SCOPE OF MANAGERIAL ECONOMICS

The scope of managerial economics is very wide as it involves the

application of economic concepts and analysis to all the problems and
areas of the manager and the firm. Managerial Economics deals with
four problems in both decision making and forward planning. These
problems are:
1.Resource allocation for optimal results, 2. Inventory and queuing
problem, 3. Pricing problems i.e. fixing prices for the products of the
firm, 4. Investment problems i.e. forward planning regarding allocation
of scarce recourses over time.
Thus the scope of Managerial Economics covers the following areas-
• Theory of Demand Analysis and Forecasting.
• Theory of Production and Production Decisions.
• Analysis of Market-Structure and Pricing Theory.
• Cost Analysis.
• Profit Analysis and Profit Management.
• Theory of Capital and Investment Decisions.
• Inventory Management.
 DEMAND ANALYSIS
Demand analysis is essential for a business firm in the following ways.

1. Demand analysis is required to identify and measure the forces that

determine sales.
2. Extent of production and cost allocation depend upon demand
analysis.
3. Demand analysis is essential for pricing and inventory holdings.
4. Demand analysis helps in sales forecasting and profit planning.
5. New product policy and advertisement policy cannot be drawn
without the analysis of demand.
6. Research and development strategy cannot be framed without
demand analysis.
7. Demand analysis is the basis of tracing the trend of the firm’s
competitive analysis.
 FACTORS AFFECTING DEMAND
1. Price of the commodity.
2. Price expectations.
3. Price of related goods.
4. Income of the consumer.
5. Population.
6. Tastes and Preferences.
7. Distribution of Income.
8. Discoveries-polythene bags.
9. Trade activity-business cycle, trade agreements.
10. Climate and weather.
11. Money supply.
12. Savings.
13. Reduction in Taxes.
DEMAND ANALYSIS AND ELASTICITY OF DEMAND
“The elasticity of demand measures the responsiveness of the quantity demanded of a
good, to change in its price, price of other goods and changes in consumer’s
income.”
Elasticity of Demand are of three types.
1.Price elasticity of demand.
a. Perfectly elastic demand. (Infinite)
b. Perfectly inelastic demand ( Zero)
c. Unitary elastic demand (One)
d. Highly elastic demand
e. Less elastic demand.

2.Income elasticity of demand.

3.Cross elasticity of demand.
4.Advertisement elasticity of sales.
 PRICE ELASTICITY OF DEMAND
The diagram shows the effect of a shift in S2
S1
supply with two different demand curves P2
b
(D & D1). Curve D1 is more elastic than D. P3 c
P
P1 a
r D1
Initially the supply curve is S1 and it i
intersects the both demand curves at c D
e
point a, at a price of P1 and a quantity of o Q 3 Q 2 Q1
Q1. Now supply shifts to S2. Quantity

In the case of the elastic demand curve D, there is

relatively rise in price and relatively fall in quantity, equilibrium is at point
b. In the case of the more elastic demand curve, there is a relatively
small rise in price but a relatively larger fall in quantity. Thus,
equilibrium is at point c.
 DETERMINANTS OF PRICE ELASTICITY
OF DEMAND
1. Availability of Substitutes-the higher the degree of closeness of the
substitutes, the greater the elasticity of demand for the commodity.
2. Nature of Commodity-luxuries, comforts and necessities.
3. Weightage in the total consumption-if proportion of income spent on a
commodity is large, its demand will be more elastic and vice versa.
4. Time factor in adjustment of consumption pattern-the time consumers
need to adjust their consumption pattern to a new price: the longer the
time allowed, the greater the elasticity.
5. Range of commodity use-the wider the range of the uses of a product,
the higher the elasticity of demand for the decrease in price.
6. Proportion of market supplied-if less than half of the market is supplied at
the ruling price, price elasticity of demand will be higher than 1 and if
more than half of the market is supplied then elasticity will be less than 1.
MANAGERIAL USES OF ELASTICITY OF DEMAND
1. Determination of Price Under Monopoly-a) If the demand for his
product is elastic he will earn more profit by fixing a low price. Low
price means large sales and hence, large total revenue. b) If the
demand is inelastic, he will be in a position to fix up high price.
2. Basis of Price Discrimination- When a monopolist sells his product at
different prices, it is called price discrimination. On the basis of
elasticity he can charge various prices from the customers.
3. Determination of Wages-If the demand for labour in an industry is
elastic, strikes and other trade union tactics will not be of any avail in
raising wages.
4. Advantage to Finance Minister-a) Taxes on goods having elastic
demand will yield less revenue. It is because of the fact that taxes will
raise their prices and thus bring down their demand and finally it
means less revenue, b) Goods having inelastic demand are taxed at a
higher rate. No doubt the price of the goods will rise on account of
these taxes but there will be little fall in their demand.
5. Determination of Prices of Public Utilities-Where the demand for services is
inelastic, a high price is charged, while in the case of elastic demand a
lower price is charged. That is why, household consumers are charged a
high rate of electricity than industrial or agricultural customers.
6. International Trade-Those exports with inelastic demand will fetch high
price.
7. The knowledge of income elasticity can be useful in forecasting demand,
when a change in personal incomes is expected. It thus helps in avoiding
over production or under production.
8. The concept of cross elasticity is of vital importance in changing price of
products having substitutes and complementary goods. If cross elasticity in
response to the price of substitutes is greater than 1, it would be
inadvisable to increase the price; rather, reducing the price may prove more
benecial.
 DEMAND ESTIMATION AND
FORECASTING
Demand estimation is defined as the process of determining the demand
equation to calculate the demand elasticities of the products under the
given assumptions, through the application of statistical tools to the
data set developed by the managers.
STEPS IN DEMAND ESTIMATION: In some cases demand estimates are
easy to find, while in others, it is highly difficult.

Data set developed by the managers

Application of statistical tools to data set

Estimation of demand equation

Use of demand equation for prediction of future demand under constant

prices, income etc.
 METHODS OF DEMAND ESTIMATION
Following methods are used for demand estimation:
1. Market Experiment Method.
2. Survey of Consumer’s Intentions.
3. Regression Analysis.
Market Experiment Method: Market experimentation involves the estimation
of demand on the basis of market behaviour of consumers. These are
of two kinds.
1. Actual Market Method: Under this method first sales outlets are opened
in different localities chosen with a mix of consumers with different
levels of income, sex, age, education level etc. Then the reactions of
consumers are observed by varying controllable variables affecting
demand such as prices, advertisement, quality of products etc.
2. Market Simulation Method: This method is also known as Laboratory
Experiment method. In this method each consumer is given a sum of
money and he is asked to shop around in a simulated market. Then the
consumer behaviour is studied by varying the price and quality of good,
its packaging, advertisement etc.
Survey of Consumer’s Intention: In this method consumers are contacted
personally to disclose their future purchase plans. For survey of
consumer’s intentions, these methods are used.
1. Census Survey Method: This is also known as Complete Enumeration
Method. In this method interviews are conducted either orally or through
questionnaire. The probable demand so collected from all the
consumers is summed up.

2. Sample Survey Method: In this method only a few consumers out of the
population are selected for study through interviews which are
conducted either orally or through questionnaire.

3. Test Marketing: This is done mainly for estimating demand of new

products or estimating sales potential of existing products in new
geographical areas. In this method a test area is selected which truly
represents the market. The product is launched in this area exactly in
the manner in which it is intended to be launched in the market.
Regression Analysis : It is a statistical technique by which demand is
estimated with the help of certain independent variables such as
income, price of the commodity, price of related goods,
advertisement etc. Regression analysis can be of two types:

1. Simple Regression Analysis: It is used when the quantity demanded

is taken as a function of a single independent variable such as
income of the consumers.

2. Multiple Regression Analysis: Multiple regression analysis is used

to estimate demand as a function of two or more independent
variables that may vary simultaneously.
 DEMAND FORECASTING
Demand forecasting for a product is the technique of estimating its demand
in the immediate or distant future. Demand forecast is important basis
for formulating inventory policy, production policy, marketing policy,
sales strategy etc. by a production unit or a selling organization.
Demand forecasts are also used to plan personnel requirements of a
firm.
Purposes of Demand Forecasting:
a) Purposes of Short-term Forecasting: It is difficult to define short-run
for a firm because its duration may differ according to the nature of
the commodity. Time duration may be set for demand forecasting
depending upon how frequent the fluctuations in demand are.
ii) For evolving appropriate production policy to avoid problems of overproduction and
underproduction.
iii) Proper management of inventories, i.e. purchasing raw materials at appropriate time, when their
prices are low, and avoid over stocking.
iv) To set up reasonable sales targets.
v) Formulating a suitable sales strategy in accordance with the changing pattern of demand and
extent of competition among the firms.
vi) Forecasting financial requirements for the short run.
 b) Purposes of Short-term Forecasting: The concept of demand forecasting is
more relevant to the long run than the short run. It is comparatively easy to
forecast the immediate future than to forecast the distant future.
i) Planning for a new project, expansion and modernization of an existing unit, diversification and technology
up gradation.
ii) Assessing long term financial needs.
iii) Arranging suitable manpower.
iv) Arranging a suitable strategy for changing pattern of consumption. The emerging pattern of
industrialization, urbanization, education, degree of contact with the rest of the world could be closely
studied by a firm for forecasting demand.
Steps Involved in Demand Forecasting:

1. Setting the objective-rise of output, fixation of price, allocation of funds for sales promotion, mode of raising
capital resources, inventory control change in product mix, up gradation of technology etc.
2. Selection of goods-consumer and capital goods, existing and new goods.
3. Selection of method-the scope and success of a particular method depends upon the area of investigation,
resources-monetary and time available with the firms, degree of accuracy required, availability of data,
availability of trained personnel etc.
4. Interpreting the results-this is the most important step in demand forecasting. The results should be very
carefully analyzed before any inference is drawn out of them. Forecasting is based on a number of
assumptions. If these assumptions change due to changes in political, economic, social and international
factors, the revision of forecast may become inevitable.
 METHODS OF DEMAND FORECASTING
Methods of Forecasting

A. Opinion Polling Methods B. Statistical Methods

Trend Barometric Regression Simultaneous

Consumers Collective Experts Projection Techniques Method Equation
Survey Method Opinion Opinion Method Method
Method Method

Leading, Index Number

Complete Sample End-Use Lagging
Enumeration Survey and Survey And
Survey Test Marketing Coincident

Indicators
Diffusion Composite
Indices Indicators

Fitting Least Squares Time Series Moving Average and ARIMA

Exponential
Trend Line by Linear Regression Analysis Annual Difference Method
Smoothing
Observation or
Graphic Method