity
I = Consumer’s income
P1..Pn = Prices of the other related goods
T = Consumer’s tastes and preferences
A = Advertisement
Ep = Consumer’s expectations about future prices
Ei = Consumer’s expectations about future income
P = Population or market size
D = Distribution or the consumers in the market according to income,
age, demand etc
U = Other determinants
F = Function
Law of Demand
“The law of demand states that a consumer’s behavior, in
demanding a commodity in relation to the variations in its prices”.
“Other things remaining the same, the amount of the quantity
demanded arises with every fall in the prices and vice versa.”
The law of demand states that other things remaining constant,
the higher the price of the commodity, the lower is the demand and
low the price, higher is the quantity demanded.
Assumptions of Law of Demand


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Consumer income throughout the operation of law of demand remain
unchanged
Consumer tastes & preferences remain unchanged
No change in fads, fashions & latest trends
Prices of the related goods un changed or are equal
Exceptions of Law of Demand

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Giffen goods or Giffen paradox
Goods of status
Future prices of goods
Ignorance effect
War or emergency
Basic Law of Demand

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Consumption
Production
Exchange
Distribution
Demand schedule
A demand schedule is a tabular presentation of the relationship
between the amount demanded of a commodities and different price
levels of that commodity.
In other words demand schedule is a tabular statement of price
and quantity relationship.
Price of the
Commodity (Y)
Demand of a
Commodity (X)
5
15
8
14
10
12
12
10
15
8
20
5
Characteristics of Demand schedule

A demand schedule shows variations in demand of a commodity at its
varying prices

It indicated behavior of an individual consumer in purchasing the
commodity at alternative prices

It shows the inverse relationship b/w demand and price of a
commodity
Types of Demand schedule
Price of oranges
Per dozen (Rs)
Demand of
Oranges (Nos)
45
2
38
3
30
4
25
6
20
10
Individual Demand Schedule
Types of Demand schedule
Price of the
Commodity
Demand by
Individuals
Total Market
demand
A
B
C
6
1
1
2
4
5
2
3
4
9
4
3
5
5
13
3
4
6
7
17
2
5
7
10
22
1
6
8
12
26
Market Demand Schedule
Various types of Demand

Price Demand

Income Demand

Cross Demand
Price Demand
It shows the inverse relationship b/w the prices of a commodity
and its demand of a commodity. That means other things being
constant if price fall demand extends, and if price rises demand
contracts.
Income Demand
It shows the functional relationship b/w income of a consumer
and quantity demand when other factors are constant. That means
when other things constant if the income of consumer increases the
quantity demand also increase and if income decreases the quantity
demand falls.
Cross Demand
Basically 2 types
1.
Substitute goods :
the goods satisfy the same want are called
substitute goods. Eg. Coffee and Tea
1.
Complementary Goods : The goods required at the same time to satisfy a
want are called complementary goods. Eg. Car
and petrol
Elasticity Demand
 It means expanding
 Its process
 It’s a product capacity
Meaning & Definition
According to Dr. Marchall – Elasticity demand means the degree of
responsiveness of demand or the sensitiveness of demand to change in
price.
“The concept of Elasticity of demand explain How much demand
increases due to a certain fall in price and How much demand decreases
due to a certain rise in the price”.
“The term Elasticity is defined as the rate of responsiveness in the
demand of a commodity for a given change in price or any other
determinants of demand”.
Formulae
Proportionate change in quantity demand of X
Ep = -------------------------------------------------------proportionate change in its determinate of Y
Types
 Price Elasticity Demand
 Income Elasticity Demand
 Cross Elasticity Demand
Importance of price elastic demand
 Importance to Monopolistic
 Importance to finance manager/minister
 Importance to international trade
 Help full to decision making process
Price Elasticity Demand
It means the degree of responsiveness or sensitiveness of a
demand for a commodity to changes in its price (Ep)
Proportionate change in quantity demand of X
Ep = -------------------------------------------------------proportionate change in its determinate of Y
Ep =
Q
P
------ * ----Q
P
Income Elasticity Demand
It means the ratio of proportionate change in the quantity of
demand for a commodity to given proportionate change in income
of a product.
Proportionate change in quantity demand of a product
Ey = -------------------------------------------------------------------proportionate change in its determinate of a consumer
Ey =
Q
Y
------ / ----Q
Y
Cross Elasticity Demand
Proportionate change in quantity demand of X
Exy = --------------------------------------------------------proportionate change in price of Y
Exy =
QX
PY
------ /------QX
PY
Measurement of Elasticity
 Perfect elastic demand
 Perfect in elastic demand
 Relatively elastic demand
 Relatively in elastic demand
 Unitary elastic demand
Types of price elasticity demand
Numerical
Measures
Types of elasticity
Relationship of demand with the
price
1. Ed =
Perfectly elastic
demand
Increase or decrease in demand to any extent
irrespective of change in price.
Eg. Imaginary
2.Ed=0
Perfectly inelastic
demand
Demand does not change with the change in
price.
Eg. Salt
3.Ed>1
Relative elastic
demand
Percentage change in demand more then
percentage change in price.
Eg. Petrol
4.Ed<1
Relative inelastic
demand
Percentage change in demand is lesser than
the percentage change in price.
Eg. Sugar
5.Ed=1
Unitary elastic
demand
Percentage change in demand is equal to
percentage change in price.
Eg. Cloth
Perfect elastic demand ( Ep=Infinity)
If a negligible change in price leads to an infinitive change in
demand is said to be perfectly elastic demand. The infinity elastic
demand curve is a horizontal straight line to X axis
Y
price
P
O
X
M
M1
Quantity demand
Perfect in elastic demand (Ep=0)
Even a great rise or fall in price does not lead and change in
quantity demand is known as perfectly in elastic demand
Y
price
P
P1
O
X
M
Quantity demand
Relatively elastic demand (Ep greater than 1)
When a proportionate change in price leads to a more then
proportionate change in quantity demand is called relatively elastic
demand
Y
price
D
A
P
B
P1
D
O
X
M
M1
Demand
Relatively in elastic demand (Ep less than 1)
When a proportionate change in price leads to a less then
proportionate change in quantity demand is called relatively elastic
demand.
Y
P
Y
D
D
A
B
P1
price
A
P
B
Demand
D
P1
D
O
O
X
M M1
Price
X
M
M1
Demand
Unitary elastic demand (Ep=1)
If the proportionate change in price leads to the same
proportionate change in quantity demand is called unitary elastic
demand
Significance of Elastic demand
 Prices of factors of production
 Price fixation
 Govt. policies
 Forecasting demand
 Planning the level of output and price
Importance of Elasticity of Demand
 Finance minister
 Monopolist
 Terms of Trade
 Determination of wages
 Price under discriminating monopoly
Demand forecasting
“Demand forecasting is the key driver for success or failure.
Future demand of the product acts as a game changing factor in
today’s competitive business environment”.
Demand forecasting
 The importance of demand forecasting is paramount when either
production or demand is uncertain.
 When the supply is not in accordance with the demand, it results in
the development of black market or excessive prices.
 The results of demand forecasting guide the entrepreneur to set up
their business or industrial activities accordingly
Importance of Demand forecasting
 Price control
 Business planning
 Competitive strategy
Types of Demand forecasting (based on time)
 Short-term demand forecasting
 Long-term demand forecasting
Types of Demand forecasting (based on level)
 Firm level
 Industry level
 National level
 Global level
Factors affecting demand forecasting
 Nature of demand
 Types of forecasting
 Forecasting level
 Degree of orientation
 Introduce new products
 Nature of goods
 Degree of competition
 Market demand
Methods of demand forecasting
Quantitative Methods
Time series
analysis
Smoothing
Technique
Qualitative Methods
Barometric
Technique
Econometric
method
Survey
Method
Economi
c polls
1.Moving average method
2.Exponential smoothing
Census
method
1.Trend line method
2.Time series analysis
3.Least square method
Equation
Method
Correlation
analysis
Regression
analysis
Sample
method
Introduction to
MANAGERIAL
ECONOMICS
Managers in their day to day activities, are
always confronted with the several issues
such as :

How much quantity is to be produced

At what price

Make or buy decision

What will be the likely demand…etc
Managerial Economics provides basic insight
into seeking solutions for managerial
problems
As the name itself implies Managerial
Economics is an offshoot of two distinct
disciplines:
 Economics &
 Management
 Economics
is the social
science that analyzes
the production,distribution,
and consumption of goods and se
rvices.
 Economics
is study of human

Adam Smith the father of Economics defined
Economics as
“The study of the nature & uses of national
wealth”.

There are two branches in Economics
Micro Economics & Macro Economics.

The study of individual firm is Micro
Economics also called theory of firm

The study of total level of economic activity in

Management is the science & art of getting
things done through others.

Management includes several functions such
as:
Planning
Organizing
Staffing
Directing
Coordinating
Definition of Managerial
Economics

“The integration of economic theory with the business practice for the
purpose of facilitating decision making & foreword planning by
management”.
Spencer & Siegel man
Supplement notes

Managerial economics refers to application of
principles of Economics to solve the
managerial problems such as Minimizing the
cost or Maximizing profit.

Managerial economics directs the utilization
of scarce resources in a goal oriented
manner.

Seeks to understand & analyze the problems
of business decision making.

Facilitates foreword planning.

Examines how an organization can achieve its
objectives in most effectively.

Focuses on Minimizing the cost & Maximizing
the profit.
Nature of Managerial economics

Close to Micro economics: Managerial
economics is concerned with the finding
solutions for different managerial problems
of a particular firm, thus it is more close to
Micro economics.

Operates against the backdrop of Macro
economics: Manager of a firm has to be
aware of the limits set by the economic

Interdisciplinary in nature:
The tools, techniques & contents of
Managerial economics are drawn from
different disciplines such as Economics,
Management, Statistics, Psychology,
Accounting, Organizational behavior,
Sociology Etc….

Offers scope to evaluate each alternative:
Managerial economics provide an opportunity
Scope of Managerial
Economics:
Or subject matter of Managerial Economics.
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Subject matter of Managerial Economics
consists of applying economic principles &
concepts towards adjusting various
uncertainties faced by the business firms,
such as
Demand uncertainty
Cost uncertainty
Price uncertainty
profit uncertainty
Production uncertainty


The scope of managerial economics refers to
its area of study.
The scope of managerial economics covers
two areas of decision making.
a) Operational
or Internal issues
b) Environmental or External issues
Operational or Internal issues
Operational issues refer to those, which wise
within the business organization and they are
under the control of the management. Those
are:
1. Theory of demand and Demand Forecasting
2. Pricing and Competitive strategy
3. Production cost analysis
4. Resource allocation
5. Profit analysis
6. Capital or Investment analysis
7. Strategic planning

1. Demand Analysis and Forecasting:


A firm can survive only if it is able to forecast
demand for its product at the right time,
within the right quantity. Understanding the
basic concepts of demand is essential for
demand forecasting.
Demand analysis also highlights for factors,
which influence the demand for a product.
This helps to manipulate demand.
2. Pricing and competitive strategy:

Pricing decisions have been always within the
preview of managerial economics. Pricing
policies are merely a subset of broader class
of managerial economic problems. Price
theory helps to explain how prices are
determined under different types of market
conditions. Competitions analysis includes
the anticipation of the response of
competitions the firm’s pricing, advertising
and marketing strategies. Product line pricing
and price forecasting occupy an important
place here.
3. Production and cost analysis:
Production analysis is in physical terms. While
the cost analysis is in monetary terms cost
concepts and classifications, cost-out-put
relationships, economies and diseconomies
of scale and production functions are some of
the points constituting cost and production
analysis.

4. Resource Allocation:

Managerial Economics is the traditional
economic theory that is concerned with the
problem of optimum allocation of scarce
resources. Marginal analysis is applied to the
problem of determining the level of output,
which maximizes profit. In this respect linear
programming techniques has been used to
solve optimization problems. In fact lines
programming is one of the most practical and
powerful managerial decision making tools
currently available.
5. Profit analysis:

Profit making is the major goal of firms.
There are several constraints here an account
of competition from other products, changing
input prices and changing business
environment hence in spite of careful
planning, there is always certain risk involved.
Managerial economics deals with techniques
of averting of minimizing risks. Profit theory
guides in the measurement and management
of profit, in calculating the pure return on
capital, besides future profit planning.
. Capital or investment analyses:


Capital is the foundation of business. Lack of
capital may result in small size of operations.
Availability of capital from various sources
like equity capital, institutional finance etc.
may help to undertake large-scale
operations. Hence efficient allocation and
management of capital is one of the most
important tasks of the managers. The major
issues related to capital analysis are:
The choice of investment project
7. Strategic planning:

Strategic planning provides management with
a framework on which long-term decisions
can be made which has an impact on the
behavior of the firm. The firm sets certain
long-term goals and objectives and selects
the strategies to achieve the same. Strategic
planning is now a new addition to the scope
of managerial economics with the emergence
of multinational corporations. The
perspective of strategic planning is global.


It is in contrast to project planning which
B. Environmental or External Issues:


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

An environmental issue in managerial
economics refers to the general business
environment in which the firm operates
A study of economic environment should
include:
The type of economic system in the country.
The general trends in production,
employment, income, prices, saving and
investment.
Trends in the working of financial institutions
summary

The environmental or external issues relate
managerial economics to macro economic
theory while operational issues relate the
scope to micro economic theory. The scope
of managerial economics is ever widening
with the dynamic role of big firms in a
society.
Managerial economics
relationship with other
disciplines:

Managerial economics is closely linked with
many other disciplines such as
1. Economics
2. Mathematics
3. Statistics
4. Operations
Research
5. Accountancy
6. Psychology
7. Organizational behavior
Relationship with economics:
 Managerial economics is the off shoot of
ECONOMICS & hence concepts of Managerial
economics are basically economic concepts.
 Economics deals with theoretical concepts where
as Managerial economics is concerned with
application of these in real life.
 Both Managerial economics & economics are
concerned with problem of scarcity & resource
allocation.
Managerial Economics and mathematics:






Managerial economist is concerned with
estimating and predicting various economic
factors for purpose of decision making &
planning.
In this process Managerial economist
extensively makes use of tools & techniques
of Mathematics such as
Algebra
Calculus
Exponentials
Vectors etc..
Managerial Economics and Statistics:
Statistics deals with various techniques which
are useful to analyse CAUSE & EFFECT
relationship.
 Tools & techniques such as
Averages
Time series
Probability
Correlation
Interpolation
Regression
Above mentioned techniques are used by the
managerial economist to deal with situations
of risk & uncertanity.

M.E and Operations Research






Operation research discipline has many tools
which helps the managerial economist to find
solutions for many managerial problems.
The O.R Models such as
Linear programming
Queuing theory
Transportation problem
Project management techniqus PERT, CPM &
so on extensively used in solving managerial
problems.
Relationship with Accountancy


Accountancy provides information
relating to COST’S, REVENUES,
RECEIVABLES, PAYABLES,
PROFIT&LOSSES and etc, this forms
the basis for the managerial
economist to act upon.
Managerial economist depends upon
the accounting data for decision
making & planning.
Relationship with Psychology



Consumer Psychology is the basis on which
managerial economist acts upon.
Example: how customer reacts to given
change in the price.
Psychology contribute towards understanding
the ATTITUDES & MOTIVATIONS of each micro
economic variable such as consumer,
seller/supplies etc.
Relationship with Organizational behavior

Organisational behaviour enables the
managerial economist to study & develop
behavioural models of the firm, integrating
the managers behaviour with that of the
owners.
summary


To conclude, managerial economics, which is an
offshoot traditional economics, has gained
strength to be a separate branch of knowledge. It
strength lies in its ability to integrate ideas from
various specialized subjects to gain a proper
perspective for decision-making.
A successful managerial economist must be a
mathematician, a statistician and an economist. He
must be also able to combine philosophic methods
with historical methods to get the right perspective
only then; he will be good at predictions. In short
managerial practices with the help of other allied
sciences.
DEMAND ANALYSIS
What is Demand ?


1.
2.
3.

Demand: desire for a commodity or service
backed by purchasing power (ability to pay) &
willingness to pay for it is called Demand.
A product or service is said to have demand when
the following three conditions are satisfied.
Desire on the part of buyer to buy.
Ability to pay the specified price for it
(purchasing power)
Willingness to pay for it
Unless all these conditions are satisfied the
product/service is not said to have demand
FACTORS DETERMINING DEMAND
1.
2.
3.
4.
5.
6.
7.
8.
9.
PRICE OF THE PRODUCT
INCOME LEVEL OF THE CONSUMER
TASTE & PREFERENCES OF THE
CONSUMERS
PRICE OF RELATED GOODS (SUBSTITUTES)
EXPECTATIONS ABOUT THE PRICES IN THE
FUTURE
EXPECTATIONS ABOUT THE INCOMES IN
THE FUTURE
SIZE OF POPULATION
ADVERTISING EFFORTS
DISTRIBUTION OF CONSUMERS OVER
DIFFERENT REGIONS.
DEMAND FUNCTION
Demand function explains the functional
relationship between quantity demanded and the
various factors that determine demand.
 Demand function can be expressed mathematically
as follows
Dn = f (Pn,I,T)
Here Dn = quantity demanded
f = functional relationship
Pn = price of the product
I = income of the consumer
T = taste & preference of the consumer

DEMAND SCHEDULE


Demand Schedule: it
shows functional
relationship between
the quantity demanded
of a product & its
price.
i.e. demand schedule
shows different
quantities of a
commodity demanded
at various prices at a
given time.
Price of Apple
(In. Rs.)
Quantity Demanded
10
1
8
2
6
3
4
4
1
5
LAW of Demand
introduction


Law of demand shows the relation between
price and quantity demanded of a commodity
in the market.
In the words of Marshall, “the amount of
demand increases with a fall in price and
diminishes with a rise in price”.


The law of demand may be explained with the
help of the following demand schedule.
Demand Schedule.
Price of Apple (In. Rs.)
Quantity Demanded
10
1
8
2
6
3
4
4
2
5


When the price falls from Rs. 10 to 8 quantity
demand increases from 1 to 2. In the same
way as price falls, quantity demand increases
on the basis of the demand schedule we can
draw the demand curve.
The demand curve DD shows the inverse
relation between price and quantity demand
of apple. It is downward sloping.
Assumptions of LAW of Demand

Law of demand is based on certain
assumptions:
This is no change in consumers taste and
preferences.
2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the
commodity
5. The commodity should not confer at any
distinction
6. The demand for the commodity should be
1.
EXCEPTIONS TO LAW OF
DEMAND
Veblen goods or luxury goods
‘Veblan’ has explained the exceptional
demand curve through his doctrine of
conspicuous consumption. Rich people buy
certain good because it gives social distinction
or prestige for example diamonds are bought
by the richer class for the prestige it possess. It
the price of diamonds falls poor also will buy is
hence they will not give prestige. Therefore,
rich people may stop buying this commodity.
Ignorance

Sometimes, the quality of the commodity is
Judge by its price. Consumers think that the
product is superior if the price is high. As
such they buy more at a higher price.
Speculative effect

If the price of the commodity is increasing the
consumers will buy more of it because of the
fear that it increase still further, Thus, an
increase in price may not be accomplished by
a decrease in demand.
Fear of shortage

During the times of emergency of war People
may expect shortage of a commodity. At that
time, they may buy more at a higher price to
keep stocks for the future.
Necessaries:

In the case of necessaries like rice, vegetables
etc. people buy more even at a higher price.
Giffen paradox:

The Giffen good or inferior good is an
exception to the law of demand. When the
price of an inferior good falls, the poor will
buy less and vice versa. For example, when
the price of maize falls, the poor are willing to
spend more on superior goods than on maize
if the price of maize increases, he has to
increase the quantity of money spent on it.
Otherwise he will have to face starvation. Thus
a fall in price is followed by reduction in
quantity demanded and vice versa. “Giffen”
first explained this and therefore it is called as
UNIT 2
ELASTICITY OF DEMAND
Introduction



The law of demand explains the direction of
change in the quantity demanded, due to
the changes in the price in case of normal
goods.
Law of demand explains only the direction
but not magnitude of change i.e.,
Law of demand does not explain how much
quantity demanded will change, in response
to change in the price, the concept of
ELASTICITY OF DEMAND explain this.



The concept of ELASTICITY OF DEMAND is
very important to the Economic theory as it
explains the extent to which the demand
changes when the price changes.
ELASTICITY OF DEMAND in general it refers
to PRICE ELASTICITY OF DEMAND.
ELASTICITY OF DEMAND is always negative
(-) for NORMAL GOODS. This is due to
inverse relationship between PRICE &
DEMAND.
Definition of PRICE ELASTICITY OF DEMAND


Degree to which quantity demanded responds
to a change in price is known as PRICE
ELASTICITY OF DEMAND.
In other words, the PRICE ELASTICITY OF
DEMAND is the ratio of percentage change in
quantity demanded, to percentage change in
price.
Mathematically it can be expressed as follows
 PRICE ELASTICITY OF DEMAND (Ep) =
Percentage change in quantity demanded
/Percentage change in price.
OR
 (Ep) = Proportionate change in quantity
demanded / Proportionate change in price.
 Proportionate change in quantity demanded
=change in demand / initial demand
 Proportionate change in price = change in
price / initial price
TYPES OF ELASTICITY OF DEAMAND

1.
2.
3.
4.
The following are various types of
ELASTICITY OF DEAMAND
PRICE ELASTICITY OF DEMAND
INCOME ELASTICITY OF DEMAND
CROSS ELASTICITY OF DEMAND
ADVERTISEMENT ELASTICITY OF DEMAND

PRICE ELASTICITY OF DEMAND: it refers to
the responsiveness of quantity demanded to
changes in prices.
MEASUREMENT
PRICE ELASTICITY OF DEMAND (Ep):

(Ep) = Proportionate change in quantity
demanded / Proportionate change in price.
INCOME ELASTICITY OF DEMAND: it refers to
the responsiveness of quantity demanded to
changes in the incomes of the consumers.
MEASUREMENT

INCOME ELASTICITY OF DEMAND

(Ei) = Proportionate change in quantity
demanded / Proportionate change in
income
CROSS ELASTICITY OF DEMAND: it refers to
the responsiveness of quantity demanded to
changes in the prices of the related goods,
say which may be substitute goods.
MEASUREMENT
CROSS ELASTICITY OF DEMAND (Ec):

(Ec) = Proportionate change in quantity
demanded / Proportionate change in prices
of related goods.
ADVERTISEMENT ELASTICITY OF DEMAND: it
refers to the responsiveness of quantity
demanded to changes in the advertisement
efforts & expenditure.
MEASUREMENT

ADVERTISEMENT ELASTICITY OF DEMAND
(Ea):

(Ea) = Proportionate change in quantity
demanded / Proportionate change in
advertisement efforts or cost.
TYPES OF PRICE
ELASTICITY OF
DEMAND

Based on numerical values price elasticity of
demand can be of five (5) types.
Perfectly elastic demand (Ep = α)
2) Perfectly inelastic demand (Ep = 0)
3) Unit elastic demand (Ep = 1)
4) Relatively elastic (Ep = > 1)
5) Relatively inelastic (Ep = < 1)
1)
Perfectly elastic demand




Perfectly elastic demand is also called as
infinitely elastic demand.
It means small change in price leads to an
infinite expansion in demand.
Even if the price remain same the quantity
demanded increases.
Perfectly elastic demand curve is horizontal
straight line to X axis
Price
P
O
Q1
Q2
Demand
Perfectly elastic demand curve is horizontal straight
line to X axis
•Even if the price remain same the quantity
demanded increases.
•
Perfectly inelastic demand


In perfectly inelastic demand even with a
great fall or rise in the price the quantity
demanded of the product does not change.
perfectly inelastic demand curve is vertical
straight line parallel to Y axis
p
p1
o


m
perfectly inelastic demand curve is vertical
straight line parallel to Y axis
What ever may be the change in the price
high or low the quantity demanded is the
same.
Unit elastic demand



Proportionate change in price leads to a
proportionate change in quantity demand is
called unit elastic demand.
If demand increases by 1% for a 1% fall in the
price, the elasticity of demand is equal to 1.
When the change in demand is equal to
change in price is called unit elasticity
demand.
Relatively elastic


It means Proportionate change in price leads
to more than proportionate change in
quantity demanded is called Relative elastic
demand.
If demand increases by more than 1% for a 1%
fall in the price, the elasticity of demand is
said to be Relative elastic demand.
Relatively inelastic


It means Proportionate change in price leads
to less than proportionate change in quantity
demanded is called Relative inelastic
demand.
If demand increases by less than 1% for a 1%
fall in the price, the elasticity of demand is
said to be Relative inelastic demand.
Importance of Elasticity of
Demand:





The concept of elasticity of demand is very
useful to the Producers and the Policy
makers.
It is used to fix prices of goods.
To fix prices (rewards) of Factors of
production.
To forecast demand. (income elasticity man
be used to forecast demand for the product)
To plan the level of output & price.
1. Price fixation:

Each seller has to take into account elasticity
of demand, while fixing the price for his
product. If the demand for the product is
inelastic, he can fix a higher price.
2.To fix prices of factors of
production

Elasticity of demand also helps in the
determination of rewards for factors of
production. For example, if the demand for
labour is inelastic, trade unions will be
successful in raising wages. It is applicable to
other factors of production.
3. Production:

Producers generally decide their production
level on the basis of demand for the product.
Hence elasticity of demand helps the
producers to take correct decision regarding
the level of out put to be produced.
4. Public Finance:



Elasticity of demand helps the government in
formulating tax policies.
For example, for imposing tax on a
commodity, the Finance Minister has to take
into account the elasticity of demand.
If a commodity has inelastic demand
increase in the tax on such commodity will
generate revenue for the government.
5. International Trade:



The concept of elasticity of demand plays
significant role in the international trade.
Much foreign exchange can be earned by
exporting goods which has elastic demand.
Small reduction in price of goods result in
good amount of foreign exchange.
DEMAND FORECASTING
METHODS
WHY TO FORECAST DEMAND ?
1.
2.
3.
To assess the likely demand.
To plan the production accordingly.
To plan the INPUTS (factors of productions)
Manpower (labour), Raw material, and
Capital.
Demand Forecasting
Methods
survey
Survey of
buyer
intentions
Sales
force
opinion
Delphi
method
Statistical
Trend
projectio
n
methods
Barometri
c
Correlatio
n
Regressio
n
other
Expert
opinion
Test
marketin
g
Controlle
d
experime
nts
Self
judgment
DEMAND FORECASTING METHODS

1.
2.
3.
DEMAND FORECASTING METHODS are
classified into
Survey methods
Statistical methods
Other methods
Survey methods
Survey of buyer intentions

Census method

Sample method
Sales force opinion method
Delphi Method
Statistical methods
1.
2.
3.
4.
Trend projection methods
Barometric techniques
Simultaneous equation method
Regression & correlation methods
Other methods
1.
2.
3.
4.
Expert opinion method
Test marketing
Controlled experiments
Judgmental approach
1.


Survey of buyer intentions: in this method
information is drawn from the buyer to estimate
demand.
In this method each potential buyer is asked how
much does he plan to buy, of the given product at
a given point of time under particular condition.
This is the most effective method because the
buyer is the ultimate decision maker, & we are
collecting the information from the potential
buyer.



Survey can be conducted by considering either
whole population or by selecting a small group of
potential buyers.
If survey is conducted by considering the whole
population it is called CENSUS method. CENSUS
method is also called as TOTAL ENUMERATION
method.
If survey is conducted by considering the small
group of potential buyers who can represent the
whole population, it is called SAMPLE method.
2. Sales force opinion method: Sales people are in


constant touch with the large number of buyers of
a particular market.
Sales force constitute valid source of information
about the likely sales of a product
Sales force is capable of assessing the likely
reaction of the customers of their territories
quickly, given the companies marketing strategy.
3.Delphi Method: A variant of the survey
method is Delphi method. It is a sophisticated
method to arrive at a consensus. Under this
method, a panel is selected to give suggestions
to solve the problems in hand. Both internal and
external experts can be the members of the
panel. Panel members one kept apart from each
other and express their views in an anonymous
manner. There is also a coordinator who acts as
an intermediary among the panelists. He
prepares the questionnaire and sends it to the
panelist. At the end of each round, he prepares
a summary report. On the basis of the summary
report the panel members have to give
suggestions.
1.Trend projection methods:

A well-established firm will have
accumulated data. These data is analyzed to
determine the nature of existing trend.
Then, this trend is projected in to the future
and the results are used as the basis for
forecast.
There are five main techniques
Trend line by observation
II. Least square method
III.Time series analysis
IV.Moving averages method
V. Exponential smoothing
I.



2.Barometric technique: under this technique
one set of data is used to predict another set.
In other words to forecast demand for a
product , some other relevant indicator,
which is known as BAROMETER is used to
forecast the future demand.
E.g.. To forecast demand for cement the
relevant indicator number of new
construction projects, are taken into
consideration for forecasting demand.




3.Correlation describes the degree of
association between two variables such as
sales and advertisement expenditure.
When two variables tend to change together
then they are said to be correlated.
The extent to which they are correlated is
measured by correlation coefficient.
For example if sales have gone up as a result
of increase in advertisement expenditure we
can say that sales and advertisement are
positively correlated.


4.Regression analysis: A statistical measure that
attempts to determine the strength of
the relationship between one dependent
variable (usually denoted by Y) and a series of
other changing variables (known as
independent variables).
The two basic types of regressions are linear
regression and multiple regression. Linear
regression uses one independent variable to
explain and/or predict the outcome of Y, while
multiple regression uses two or more
independent variables to predict the outcome.

The general form of each type of
regression is:
Linear Regression: Y = a + bX + u
Multiple Regression: Y = a + b1X1 + b2X2
+ B3X3 + ... + BtXt + u
Where:
Y= the variable that we are trying to predict
X= the variable that we are using to predict
Y
a= the intercept
b= the slope
u= the regression residual.


1.Expert opinion method: an expert is good at
forecasting and analyzing the future trends for a
given product or service at a given level of
technology.
Apart from salesmen, consumers & distributors,
outside experts may also used for forecasting. In
the United States of America, the automobile
companies get sales estimates directly from their
dealers. Firms in advanced countries make use of
outside experts for estimating future demand.


2.Test marketing: in test marketing the entire
product and marketing program is carried for the
first time in a small number of well chosen and
authentic sales environment.
The primary objective of test marketing is to know
whether the customer will accept the product in the
present form or not


3.Controlled experiments: major determinants of
demand are manipulated to suit to the customers
with different tastes and preferences
In this method the product is introduced with
different packages, different prices, in different
markets to assess which combination appeals to
the customer most

4.Judgmental approach: when none of
statistical and other methods are directly
related to the given product/service the
management has no alternative other than
using its own judgment in forecasting the
demand.
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