MANAGERIAL ECONOMICS PDF
One standard definition for economics is the study of the production, distribution, and consumption of goods and services. A second definition is the study of. PDF | Managerial Economics: Concepts and Tools is intended as a textbook for Managerial Economics courses in Business and Management. At the end of the reading this chapter, the reader will be able to understand that economics is the study of mankind's attempt to satisfy their unlimited wants with.
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What is Economics 1. Opportunity Cost 3. Macroeconomics Versus Microeconomics 3. What is Managerial Economics 4. Theories and Models 5. Descriptive. Managerial Economics can be viewed as an application of that part of Study of Managerial Economics essentially involves the analysis of certain major. Managerial Economics – Analysis, Problems and Cases, P.L. Mehta, Sultan Chand Managerial Economics – Varshney and Maheshwari, Sultan Chand and.
The management gives top most priority to this aspect. There are many theories in profit management, like emergence of profit, functions of profit and its measurement, profit policies, techniques, profit planning, profit forecasting and break even point. Capital management This is one of the essential areas of business unit. The success of any business is based on proper management and adequate capital investment.
Business managers, as part of cost-benefit analysis, have to study the cost of employing capital and the rate of return expected from each and every Sikkim Manipal University Page No.
Under capital management, managers should assess capital requirement, methods of capital mobilisation, capital budgeting, optimal allocation of capital, selection of highly profitable projects, cost of capital, return on capital, planning and control of capital expenditure, etc. Linear programming and theory of games The term linear means that the relationships handled can be represented by straight lines and the term programming implies systematic planning or decision-making.
It implies maximisation or minimisation of a linear function of variables subject to a constraint of linear inequalities. It offers actual numerical solution to the problems of making optimum choices. It involves either maximisation of profits or minimisation of costs. Basically, the theory of games attempts to explain the rational course of action for an individual firm or an entrepreneur who is confronted with a situation, wherein the outcome depends not only on his own actions, but also on the actions of others who are also confronted with the same problem of selecting a rational course of action.
In short, under the conditions of conflicts and uncertainty, a firm or an individual faces problem similar to that of the player of any game.
Both these techniques are extensively used in business economics to solve various business and managerial problems. Market structure and conditions The information on market structure and conditions of various markets is the most important part of the business. The nature, extent and degree of competition, number of sellers and buyers, etc. Strategic planning It provides long term decisions, which will have a huge impact on the behaviour of the firm. The firm fixes up some long-term goals and objectives and selects a different strategy to achieve them.
This framework is a recent addition to the scope of business economics with the emergence of MNCs. The perspective of strategic planning is global. In fact, the integration of business economics and strategic planning has given rise to a new area of study called corporate economics. Few examples of external environment impacting managerial economics are as follows: 1. Macroeconomic management of the country relating to economic system, national income, trade cycles, savings and investments and its impact on the working of a firm 2.
Budgetary operations of the government and its implications on the firm 3. Knowledge and information about various government policies such as monetary, fiscal, physical, industrial, labour, foreign trade, foreign capital and technology, MNCs, etc. Impact of liberalisation, globalisation, privatisation and marketisation on the operations of a firm 5.
Impact of international changes, role of international financial and trade institutions in formulating domestic polices of a firm 6. Problems of environmental degradation and pollution and its impact on the policies of a firm 7. Improvements in the field of science and technology and its impact on a firm, etc 8.
Socio-political, cultural and other external forces and their influence of business operations Thus, it is clear that the scope of managerial economics is expanding with the growth of modern business and business environment.
Managerial economics does not give importance to the study of theoretical economic concepts. Its main concern is to apply theories to find solutions to day-to-day practical problems faced by a firm.
The following points indicate the significance of the study of this subject in its right perspective: 1. It gives guidance for identification of key variables in decision-making process. It helps the business executives to understand the various intricacies of business and managerial problems and to take right decisions at the right time.
It provides the necessary conceptual, technical skills, toolbox of analysis and techniques of thinking and other such modern tools and instruments like elasticity of demand and supply, cost and revenue, income and expenditure, profit and volume of production, etc to solve various business problems. It is both a science and an art. In the context of globalisation, privatisation, liberalisation and marketisation and a highly competitive dynamic economy, it helps in identifying various business and managerial problems, their causes and consequence, and suggests various policies and programmes to overcome them.
It helps the business executives to become much more responsive, realistic and competent to face the dynamic challenges in the modern business world. It helps in the optimum use of scarce resources of a firm to maximise its profits. It also helps in achieving other objectives a firm likes attaining industry leadership, market share expansion and social responsibilities, etc.
It helps a firm in forecasting the most important economic variables like demand, supply, cost, revenue, price, sales and profit, etc and formulate sound business policies 9.
It also helps in understanding the various external factors and forces which affect the decision-making of a firm. Thus, it has become a highly useful and practical discipline in recent years to analyse and find solutions to various kinds of problems in a systematic and rational manner.
Managerial economist is a specialist and an expert in analysing and finding answers to business and managerial problems. He has in-depth knowledge of the subject. He is an authority and has total command over his subject. Decisions making and forward planning are described as the two major basic functions and remaining functions are derived from the two basic functions. A detailed description of the basic functions is given below for better understanding.
The act of making a choice that signifies a solution for an economic problem is economic decision making. It involves making a choice amongst a set of alternative courses of action. Decision-making is essentially a process of selecting the best option out of many alternative opportunities or courses of action that are open to a manager.
The choice made by the business executives are difficult, crucial and have far-reaching consequences. The basic aim of making a decision is to select the best course of action which maximises the economic benefits and minimises the use of scarce resources of a firm. Hence, each decision involves cost-benefit analysis. A slight error or delay in decision making may cause considerable economic and financial damage to a firm.
It is for this reason that the management experts are of the opinion that right decision- making at the right time is the secret of a successful manager. It is a deliberate activity. In the long period, the firm can change its output by changing its size. In the short period, the output of the industry is fixed because the firms cannot change their size of operation and they can vary only variable factors.
In the long period, the output of the industry is likely to be more because the firms have enough time to increase their sizes and also use both variable and fixed factors. In the short period, the average cost of a firm may be either more or less than its average revenue. In the long period, the average cost of the firm will be equal to its average revenue. A decision may be made on the basis of short run considerations, but may as time elapses have long run repercussions which make it more or less profitable than it at first appeared.
Illustration: The firm which ignores the short run and long run considerations will meet with failure can be explained with the help of the following illustration. Suppose, a firm having a temporary idle capacity, received an order for 10, units of its product.
The customer is willing to pay only Rs. The short run incremental cost ignoring the fixed cost is only Rs. Therefore, the contribution to overhead and profit is Rs.
If the firm executes this order, it will have to face the following repercussion in the long run: a It may not be able to take up business with higher contributions in the long run. The Opportunity Cost Concept: Both micro and macro economics make abundant use of the fundamental concept of opportunity cost. In everyday life, we apply the notion of opportunity cost even if we are unable to articulate its significance.
In Managerial Economics, the opportunity cost concept is useful in decision involving a choice between different alternative courses of action. Resources are scarce, we cannot produce all the commodities. We cannot have everything we want. We are, therefore, forced to make a choice. Opportunity cost of a decision is the sacrifice of alternatives required by that decision. Sacrifice of alternatives is involved when carrying out a decision requires using a resource that is limited in supply with the firm.
Opportunity cost, therefore, represents the benefits or revenue forgone by pursuing one course of action rather than another. The concept of opportunity cost implies three things: 1. The calculation of opportunity cost involves the measurement of sacrifices. Sacrifices may be monetary or real. The scope of managerial economics includes following subjects: Managerial economics uses a wide variety of economic concepts, tools and techniques in the decision-making process.
These concepts can be enlisted as follows: Explain concept and techniques of managerial economics. How is Managerial Economics applied in analysis and decision-making?
Why managers need to know economics? Explain the importance of managerial economics. Short Notes a. Meaning and definition of managerial economics b. Application of managerial economics c. Theories of managerial economics d. Characteristics of managerial economics e. Optimisation and forecasting in managerial economics 1. Managerial Economics, Chopra O P. Managerial Economics, Varshney R L. How far are these principles followed in present managerial economic scenarios?
It is a continuous process Content Map 2. Demand theory is the building block of the demand curve- a curve that establishes a relationship between consumer demand and the amount of goods available. Demand is shaped by the availability of goods, as the quantity of goods increases in the market the demand and the equilibrium price for those goods decreases as a result.
Demand theory is one of the core theories of microeconomics and consumer behaviour. It attempts at answering questions regarding the magnitude of demand for a product or service based on its importance to human wants. Based on the perceived utility of goods and services to consumers, companies are able to adjust the supply available and the prices charged. In economics, demand has a specific meaning distinct from its ordinary usage.
This is incongruent from its use in economics. In economics, demand refers to effective demand which implies three things: For instance, a person may desire to own a scooter but unless he has the required amount of money with him and the willingness to spend that amount on the purchase of a scooter, his desire shall not become a demand.
The following should also be noted about demand: For instance, the statement, 'the weekly demand for potatoes in city X is 10, kilograms' has no meaning unless we specify the price at which this quantity is demanded. For instance, the statement that demand for potatoes in city X at Rs. A complete statement would therefore be as follows: It is necessary to specify the period and the price because demand for a commodity will be different at different prices of that commodity and for different periods of time.
Thus, we can define demand as follows: An Effective Need: Effective need entails that there should be a need supported by the capacity and readiness to shell out. Hence, there are three basics of an effective need: The individual should have a need to acquire a specific product. He should have sufficient funds to pay for that product. He should be willing to part with these resources for that commodity. A Specific Price: A proclamation concerning the demand of a product without mentioning its price is worthless.
For example, to state that the demand of cars is 10, is worthless, unless expressed that the demand of cars is 10, at a price of Rs. A Specific Time: Demand must be assigned specific time. For example, it is an incomplete proclamation to state that the demand of air conditioners is 4, at the price of Rs.
The statement should be altered to say that the demand of air conditioners during summer is 4, at the price of Rs. A Specific Place: The demand must relate to a specific market as well. For example, every year in the town of Dehradun, the demand for school bags is 4, at a price of Rs.
Nevertheless, the significance of a specific market or place is not as significant as the price and time period for which demand is being measured. As explained the first and the most important factor that determines the demand of a commodity is its price. If all other factors noted above remain constant, it may be said that as the price of a commodity increases, its demand decreases and as the price of a commodity decreases its demand increases.
This is a general behaviour observed in a market. This gives us the law of demand: The law of demand thus merely states that the price and demand of a commodity are inversely related, provided all other things remain unchanged or as economists put it ceteris paribus. These are then the assumptions of the law of demand.
We can state the assumptions of the law of demand as follows: Income level should remain constant: The law of demand operates only when the income level of the buyer remains constant. If the income rises while the price of the commodity does not fall, it is quite likely that the demand may increase.
Therefore, stability in income is an essential condition for the operation of the law of demand. Tastes of the buyer should not alter: Any alteration that takes place in the taste of the consumers will in all probability thwart the working of the law of demand. It often happens that when tastes or fashions change people revise their preferences. As a consequence, the demand for the commodity which goes down the preference scale of the consumers declines even though its price does not change.
Prices of other goods should remain constant: Changes in the prices of other goods often impinge on the demand for a particular commodity. If prices of commodities for which demand is inelastic rise, the demand for a commodity other than these in all probability will decline even though there may not be any change in its price. Therefore, for the law of demand to operate it is imperative that prices of other goods do not change.
No new substitutes for the commodity: If some new substitutes for a commodity appear in the market, its demand generally declines. This is quite natural, because with the availability of new substitutes some buyers will be attracted towards new products and the demand for the older product will fall even though price remains unchanged.
Hence, the law of demand operates only when the market for a commodity is not threatened by new substitutes. Price rise in future should not be expected: If the buyers of a commodity expect that its price will rise in future they raise its demand in response to an initial price rise. This behaviour of buyers violates the law of demand. Therefore, for the operation of the law of demand it is necessary that there must not be any expectations of price rise in the future.
Advertising expenditure should remain the same: If the advertising expenditure of a firm increases, the consumers may be tempted to buy more of its product. Therefore, the advertising expenditure on the good under consideration is taken to be constant. Desire of a person to purchase a commodity is not his demand. He must possess adequate resources and must be willing to spend his resources to buy the commodity.
There may be some problems in applying this flow concept to the demand for durable consumer goods like house, car, refrigerators, etc. However, this apparent difficulty may be resolved by considering the total service of a durable good is not consumed at one point of time and its utility is not exhausted in a single use.
The service of a durable good is consumed over time. At a time, only a part of its service is consumed. Therefore, the demand for the services of durable consumer goods may also be visualised as a demand per unit of time. However, this problem does not arise when the concept of demand is applied to total demand for a consumer durable.
Thus, the demand for consumer goods also is a flow concept. A demand schedule is a series of quantities, which consumers would like to buy per unit of time at different prices. To illustrate the law of demand, an imaginary demand schedule for tea is given in Table 2.
It shows seven alternative prices and the corresponding quantities number of cups of tea demand per day. Each price has a unique quantity demanded, associated with it. As the price per cup of tea decreases, daily demand for tea increases, in accordance with the law of demand.
Demand curve is a locus of points showing various alterative price-quantity combinations. It shows the quantities of a commodity that consumers or users would buy at difference prices per unit of time under the assumptions of the law of demand. An individual demand curve for tea as given in Fig.
The combinations read in alphabetical order should decreasing price of tea and increasing number of cups of tea demanded per day. Price quantity combinations in reverse order of alphabets illustrate increasing price of tea per cup and decreasing number of cups of tea per day consumed by an individual. The whole demand curve shows a functional relationship between the alternative price of a commodity and its corresponding quantities, which a consumer would like to buy during a specific period of item—per day, per week, per month, per season, or per year.
The demand curve shows an inverse relationship between price and quantity demanded. This inverse relationship between price and quantity demanded results in the demand curve sloping downward to the right. The downward slope of the demand curve reads the law of demand i. The reasons behind the law of demand i. When the price of a commodity falls it becomes relatively cheaper if price of all other related goods, particularly of substitutes, remain constant.
In other words, substitute goods become relatively costlier. Since consumers substitute cheaper goods for costlier ones, demand for the relatively cheaper commodity increases. The increase in demand on account of this factor is known as substitution effect.
As a result of fall in the price of a commodity, the real income of its consumer increase at least in terms of this commodity.
The increase in real income or purchasing power encourages demand for the commodity with reduced price. The increase in demand on account of increase in real income is known as income effect.
It should however be noted that the income effect is negative in case of inferior goods. Consequently, they substitute the superior good for the inferior ones, i. Thus, the income effect on the demand for inferior goods becomes negative. Diminishing marginal utility as well is to be held responsible for the rise in demand for a product when its price declines. When an individual purchases a product, he swaps his money revenue with the product in order to increase his satisfaction.
He continues to purchase goods and services as long as the marginal utility of money MUm is lesser than the marginal utility of the commodity MUC. This plan works well under both Marshallian assumption of constant MUm as well as Hicksian assumption of diminishing MUm. Thus, equilibrium state is upset.
To get back his equilibrium state, i. For this reason, demand for a product rises when its price falls. When consumers anticipate a constant rise in the price of a long-lasting commodity, they purchase more of it despite the price rise. They do so with the intention of avoiding the blow of still higher prices in the future.
Likewise, when consumers expect a substantial fall in the price in the future, they delay their purchases and hold on for the price to decrease to the anticipated level instead of purchasing the commodity as soon as its price decreases. These kinds of choices made by the consumers are in contradiction of the law of demand. Rich people mostly purchase such goods as they are very costly. An exception to this law is the typical case of Giffen goods named after Sir Robert Giffen It could be any low-grade commodity which is cheap as compared to its superior alternatives, consumed generally by the lower income group families as an important consumer good.
If price of such goods rises price of its alternative remaining stable , its demand escalates instead of falling. They have a fixed expenditure of Rs.
No doubt, the family's demand for bajra rises from 20 to 25 kgs when its price rises. The total quantity which all the consumers of a commodity are willing to buy at a given price per time unit, other things remaining the same, is known as market demand for the commodity. In other words, the market demand for a commodity is the sum of individual demands by all the consumers or buyers of the commodity, per time unit and at a given price, other factors remaining the same.
For instance, suppose there are three consumers viz. The last column presents the market demand i. Table 2. Price and Quantity Demanded Price of Quantity of X demanded by Market Demand Commodity X A B C Price per unit 10 4 2 0 6 8 8 4 0 12 6 12 6 2 20 4 16 8 4 28 2 20 10 6 36 0 24 12 8 44 Graphically, market demand curve is the horizontal summation of individual demand curves.
The individual demand schedules plotted graphically and summed up horizontally gives the market demand curve as shown in Fig. The horizontal summation of these individual demand curves results into the market demand curve DM for the commodity X. The curve DM represents the market demand curve for commodity X when there are only three consumers of the commodity.
Derivation of market demand Study Notes Assessment 1. What are the essentials of a Demand? Explain Law of Demand, in detail. The above-stated demand function is a complicated one.
Again, factors like tastes and unknown influences are not quantifiable. Economists, therefore, adopt a very simple statement of demand function, assuming all other variables, except price, to be constant. Thus, an over-simplified and the most commonly stated demand function is: The traditional demand theory deals with this demand function specifically. It must be noted that by demand function, economists mean the entire functional relationship i.
In other words, the statement, 'the quantity demanded is a function of price' implies that for every price there is a corresponding quantity demanded. To put it differently, demand for a commodity means the entire demand schedule, which shows the varying amounts of goods purchased at alternative prices at a given time. Fig 2. If any of the other factors e. This will cause a downward shift in demand curve from D2 to D1.
Similarly, increase in disposable income of the consumer due to reduction in taxes may cause an upward shift from D2 to D3. Such changes in the position of the demand curve are known as shifts in demand curve. Reasons for Shift in Demand Curve Shifts in a price-demand curve may take place owing to the change in one or more of other determinants of demand. Consider, for example, the decrease in demand for commodity X by Q1Q2 in Fig 2.
Study Notes Assessment Explain, why there is shift in demand curve? Discussion Give the functional relationship between the demand for a commodity and its various determinants, in mathematical terms of a demand function.
This relation, as already discussed, is inverse baring some rare exceptions. However, a manager needs an exact measure of this relationship for appropriate business decisions. Elasticity of demand is a measure, which comes to the rescue of a manager here. It measures the responsiveness of demand to changes in prices as well as changes in income.
A manager can determine almost exactly how the demand for his product would change when he changes his price or when his rivals alter prices of their products.
He can also determine how the demand for his product would change if incomes of his consumers go up or down. Elasticity of demand concept and its measurements are therefore very important tools of managerial decision making.
From decision-making point of view, however, the knowledge of only the nature of relationships is not sufficient. What is more important is the extent of relationship or the degree of responsiveness of demand to changes in its determinants. The responsiveness of demand for a good to the change in its determinants is called the elasticity of demand.
The concept of elasticity of demand was introduced into the economic theory by Alfred Marshall. The elasticity concept plays an important role in various business decisions and government policies. In this unit, we will discuss the following kinds of demand elasticity. Elasticity of demand for a commodity with respect to change in its price. Elasticity of demand for a commodity with respect to change in the price of its substitutes.
More precisely, elasticity of demand is the percentage change in the quantity demanded of a commodity as a result of a certain percentage change in its price. A formal definition of price elasticity of demand e is given below: The measure of price elasticity is converted into a more general formula for calculating coefficient of price elasticity given as eq.
Note that a minus sign - is generally inserted in the formula before the fraction with a view to making elasticity coefficient a non-negative value.
The elasticity measured on a finite point of a demand curve is called point elasticity and the elasticity measured between any two finite points is called arc elasticity. Let us now look into the methods of measuring point and arc elasticity and their relative usefulness.
The concept of point elasticity is useful where change in price and the consequent change in quantity demanded are very small. The point elasticity may be symbolically expressed as eq.
These values can be obtained by assuming a very small decrease in the price. However, it will be difficult to depict these changes in the figure as and hence Q —O. In derivative given the slope of the demand curve MN. That is, may be proved as follows. If we draw a horizontal line from P and to the vertical -. For proof, see the proceeding section. According to William J. Baumol, a Nobel Prize winner, price elasticity at upper terminal point of the demand curve is undefined.
It is undefined because measuring elasticity at terminal point M involves division of zero and division by-zero is undefined. The reader who has forgotten why division by zero is immoral may recall that division is the reverse operation of multiplication. However, where change in price and the consequent hunger in demand is substantial, the concept of arc elasticity is the relevant concept.
Arc elasticity is a measure of the average of responsiveness of the quantity demanded to a substantial change in the price. In other words, the measure of price elasticity of demand between two finite points on a demand curve is known as arc activity. For example, the measure of elasticity between points J and K Fig. The arc elasticity between point J and K and moving from J to K can be obtained by substituting these values in the elasticity formula. I It means that a one percent decrease in price of commodity X results in a 1.
Arc elasticity coefficients differ between the same two finite points on a demand curve if direction of change in price is reversed. Arc elasticity for a decrease in price will be different from that for the same increase in price between the same to points on a demand curve.
For example, the price elasticity between points J and K — moving from J to K — is equal to 1. This is the elasticity for decrease in price from Rs 25 to Rs But a reverse movement on the demand curve, i. Substituting these values in the elasticity formula, we get The measure of arc elasticity co-efficient in equation I for the reverse movement in price is obviously different from the one given in equation II.
Therefore, while measuring the arc elasticity, the direction of price change should be carefully noted, otherwise it may yield misleading conclusions. Elasticity co-efficient 0. It gives only mean of the elasticity between the two points. It is important to note that elasticity between the mid-point and the upper point J or lower point K will be different.
Such demand curves can be placed in the following categories: These three types of demand curves are illustrated in Fig. Constant Elasticity Demand Curve 2. But this conclusion is misleading because two demand curves with different slopes may have the same elasticity at a given price. In fact, what appearance of a demand curve reveals is its slope, not the elasticity. We will show below: In Fig. It may be proved as follows: Obviously, the slopes of the two demand curves are different.
Let us now show, that at a given price, both the demand curves have the same elasticity. As shown in Fig. It can be geometrically proved that the two elasticity are equal, i. Therefore, all the three triangles are right-angled triangles. As noted above, the ratios of their two corresponding sides of similar right-angle triangles are always equal. Price Elasticity of two parallel demand curves Now, we will compare the price elasticity at two parallel demand curves at a given price.
This has been illustrated in Fig 2. The two demand curves which are parallel to each other imply that they have the same slope. Now, draw a perpendicular from point R to the point P on Y-axis.
Thus, at price OP the corresponding points on the two demand curves are Q and R respectively. It also follows that as the demand curve shifts to the right the price elasticity of demand at a given price goes on declining. Thus, as has been just seen, price elasticity at price OP on the demand curve CD is less than that on the demand curve AB.
It pertains to the relationship between price elasticity and the marginal change in the total revenue of the firm planning to change the price of its product. The relationship between price elasticity and the marginal revenue MR can be derived as follows. Let us suppose that a given output, Q, is being sold at a price P, so that the total revenue, TR, equals P times Q, i.
I Since P and Q in eq. I are inversely related, a question arises, whether a change in P will increase or decrease or leave the TR unaffected. It depends on whether MR is greater than or less than or equal to zero, i. Price elasticity and total revenue Given the relationship between marginal revenue and price elasticity of demand in Eq. II, the decision-makers can easily know whether or not it is advantageous to change the price. Given Eq. Therefore, change in price will not cause any change in TR.
The effect of change in price on TR for different price-elasticity co-efficient is summarised in the table mentioned below: Perfect inelasticity of demand implies no change in quantity demanded when price is changed. Therefore, a rise in price will increase the total revenue and vice versa. In case of an inelastic demand i. Total revenue increases when price increases because quantity demanded decreases less than proportionately. Therefore, the total revenue remains unaffected.
Therefore, the total revenue increases when price falls and vice versa. The case of an infinitely elastic demand is rare.
Such a demand line simply implies that a consumer has the opportunity of buying any quantity of a commodity and the seller can sell any quantity of the commodity, at a given price: From the law of demand, we know that quantity demanded of a commodity increases when its price falls. But, what happens to the total expenditure on that commodity: The relationship between price-elasticity and total consumption expenditure may be derived as follows. III By differentiating Eq.
IV The relationship between, total expenditure and price elasticity of demand has summed up in the following table: Hence, total expenditure decreases. And, if price decreases quantity demanded increases more than proportionately.
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As a result, total expenditure increases. For instance, cross- elasticity of demand for tea T is the percentage change in its quantity demanded with respect to the change in the price of its substitute, coffee C. The formula for measuring cross-elasticity of demand for tea et,c with respect to price of coffee Pc The cross elasticity of demand for coffee QC with respect to price of tea Pt is ………… Eq.
By substituting these values in Eq. V, we get cross-elasticity of demand for tea with respect to price of coffee, as It is important to note that cross-elasticity between any two substitute goods is always positive. The same formula is used to calculate the cross-elasticity of demand for a good in reaction to the change in the price of its complementary goods. Electricity to electrical gadgets, petrol to automobile, butter to bread, sugar and milk to tea and coffee, are the examples of complementary goods.
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Notice that the demand for complementary goods has negative cross-elasticity e. A significant characteristic of cross-elasticity is that if cross-elasticity between two goods is positive, the two may be regarded as substitutes for each other. Moreover, the greater the cross-elasticity, the closer the substitute.
Likewise, if cross-elasticity of demand for two related goods is negative, the two may be regarded as complementary of each other: Income elasticity of demand for a product, say X i. Unlike price elasticity of demand which is negative except in case of Giffen goods , income elasticity of demand is positive because of a positive relationship between income and demand for a product. There is an exception to this rule. Income elasticity of demand for an inferior good is negative, because of negative income-effect.
When income is more, consumers change over to the consumption of superior commodities. For instance, when income increases, people would rather purchase more of rice and wheat and less of inferior food grains like bajara, ragi and use more of taxi and less of bus service and so on.
Consumer goods are usually categorised under three classes, viz. The universal structure of income elasticity for goods of various categories or a rise in income and their effect on sales are provided in Table 2.
The other aspect which could bring about a deviation from the universal structure of income elasticity is the frequency of rise in income. Income rises often and repeatedly, income-elasticity as provided in Table 2.
A few significant uses of income elasticity are as follows: First, the concept of income elasticity can be used to approximately calculate the potential demand only if the rate of rise in income and income elasticity of demand for the commodities are identified. The information of income elasticity can hence be useful in predicting demand, when changes in personal incomes are anticipated, other things remaining the same.
Elasticity of Demand 2. Arc Elasticity of Demand 3. Price Elasticity and Consumption Expenditure 5.
Nature of Demand Curves and Elasticity 6. Cross elasticity and income elasticity. Discussion Discuss the problems in using Arc Elasticity. While the demand of some commodities is highly elastic, the demand for others is highly inelastic. In this section, we will describe the main determinants of the price elasticity of demand. Availability of Substitutes One of the most significant determinants of elasticity of demand for a commodity is the availability of its substitutes.
Closer the substitute, greater is the elasticity of demand for the commodity. For instance, coffee and tea could be regarded as close substitutes for one another.
Thus, if price of one of these goods rises, its demand reduces more than the proportionate rise in its price as consumers switch over to the relatively lower-priced substitute.
Moreover, broader the choice of the substitutes, greater is the elasticity. Thus, the price-elasticity of demand for each brand will be to a large extent greater than the general commodity. In contrast, sugar and salt do not have their close substitute and for this reason their price-elasticity is lower.
Nature of Commodity The nature of a commodity as well has an effect on the price elasticity of its demand. Commodities can be categorised as luxuries, comforts and necessities, on the basis of their nature.
Demand for luxury goods e. In contrast, consumption of essential goods, e. Commodities may also be categorised as durable goods and perishable or non-durable goods. Proportion of Income Spent on a Commodity Another aspect that has an impact on the elasticity of demand for a commodity is the proportion of income, which consumers use up on a specific commodity. If proportion of income spent on a commodity is extremely little, its demand will be less elastic and vice versa. Characteristic examples of such commodities are sugar, matches, books, washing powder etc.
Thus, people continue to buy approximately the same quantity even at the time their price rises. Time Factor Price-elasticity of demand relies moreover on the time which consumers take to amend to a new price: As each year passes, consumers are capable of altering their spending pattern to price changes.
For instance, if the price of bikes falls, demand may not rise instantaneously unless people acquire surplus buying capacity.
In the end nevertheless people can alter their spending pattern so that they can purchase a car at a new lower price. Range of Alternative Uses of a Commodity Broader the range of alternative uses of a commodity, higher the price elasticity of its demand intended for the fall in price however less elastic for the increase in price. As the price of a versatile commodity falls, people broaden their consumption to its other uses.
Thus, the demand for such a commodity usually rises more than the proportionate fall in its price. The demand for milk will thus be extremely elastic for fall in their price. Likewise, electricity can be utilised for lighting, cooking, heating, as well as for industrial purposes. Thus, demand for electricity is extremely price elastic for fall in its price.
For this reason, nevertheless, demand for such goods is inelastic for the increase in their price. The Proportion of Market Supplied Price elasticity of market demand furthermore relies on the proportion of the market supplied at the determined price. Study Notes Assessment What are the factors, which determine the demand of a commodity? Discussion Discuss how availability of Substitute goods determines the demand of a good.
It tries to evaluate the magnitude and significance of forces that will affect future operating conditions in an enterprise. Demand forecasting involves use of various formal and informal forecast techniques such as informed guesses, use of historical sales data or current field data gathered from representative markets. Demand forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in making decisions on whether to enter a new market.
Thus, demand forecasting is estimation of future demand.
It is essential for profit maximisation and the survival and expansion of a business. However, before selecting any vendor a retailer should well understand the requirement and the importance of demand forecasting.
In management circles, demand forecasting and sales forecasting are used interchangeably. Sales forecasts are first approximations in production and forward planning. These provide a platform upon which plans could be prepared and amendments may be made. Short Term Objectives a. Drafting of Production Policy: Demand forecasts facilitate in drafting appropriate production policy so that there may not be any space between future demand and supply of a product.
This can in addition ensure: Demand forecasting assists in figuring out the preferred volume of production. The essential prerequisite of raw materials in future can be calculated on the basis of such forecasts. This guarantees regular and continuous supply of the materials in addition to managing the amount of supply at the economic level.You may also like Time domain: Various models are used to quantify risk and asymmetric information and to employ them in decision rules to manage risk.
We can state the assumptions of the law of demand as follows: A detailed description of the basic functions is given below for better understanding. Similarly, with 3 units of labour, any increase in capital beyond 2 units is redundant.
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