Managerial Economics

I Module
 Definition: Economics
• The term Economics came into existence
because of 2 reasons
– unlimited needs, wants and desires
– scarce resources
• It refers to the allocation of scarce resources
among unlimited needs, wants and desires
• Economics is a social science which studies
human behavior in relation to optimizing
allocation of available resources to achieve
given ends.
 Economics
It encompasses
Choice Making Behavior
Maximizing Behavior
Alternative Choices
 Branches of Economics
• There are 2 branches in Economics
1. Micro Economics
2. Macro Economics
 Micro Economics
• It deals with individual units of the economy like
investor, a company, a firm, a producer etc.
• It deals with how an individual company or a
firm or a consumer behaves while making their
various decisions.
• Microeconomics studies man’s economic
behavior at the level of the individual, such as
buyer, a consumer, a producer, a seller and so on.
Uses of Microeconomics
• Price Fixation, Knowing the Market mechanism, Market
Competition
• It helps the Business to attain maximum productivity form
optimum allocation of scarce resources.
• It helps in Selection of Projects , making investment decisions
• It helps in Demand Forecasting, Sales forecasting.
• It helps in how to achieve maximum out of minimum resources
• It helps the Govt in deciding on Tax Structure on various
industries, products and services.
• It helps in reducing the wastages and use the resources optimally
 Macro Economics
• It deals with aggregate economic variables of a
country.
ex: GDP, Inflation, Unemployment, Interest
rates, Fiscal policies.

• It deals with how aggregate economic

variables affect the growth of the country and
how does it effect the individual units of the
country
Managerial Economics
• It is applied branch of economics
• It is an integration of economic theory,concepts,logic
into business practices which facilitate accurate
decision making
• A study & application of economic theories, logic and
tools of economic analysis that are used in the
process of business decision making.
• It is the study of scarce resources and how they can
be used most efficiently to achieve the business goals.
It is a valuable tool for analyzing business situations
to take better decisions.
Managerial Economics
• Economic Theories are applied to –
Analyze Business Problems
Evaluate Business Options and Opportunities
Helps in Taking Better Decisions as a
Manager
Difference b/w Economics &
Managerial Economics
Economics
• It is both micro and macro
in nature
• It is theoretical in nature.
• It deals with aggregate
economic variables.
• It studies about choice
making behavior &
Maximizing behavior
Managerial Economics
• It is predominantly Micro in
Nature.
• It is practical application of
economic theories & concepts.
• It deals with individual units
of the country.
• It deals with Analyzing the
Business Problems &
Evaluating Business Options
and Opportunities
Scope of Managerial Economics
• As Managerial Economics deals with allocating
the scarce resources in a manner that
minimizes the cost.
• The scarcity of resources gives rise to three
fundamental questions-
– What to produce?
– How to produce?
– For whom to produce?
Scope of Managerial
Economics-What to produce?
1. What goods and services should be produced?  
– Homogeneous/ Heterogeneous /Differentiated
– This is answered by studying Demand Theory
– It examines Consumer Behaviour/Purchase Patterns,
Factors influencing demand
– Goods or services which consumers might not purchase
and consume in future.
2. What amount/quantities of Goods should be
produced?
• This is answered by Demand Forecasting
Scope of Managerial
Economics-How to produce?
• The firm has now to choose among different
alternative techniques of production.
• It has to make decision regarding purchase of raw
materials, capital equipments, manpower, etc. 
• It also has to decide the scale of operations
• It has to make a Production & Cost Analysis
• It also has to decide the optimum level of production
• This also involves Project Appraisals
Scope of Managerial Economics-
For whom to produce?
• This question is answered by studying the
market structure
• Who are my target customers?
• Domestic Market or International Market
• Kind of market competition firm is facing?
• This would help the firm to decide its pricing
strategies
 Scope of Managerial Economics
• Theory of Demand : Demand Analysis, Demand
Schedule, Demand Forecasting, Factors affecting
demand, Elasticity of Demand
• Theory of Cost : Estimation of Costs
• Theory of Pricing : Fixation of Pricing based on
Cost estimates
• Pricing Policies & Strategies
• Theory of Profit
• Capital Management & Investment
Decisions
Role of Managerial Economist
A managerial economist in a business firm may carry on a wide
range of duties, such as:
• Demand estimation and forecasting.
• Preparation of business/sales forecasts.
• Analysis of the market survey to determine the nature and
extent of competition.
• Analyzing the issues and problems of the concerned
industry.
• Assisting the business planning process of the firm.
• Discovering new and possible fields of business expansion
and its cost-benefit analysis as well as feasibility studies.
Economic Concepts applied to Business
• Consumption
• Variables
• Function
• Market Supplied Goods
• Owner Supplied Goods
• Explicit Costs & Implicit Costs
• Economic Profit & Accounting Profit
• Opportunity Cost
• Incremental Principle
• Time Perspective
• Discounting Principle
• Equi Marginal Principle
Consumption
• Consumption means using up of utilities.
• It is the satisfaction of our wants by use of
products & services
• In Economics it is defined as “The destruction
of the utility”
Variables and Functions
• A variable is a quantity which varies from one
individual observation to another.
• Examples- Height & Age of a Person, IQ of a
Person, Speed of a Vehicle
• Speed=Distance/Time
Types of Variables
• Discrete Variables : These variables can only be
counted but not measured
• Continuous Variables : These can be measured, they
can assume any value even fractions
• Exogenous Variables : These variables emerge from
outside the system like Production of a commodity can
be influenced by Labour dispute, Govt Policy
• Indogenous Variables : These variables emerge from
within the system like technology used , Firms Capital
Functions
• Function refers to numerical relationship or
dependence of one variable on the other
variable.
• Most economic variables are interrelated and
interdependent.
• In economic analysis, usually an attempt is
made to establish relationships among
variables with a view to predict how the
variables will behave when one or more other
variables change in values.
Examples
• Demand Functions Dx=f(p),denotes that
demand for commodity “x” is the function of
price “p”
• Consumption Function C=f(y),denotes that
consumption C is the function of income “y”
Terminologies used in Managerial
Economics
• Market Supplied Resources : Resources that
are supplied by an outsider to the firm are
called as Market Supplied Resources
• Owner Supplied Resources : If the firm uses
it own resources for the operation of the
business are called as Owner Supplied
Resources
Terminologies used in
Managerial Economics
• Explicit Costs : The cost involved in market
supplied resources is called as Explicit Costs
• Implicit costs : The Opportunity cost involved in
Owner supplied resources is called implicit costs
• Explicit cost in reflected in the Profit & Loss
Statement of the firm
• Implicit cost is not reflected in the P&L statement
Economic Profit & Accounting
Profit
• Economic Profit = Total Revenues- Explicit
Costs- Implicit Cost
• Accounting Profit =Total Revenues-Explicit
Costs
Opportunity Cost
• Opportunity cost is the income lost/sacrificed due to the best
choice selected from the alternate use of a particular resource.

• The difference between actual earning and its opportunity cost

is called Economic Profit(gain).

• The cost of the next best alternative foregone.

• The opportunity cost of going to college is the money you

would have earned if you worked instead. On the one hand,
you lose 2 years of salary while getting your degree; on the
other hand, you hope to earn more during your career, thanks
to your education, to offset the lost wages. 
Incremental Principle
• The main objective of this principle is maximization
of profits. In other words to raise the profits in the
business
• By increasing in the production, the total cost of the
product raises and simultaneously profit also rises.
• It helps is deciding on How much extra firm should
produce to get the best profits and how much extra
cost is incurring for the extra production.
Incremental Principle
• Incremental concept involves estimating the impact
of any decision alternatives on costs and revenues
• The two basic components of incremental Principle
are:
– Incremental cost ; Incremental cost may be defined as the
change in total cost resulting from a particular decision
– Incremental revenue ; Incremental revenue is the change
in total revenue resulting from a particular decision.
Incremental Principle
• A decision is a profitable one if—
1.It increases revenue more than cost
2.It reduces cost more than revenues.
3. It decreases some costs to a greater extent
than it increases others
4.It increases some revenues more than it
decreases others
Time Perspective
• Economists widely use the concepts of time
periods, short run, long run in their analysis.
• The time perspective is very important in
Business decision making
• The Business Manager has to review the long
range effects on Costs & Revenues of
decisions.
Discounting Principle
• Discounting principle is based on the fact that
Present Gain is valued more than future gain.
• In investment decision making discounting of future
value to present value is very essential.
• If a decision affects costs and revenues at future
dates than those future costs & revenues need to be
discounted to present values to make valid
comparison
Concept of Utility
• In General Utility is “Usefulness”
• In economics it is the “ Capacity of a product
to satisfy a human want, need or desire
Utility & Its characteristics
• Utility has no ethical or moral importance
• Utility is Psychological
• Utility is always individual and relative: Time &
Situations
• Utility is not necessarily equated with usefulness
or betterment
• Utility cannot be measured objectively
• Utility depends on Intensity of want
• Utility is different from Pleasure
Kinds of Utility
• Marginal Utility
• Total Utility
• Average Utility
Marginal Utility
• It is the additional utility derived from the
extra unit of a product consumed, purchased
by the consumer
• Kinds of Marginal Utility
– Positive Marginal Utility
– Zero Marginal Utility
– Negative Marginal Utility
Kinds of Marginal Utility
• Zero Utility : When the consumption of extra
unit of a product makes no addition to the
total utility, it is called as Zero utility
• Negative Utility : It is that utility where extra
consumption of a product will start creating
dis-satisfaction
Marginal Utility Table
Number of Chocolates Marginal Utility Kinds of Marginal
Utility

1 20

2 16

3 12 Positive Utility

4 8

5 4

6 0 Zero Utility

7 -4 Negative Utility
Total Utility & Average Utility
• Total Utility : It refers to the total utility given
by all the units of a particular product
consumed. It is the sum of all marginal
utilities associated with the consumption of
additional units
Total Utility Table
Number Of Marginal Utility Total Utility
Chocolates

1 20 20

2 16 36 (20+16)

3 12 48 (20+16+12)

4 8 56 (20+16+12+8)

5 4 60 (20+16+12+8+4)

Total= 60
Average Utility
• It refers to that utility in which the Total
Utility of Product is divided by total units of
product consumed.
Average Utility Table
Unit of Marginal Utility Total Utility Average Utility
Chocolates

1 16 16 16

2 12 28(16+12) 28%2=14

3 8 36(16+12+8) 36%3=12

4 4 40(16+12+8+4) 40%4=10

5 0 40(16+12+8+4+0) 40%5=8

6 -4 36(40-4) 36%6=6

7 -8 28(36-8) 28%7=4
To Remember
• Marginal Utility Goes on diminishing with
consumption of every additional unit of product
• Total utility goes on increasing with consumption of
every additional unit of product
• When Marginal Utility is Zero, Total Utility is
Maximum
• When Marginal Utility is negative, Total Utility
decreases
• Total Utility is the sum of all marginal utility of all
additional units consumed
Concept of Demand
• Desire or want to have something generally
means demand
• In Economics it refers to effective demand
supported by ability to pay and willingness to
pay
Concept of Demand
• Desire to Buy + Willingness to Spend Demand
• Desire to Buy + Ability to Buy Demand
• Desire to Buy + Ability to Pay+ Willingness to Spend
= Demand
• All 3 conditions have to be satisfied in order to call it
as a demand for a product
Concept of Demand
Initiation of Need, Want or Desire to
buy a product

Ability to Pay the Price of a Product

or Capacity to pay the price of the
product

Willingness to Pay the price of

Product & Buy the Product
• Definition of Demand –
• Demand means the ability and willingness to buy a
specific quantity of a commodity at the prevailing price
in a given period of time.
• The demand for a product refers to the No of Units of
product or a service that the consumer is willing to
purchase at a particular price.
• Demand is always referred against a specific price,
particular period of time and place
• Example: Demand for Apples by households at a price
of Rs 30 per Kg is 10 Kg per Week
5 Elements of Demand
• Need, want or Desire to buy a product
• There must be ability to purchase the product
by paying its price
• There should also be willingness to purchase
the product
• The product should be purchased at a price
during a given time
Types of Goods
• Consumer Goods : It refers to those product
that are consumed by the end customers for
satisfying there desires
• Capital Goods : It refers to those goods that
are used as input or raw materials for
production of other goods and services and
satisfying others desire
Consumer goods
• Consumer goods are categorized in 2 types
• Consumer Durable Goods
• Consumer non Durable Goods
Different Types of Demand
• Price demand
– Price demand refers to the different quantities of
the products or service which consumers will
purchase at a given time and at given prices,
assuming other things remaining the same.
• Income demand
– Income demand refers to the different quantities
of a products or service which consumers will
buy at different levels of income, assuming other
things remaining constant.
Different Types of Demand
• Cross demand
– When the demand for a commodity depends not on its price
but on the price of other related commodities, it is called
cross demand.
– Substitute & Complimentary Demand
• Direct demand
– Products or services which satisfy our wants directly are
said to have direct demand. 
• Indirect Demand/Derived Demand
– Products or services demanded for producing other goods
which satisfy our wants directly are said to have derived
demand.
Different Types of Demand
• Joint demand
• Composite demand- A commodity is said to have a
composite demand when its use is made in more than
one purpose.
• Industry & Company Demand
– Refers to the classification of demand on the basis of market.
– The demand for the products of an organization at given
price over a period of time is known as organization
demand .
– The sum total of demand for products of all organizations in
a particular industry is known as industry demand .
Different Types of Demand
• Individual Demand
– Demand for a product from a particular
consumer is Individual Demand
• Market Demand
– Total demand of all individual buyers put together
refers to Market Demand
Factors Influencing Individual Demand
 Price
 Consumers Income
 Tastes, habits and preferences, Fashions, Trends
 Relative prices of other goods – substitute and complementary
products
 Consumer’s expectations
 Money Circulation
 Advertisement effect
 Climatic Changes/Weather Conditions
 Level of taxation and tax structure
 General standards of living and spending habits of the people
 Population
 Inventions & innovations
Factors
•
Influencing Demand
Price : There is a inverse relationship between the price of product and its qty
demanded
• Income : There is a direct relationship between the qty of product purchased and
the income of the consumer purchasing
• Tastes, Habits, Preferences : Changes in the tastes, habits in favor of a product
will increase its demand, Changes in the tastes, habits against a product will
decrease its demand
• Consumer’s expectation: If consumers expect future rise in prices it will lead to
increase in the demand of the product, if consumers expect a future decline in its
prices it will lead to decrease in the demand for a product
• Climatic Changes: Demand for certain products are determined by the climatic
conditions.
• General standards of living and spending habits of the people
• Level of taxation and tax structure
• Advertisement effect
• Inventions & Innovations
Demand Function
• It is function showing the relationship between
It is function showing the relationship between
demand for the product & factors influencing the
demand for that product
• Dx = f (Px, Ps, Pc, Yd, T, A, N, u)
– Px- Price of the Product
– Ps – Price of the Substitute Product
– Pc- Price of Complimentary Product
– Yd – Income of the consumer
– T – Taste of the consumer
– A- Advertisement effect
– N- Number of Buyers
Demand Function
• Linear form Dx=a-P+Y+Ps-Pc+A
• The Qty demanded of good X depends upon
the price of X(Px),monthly income of
consumer(Y), and the price of a related good
Y(Py).
• Demand for the good X is given by equation
D(x)=1500-10Px+4Y-15Py. Find the qty
demanded if Y=Rs 500, Py= Rs 60, Px= Rs 150
Law of demand
• Law of Demand explains the functional relationship
between price & qty of product demanded at that
price
• Law of demand states that the qty of product demanded
and its price are inversely related, other things
remaining constant.
• That is, if the income of the consumer, prices of the
related goods, and tastes and preferences of the consumer
remain unchanged, the qty of product demanded will
increase with decrease in its price and vice versa
• D=f(p) where D represents Demand, P Stands for Price, f
represents functional relationship
Table showing Law of Demand
Price of Mango Increase in Qty of Mangoes
purchased
1 10
2 8
3 6
4 4
5 2

Price of Mango Decrease in Qty of Mangoes

purchased

5 2
4 4
3 6
2 8
1 10
Assumptions
of Law of Demand
• Money or income of the consumer does not change.
• Habits, tastes and fashions remain constant
• Prices of other goods remain constant
• The commodity in question has no substitute
• The commodity is a normal good and has no prestige
or status value.
• People do not expect changes in the prices.
Reasons behind Law of Demand
• Price Effect: As the Price of Product decreases
the Disposable income of consumer will
increase which will motivate to purchase
more qty of same products with same income
• Income Effect: As the Income of Consumer
increase ,it will lead to increase in his
purchasing power leading to increase in his
consumption or products
• Substitution Effect
Exceptions to Law of Demand
• Giffen goods or Low Quality Goods, inferior
product that does not have easily available
substitutes
• Veblen Goods ,Commodities which are used as
status symbols like Diamonds, Imported Cars
• Ignorance
• Emergencies
• Future changes in prices
• Change in fashion
Demand Schedule
• It is a tabular statement of showing the
relationship of a price of a product & its
quantity
• It is the list of different qty of products that
buyer is willing to purchase at a different
prices during a particular time
• There are 2 types of Demand Schedule
 Individual Demand schedule
 Market Demand Schedule
Individual Demand schedule
• A Qty of a product that will be purchased by an
individual at each conceivable price in a given
period of time is referred as Individual Demand
schedule.
Example: Individual Demand schedule

Price of Mangoes (Rs Amount Demanded

per Kg) per Week (Kg)
50 2
40 4
30 6
20 10
10 12
Market Demand Schedule
• It is tabular statement narrating the Qty of
products demanded in total by all the buyers
in the market at different prices over a given
period of time.
• It represents the total market demand at
various prices.
Demand Curve
• A Demand curve is a graphical representation
of a demand schedule.
• It depicts the data in a demand schedule in
graphical format.
Demand Curve Representation
Characteristics of Demand Curve

• A Demand Curve is having negative slope.

• It runs from left to right.
• It has negative relationship with price.
Shifts in Demand Curve
• If demand increases or decreases because of factors
other than price it would lead to shift in demand
curve
• Shift in Demand Curve indicates that there is change
in demand at each possible price because of change
in income, price of related goods, tastes, etc
• Demand Curve shifts to the right if demand
increases without any change in price
• Demand Curve shifts to the left if demand decreases
without any change in price
Shifts in Demand Curve:
Positive
Price (Per Cup) Demand( Monthly Demand (Monthly
Income Rs 20,000) Income Rs 30,000)

5 50 60
10 40 50
15 30 40
20 20 30
25 10 20
Positive Shift in Demand Curve
Shifts in Demand Curve:
Negative
Price (Per Cup) Demand (Monthly Demand( Monthly
Income Rs 30,000) Income Rs 10,000)
50
5 60 50
10 50 40
15 40 30
20 30 20
25 20 10
Negative Shift in Demand Curve
Shifts in Demand Curve
Positive Shift in Demand Curve
Negative Shifts in Demand Curve
Problem 1:
• Assume that there is a fruit seller who has 20 Kg of
Apples to be sold and he wants to fix the price so that
all apples are sold. There are three customers in the
market and their individual demand functions are
given below.
• D1= 25-1.0P
• D2= 20-0.5P
• D3= 15-0.5P
– Determine the Market Demand equation for the fruit seller
and find out the price at which he can sell all the apples
Supply
• Supply Refers to the quantities of good that
the seller is willing and able to provide at a
price at a given point of time all other thing
remain same.
Determinants of Supply
• Price of the Commodity
• Cost of Production
• State of technology
• Number of Firms
• Govt Policies
Supply Function
• It is a mathematical relationship between supply and its determinants.
• Sx=(Px,C,T,G,N)
Px=Price of Product
C=Cost of Production
T=State of Technology
G=Govt Policy
N=Other Factors

A linear Supply Function

Qs=C+dP

“C” & “d” are constants,C represents the Supply when price is zero
D represents positive change in Qty supplied per unit increase in price
Law of Supply
• Law of Supply states that other things
remaining same the higher the price of the
product higher will be qty supplied.
• Higher price represents higher revenue to the
supplier and hence greater profits
Supply Schedule & Supply
Curve
• It is a tabular statement showing different qty
of products supplies at different prices
• Supply curve is the graphical representation
of supply schedule.
• It shows qty supplied of a product at different
price levels
Supply Schedule
Price (Rs per Cup) Supply (‘000 cups per month)

5 10

10 20

15 30

20 40

25 50
Market equilibrium
• Market equilibrium implies there is neither
excess demand nor excess supply
• It is a stage where demand of products is
equal to supply of products
• The point of equilibrium determines the
equilibrium price
Market Equilibrium Table
Price Supply Demand

15 10 50

20 15 40

25 30 30

30 45 15

35 70 10
Problem:
• Suppose the demand equation for Wrist
watches by Titan for the Year 2012 is given
by Q=1000-P and the supply equation is
given by Qs=100+4P
• What is the equilibrium Price?
• What is the excess demand or supply if price is
 Rs 500 & Rs 100
Elasticity of Demand
• The intensity or the magnitude with which demand reacts
to the change in the price is explained through Elasticity
of Demand
• The extent to which a good responds to a price change is
called its price elasticity
• The good which responds more to the price change is said
to have higher elasticity
• The good which responds less to the price change is said
to have lower elasticity.
• Price elasticity is commonly known as Elasticity of
Demand
Elasticity of Demand
• Elasticity of Demand refers to the magnitude
of responsiveness of Demand to the
determinants of demand.
• It is the ratio of % Change in qty demanded to
the % change in factors affecting demand
Kinds of Elasticity of Demands
• Price elasticity of Demand
• Income Elasticity of Demand
• Cross Elasticity of Demand
Price elasticity of Demand
• It is the extent of change in demand of a product with
respect to the change in the price of the product , other
determinants remaining constant.
• It is the ratio of relative change in demand and price
variable.
• Price elasticity of demand is measured as the ratio of
percentage change in the quantity demanded of a product
to the percentage change in its price.
• E=Proportional change in demand/Proportional change
in Price
Price elasticity of Demand
Price of Apples Qty Demanded

20(P1) 100(Q1)

21(P2) 96(Q2)
Types of Price Elasticity
Unit elasticity of demand (e = 1)
Elastic demand (e > 1), i.e., elasticity is greater than unity.
Inelastic demand (e < 1 ), i.e., elasticity is less than unity.

• Perfectly elastic demand; ep = ~

• Perfectly inelastic demand; ep = 0
• Relatively elastic demand; ep >1
• Unitary inelastic demand; and ep =1
• Relatively inelastic demand ep <1
Types of Price Elasticity
Value of Type of Elasticity Description
Elasticity
Ep=0 Perfectly In Elastic Qty demanded does not
change at all with change in
price. Ex Life Saving Drugs

Ep<1 Relatively In Elastic % change in qty demanded

is less than % change in
Price. Ex Food, Medicines

Ep=1 Unit Elasticity % Change in demand is

exactly equal to % change
in Price

Ep>1 Relatively Elastic % change in qty demanded

is more than % change in
Price. Ex Luxurious
Goods,Cars,TV

Ep=~ Perfectly Elastic Buyers buy all goods at a

specific price and none at all
at a different price
Measurement of Price elasticity
of demand
• Ratio Method
• Point Method
 Total Outlay method
• Ratio Method=% Change in Demand/% Change in Price
• Total Outlay Method:
• It measures the elasticity of demand in relation to the change in total
revenue as a result of change in price and in turn change in demand of
product
• Elasticity is One : If the rise or fall in price leaves the total revenue
unaffected than elasticity is said to be one.
• Elasticity more than one : If the fall in price leads to increase in total
revenue, while rise in price reduces the total revenue elasticity is said to
be more than one.
• Elasticity less than one : If fall in price reduces total revenue while rise in
price increases total revenue, elasticity is said to be less than one
Point elasticity
• Elasticity measured at a given point on the
demand curve (function).
Point elasticity
• It affectively measures elasticity at a point on
the demand curve assuming infinitely small
changes in price & qty variables.
• Point Elasticity= dq P
dp Q
Arc Elasticity
• Average elasticity measured over between a
specific range (two points) of a demand curve
(function).
• It s used to calculate price elasticity over some
portion the demand curve rather at a point.
• Arc Elasticity = q (p1+p2)
p (q1+q2)
Factors Affecting Elasticity of
Demand
• Nature of commodity: Necessity or Luxury Goods
• Availability of substitutes & Complementary
goods
• Number of uses of product
• Consumer’s income
• Proportion of income spent on Product
• Habit
• Possibility of postponement.
Income Elasticity
• Definition: The income elasticity is defined as
a ratio of percentage change in the quantity
demanded to the percentage change in income
of consumer.
Types of Income Elasticity
• Unitary income elasticity of demand; (em = 1);
• Income elasticity of demand greater than unity; (em > 1);
• Income elasticity of demand less than unity; (em < 1);
• Zero income elasticity of demand; (em = 0); and
• Negative income elasticity of demand. (em < 0);
Cross Elasticity of Demand
• The Cross elasticity of Demand refers to the
degree of responsiveness of demand for a
product to a given change in price of other
related product.
Cross Elasticity of Demand
• Positive value suggests substitute products.
• Negative value suggests complementary
products.
• Two unrelated goods have zero Cross
elasticity.
Example: Substitute Goods
Product Original Change
Tea(X) P1=3,Q1=50 P2=3,Q2=60
Coffee(Y) P1=4,Q1=60 P2=6,Q2=40
Example: Complimentary Goods
Product Original Change

Cars(X) P1=100000,Q1=100 P2=100000,Q2=90

Petrol(Y) P1=60,Q1=50 P2=70,Q2=40
Advertising or Promotional
Elasticity of Demand
• It is the degree of responsiveness of demand to
changes in advertising elasticity.
Advertising or Promotional
Elasticity of Demand
• E=(% change in sales)/(% change in
Advertising costs)
Example:
Advertisement Expenses Sales
A1=Rs 50000 S1=80000
A2=Rs 60000 S2=100000
Point elasticity
• Ep=(dQ/dP)*P/Q
• Example 1: The following linear equations represent
different possible demand functions for three products
X,Y & Z
1) Dx=240-3P
2) Dy= 320-5P
3) Dz= 20+5P
What are the associated price elasticity at P=4? Comment
on the values obtained
Problem 2:
• A firm increases its advertizing expenses from
Rs 60000 to Rs 75000.Its Sales increase by
20% from the initial volume of Rs 90000
units. Calculate Advertising elasticity of
demand.
Problem 3:
• Consider 2 goods X & Y. There was no change
in price of X, but its demand was seen to
decrease from 6000 units to 5500 units. On
analysis it was found that price of another
product Y has decreased from Rs 250 to Rs
225.Find out the cross elasticity between X &
Y and the relationship b/w 2 products
Problem 4:
• Consider 2 goods X & Y. There was no change
in price of X, but its demand was seen to
increase from 5500 units to 6000 units. On
analysis it was found that price of another
product Y has decreased from Rs 250 to Rs
225.Find out the cross elasticity between X &
Y and the relationship b/w 2 products
Problem 5:
• For each of the following equations ,
determine whether demand is elastic ,
inelastic or unitary elastic at the given price.
• Q=100-4P at P=Rs 20
• Q=1500-20P at P=Rs 5
• P=50-0.1Q at P= Rs 20
Problem 6:
• In the Following demand schedule calculate the
elasticity of demand with initial price of Rs 4

• Qty Demanded Price

15 3
12 4
09 5
Problem 7:
• Unlimited Storage Inc determines that in year 2006 the demand
curve for its pen drive devices is P=2000-50Q,where ‘P’ is price of
pen drive & ‘Q’ is qty of pen drive sold.
1.What price would the company have to charge to
sell 20 Pen drives per month
2.If it sets a price of Rs 500 for a drive,how many
drives will it sell
3.What is the price elasticity of demand if price is
Rs 500
Demand Forecasting
• Demand forecasting is an estimate of sales in dollars or in
physical units for a specified future period of time under a
proposed marketing plan.
• It is a tool to scientifically predict the demand for the product in
the future.
• It involves estimation of level of demand, elasticity of demand in
relation to price, income of consumers & prices of other products
• Demand forecasting can be categorized as follows
• Industry , Firm, Economy
• Short Run , Long Run
Techniques of Demand
forecasting
• Consumers Opinion Survey
• Sales force Composite method
• Experts opinion Method
1. Group Discussion
2. Delphi Technique
• Market Simulation
• Test Marketing
• Trend Projection
Consumers Opinion Survey
Method
• Buyers are asked about their future buying intentions of
products
• They are questioned on their possible response to any change
in the price of the product or to any possible change in
features of the product
• Survey can be conducted in 2 ways
– Census Method -It Involves contacting each and every potential
buyer, which becomes very time consuming and costly method and
often not desirable
– Sample Method : It involves survey of only representative sample of
buyers, which saves time and cost
Merits & Demerits of
Consumers Opinion Survey
• Merits-
– Simple to conduct & Understand
– The results obtained are realistic as they are collected
from direct consumers
– Suitable for Short term decisions
• Demerits-
– Often Expensive & time consuming
– Not suitable for long term demand forecasting
– Buyers may not disclose their real buying intentions
Sales Force Composite method
• Sales persons are asked about their estimated sales
targets in their respective sales territory in a given
period of time
• The sum total of all such estimates forms the total
demand forecast
• It is expected that they have better understanding of
the market
• Sales representatives, Sales Managers, Dealers,
distributors would be used to have the estimates
Merits & Demerits of Sales
Force Composite method
• Merits-
– Method is simple to administer
– It is very cost effective as there is no additional cost incurred to collect the
data
– Estimated figures are more reliable as it is based on sales people data who
are in direct contact with customers
• Demerits-
– The estimates differ depending upon the optimism or pessimism of the
sales persons
– Sales persons may be unaware of economic environment of business and
may make wrong estimates by ignoring economic changes
– The method is ideal for short term demand forecasting
Experts Opinion Method
• Group Discussion:
– Experts meet as a group to find out the future
demand
– Decisions may be taken with the help of brain
storming sessions
– Meeting may be physical or through tele or video
conferencing
Experts Opinion Method-
Delphi Technique
• Delphi is a way of getting the experts opinion without
their face to face interaction
• A Panel of carefully selected experts answers
questionnaires in 2 or more rounds.
• At the end anonymous summary of each experts
opinion is provided.
• This offers scope for revisions of previous replies by
the experts and the group eventually converges
towards the correct answer
Merits & Demerits of Delphi
Technique
• Merits:
– Decisions are enriched with the experience of competent
experts
– The firm need not spend time and resources in collection of
data & survey
• Demerits:
– The technique relies more experts knowledge than on real
data and thus may involve some amount of bias
– The firm may be exposed to the risk of loss of confidential
information to the rival firms