managerial economics for imt
TRANSCRIPT
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MANAGERIAL ECONOMICS FOR IMT
MANAGERIAL ECONOMICS
KEY TERMS
1) NEED OR DESIRE : The items we need in our
daily lives. Needs are unlimited.
2) UTILITY : the satisfaction received when someneed is fulfilled. It is a state of mind. The items
which provide satisfaction are called utilities.
3) COMMODITY : It includes goods and services,
which will satisfy needs.
4) DEMAND: Need becomes demand when the
following conditions are satisfied
a) willingness to purchase
b) ability to purchase.
The most important factor of economics and
determinant of all economic activities. It is inversely
proportional to price of commodities.
5) SUPPLY : Providing commodities for satisfying
demand. It is directly proportional to price of
commodities.
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6) PRODUCTION : The act of creation of
commodities, or conversion of natural resources to
usable commodities capable of satisfying demand . it
is called creation of utility.Factors of production the resources required for
production are
LAND, LABOUR, CAPITAL, ENTREPRENEUR
7) CONSUMPTION : The act of utilization of
commodities to derive satisfaction is consumption. It
is called destruction of utility.
8) INCOME : Any earning out of productive service
is income. Earning is always as factor of production.
Land Rent
Labour Wages/salary
Capital - InterestEntrepreneur - Profit
9) SAVINGS : Part of the income not used for
consumption is savings
10) INVESTMENT :Part of the savings used for
income generating assets for future is investments.
BASIC Problems of an Economic System
An economic system has to search answers to three
basic problems
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What to produce ?
How to produce ?
For whom to produce ?
In a free market economy, these problems can be
solved by operation of a invisible hand.
But in a command economy these problems are
solved by planning undertaken by a central planning
authority.
CIRCULAR FLOW OF GOODS ANDINCOME
TWO SECTORS
Household Firms
Generates demand Generates supply
Buyer of goods Seller of goods and
and services services
Supplier of factors Buyer of factors
SUPPLY OF FACTORS
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PAYMENT FORGOODS
SUPPLY OF GOODSPAYMENT FOR FACTORS
THREE SECTORS
Inclusion of govt. sector
Purchase of goods
Taxes & subsidy
taxes
compensation&social security
&subsidy
HOUSEHOL FIRMS
househol firmFinancialmarkets
governm
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Savings Investments
Cardinal utility analysis
Proposed by Prof. A. Marshall
Main presumption : utility is measurable in terms of
money.
1 unit of utility from a commodity = Re 1 spend on
it
Total utility (TU) : total satisfaction received from
all the units consumed
Marginal utility (MU) :utility received fromconsumption of one additional unit of a good
MU = TU / x = TUn TU n-1
Where x the good being purchased
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Law of diminishing MarginalUtility
The law states that when a person consumessuccessive units of a commodity, the marginal utility
from each successive unit gradually diminishes and
finally becomes negative. The total utility first
increases and then falls.
Assumptions of the law
1) The consumer is rational.
2) The commodity is a normal good and the
consumers need for the good is not satiated.
3) The commodity is finely divisible.
4) The consumer purchases all units successively ,i.e.
there is no time gap between successive
consumption.
5) The price of the commodity and the money
income of the buyer remains constant during
analysis.
6) There is no improvement in the quality of the
product.
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Table showing
diminishing MU
Figure showing relation between TU and MU
No.
of
units
TU MU
1 8 -
2 15 7
3 20 5
4 22 2
5 22 0
6 20 -2
TU
UNITS
CONSUMED
UTILITY
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CONSUMERS EQUILIBRIUMPURCHASE
Up to what level would a consumer consume a
particular commodity ?
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A consumer is willing to purchase a unit as long as
the utility from that unit is greater than or equal to the
[price paid for it.
If price is fixed or falls for every successive unit, hewill purchase up to that unit when MU = P
E
Ordinal utility analysis
Proposed by Prof. J. R. Hicks
units P MU
1 8 12
2 8 11
3 8 9
4 8 8
5 8 6
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Main presumption : utility cannot be measured,
consumers can rank commodities according to
their utilities.
Types of ordering of utility
Strong preference:- A>B or A P B
When good A provides much more utility than
good B and if good A is not available, buyer will
not buy good B.
Weak preference :- A B or A R B
Both good A and good B gives more or less
equal utility but if both are available buyer willchose good A.
Indifference :- A B or A I B
good A and good B gives exactly same utility
and the buyer chooses any one randomly.
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AXIOMS OF ORDINAL UTILITY
ANALYSIS
RATIONALITY : The buyer is rational. He
seeks to maximize utility.
COMPLETENESS : the buyer will express any
one the above preferences.
CONSISTENCY : If between any two goods at
any time A > B , then for any time B will not
be preferred to A.
TRANSITIVITY : If A > B and B > C, then A
> C.
If A = B and B = C, then A = C.
NON-SATIETY : the consumer is not fully
satisfied with the two commodities. He still
needs more units of at least one of the good.
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DIMINISHING MARGINAL RATE OF
SUBSTITUTION : As quantity of A increases,the quantity of B the consumer is ready to
sacrifice gradually diminishes.
MRS = - B / A = - MUx/MUy
Marginal rate of substitution is the units of any
good B which the buyer is ready to sacrifice, to
buy one additional unit of another good A.
Concept of DMRS can be explained from this
table. It is assumed that the buyers income is
fixed and he is buying two goods A & B.
Units of A Units of B MRS8 10 -
9 6 4
10 4 2
11 3 1
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12 2.5 0.5
Indifference curve analysis
The choice or preference pattern in the ordinal
utility analysis is explained with the help of anindifference curve. The demand and buyingpattern of consumers can be shown with thehelp of this curve.
If we assume that a buyer buys two goods,then the locus of the different combination of
the two goods among which the consumer isindifferent , i.e. he gets the same level ofutility, is known as indifference curve.
Assumptions of Indifference curve
1.The consumer buys only two goods X andY.
2.There can be different combinations of thetwo goods that he buys. Each suchcombination is called a commodity bundle.
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3.The consumer is rational, he seeks tomaximize utility.
4.The consumer has a given fixed moneyincome.
5.The prices of the two goods remain fixed.
Properties of Indifference curve
It is downward sloping
It is convex to origin
Two Indifference curves will never intersect
Higher Indifference curves indicate higherlevel of utility.
DEMAND ANALYSIS
Demand : the desire to get a commoditysupported by two qualities :-
o Willingness to purchase it.
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o Ability to purchase i.e. having the
necessary purchasing power.
FACTORS AFFECTING DEMAND
Factors affecting demand of anindividual
The need of the buyer
Price of the commodityIn usual cases, price and demand areinversely related.
In exceptional cases, positive relationmay prevail.
Income of the buyerUsually for normal goods, demand riseswith increase in income.
If demand falls with rise in income, it isan inferior good.
Price of other related commodities Complementary goods Px and Dy are
inversely related.
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Substitute goods Px and Dy aredirectly related.
Taste and preference of the buyer
Demonstration or publicity affect
Factors affecting demand for the entire
market or country
Total population
Age composition of population
Availability of consumer credit
Expectation regarding future changes in
price
LAW OF DEMAND
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States the inverse relationship betweendemand and price. The law states
other factors remaining constant, the
demand will rise with a fall in price and willfall with a rise in price.
Demand schedule
price Qty.demanded
20 1524 1228 1032 9
36 8
Explanation to the law of demand
OrExplanation to the downward slope of the
demand curve
There are two major explanations
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1) Law of diminishing Marginal Utility
Asexplained by Prof. Marshall, due to theprinciple of MU = P to make any purchase, as
price falls, the buyer gets utility frompurchasing some further units of the good
2) Price EffectAs explained by Prof. Hicks, price effect
is a combination of 2 effects:- income effect
and substitution effect.Income effect: the increase in real incomeexperienced by the buyer when the price of agood falls. This induces him to buy a few moreunits of that good.
Substitution effect: after a fall in price, thegood becomes cheaper compared to its
substitutes. So the buyer purchases more units.
P.E. = I.E. + S.E.
3) Increase in no. of consumers:
As price falls, some more buyers are ableto afford the good or the good is put to moreuse. Thus consumption increases.
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Exceptions to the law of demandOrCan the demand curve slope upwards ?
Cases where the law of demand is not obeyed
Giffen goods /Giffen effect
Bandwagon and Snob effect
Veblen effect items of conspicuousconsumption
Share market
Certain expectations of future pricechanges
Elasticity of demand
The relative change in demand due to changein any of the factors affecting demand
Different types of elasticity:
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1) Price elasticity : percentage change in demand due
to 1% change in the own price of the commodity.
ep = ( q/ p)*(p/q)
2) Income elasticity : percentage change in demand
due to 1% change in the income of the buyer.
ei = ( q/ Y)*(Y/q)
3) Cross price elasticity : percentage change in
demand due to 1% change in the price of related
commodities like complements or substitutes.
ec = ( qx/ py)*(py/qx)
4) Advertising / Promotional elasticity :percentage increase in sales of a good due to1% increase in advertising expenses.
EA = ( S/ A)* A/S
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DIFFERENT TYPES OF PRICE
ELASTICITY
Perfectly Inelastic
When there is no change in demand
for some infinite change in price
Ep = 0
Relatively Inelastic
When proportional change in demand isless than proportional change in price.
Ep < 1
Unit Elastic
When proportional change in demand is
equal to proportional change in price.
Ep = 1
Demand
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Relative elastic
When proportional change in demand is
more than proportional change in price.
Ep > 1
Perfectly Elastic
When there is no change in price but
infinite change in demand.
Ep =
Factors affecting price elasticity
Nature of the good
Availability of substitutes
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Use of the good
Possibility of postponing consumption
Time factor