IILMInstituteforHigherEducation

CourseManual MANAGERIALECONOMICS ES301

PGP201012

MANAGERIALECONOMICS PGPBatch[201012]

I.CourseFacilitators
Facilitator Ms.RakhiSingh Mr.AbhijitMukhopadhyay Ms.DeepaBhaskaran Emailid

rakhi.singh@iilm.edu abhijit.mukhopadhyay@iilm.edu deepa.bhaskaran@iilm.edu

II.CourseOverview ManagerialEconomicscanbeviewedasanapplicationofthatpartofmicroeconomics thatfocusesontopicslikedemand,production,cost,pricingandmarketstructure.The objectiveofthecourseistofacilitatethelearningofbasicmicroeconomictheoryand toolswithanemphasisonapplicationstobusinessproblemsanddecisionmakinginthe realworld. III.CourseTopics: a.Introduction b.OptimizationtechniquesandNewManagementtools c.DemandAnalysis d.ProductionTheory e.CostTheory f.MarketStructure IV.LearningOutcome 1. Developanunderstandingofkeymicroeconomicconcepts,theoriesandtools. 2. Developskillsforrigorouseconomicanalysisofdifferentmarketstructures. 3. Understandbasiceconomicissuesandprinciplesanddevelopeconomicreasoning forformulationofeffectivebusinesspoliciesatfirmlevel.

V.BooksandReferences: MainTextbook:

DominikSalvatore(AdaptedbyRavikeshSrivastava):ManagerialEconomics,Principles andWorldwideApplications,SixthEdition,OxfordUniversityPress. AdditionalReadings 1. Hirschey:EconomicsforManagers,Thomson,1stIndianEd.,2007 2. SatyaP.Das:MicroeconomicsforBusiness,SageIndia,2007 3. Dean,Joel:ManagerialEconomics,PHI 4. Keat,PaulG.&PhilipK.Y.Young,:ManagerialEconomics,PearsonEducation, 4thEd.,2003 5. Boyes,William:NewManagerialEconomics,1STEd.,2005,Biztantra 6. StevenLevitt andStephenJ.Dubner:Freakonomics,WilliamMorrow,2005.

VI.Assessment(Total100Marks) Sl.No. 1 2 3 Total VII.SessionPlan Sessions Topics Readings/Cases Chapters Components MidTermTest ContinuousAssessment EndTermTest Weightage 20 20 60 100

Module1:Introduction ThescopeofManagerial Economics Thebasicprocessofdecision making Thetheoryoffirm Thenatureandfunctionof profit CaseStudy12:The ManagementRevolution CaseStudy13:Profitsin thePersonalComputer Industry Dominic Salvatore, Chapterno.1

Module2:OptimizationtechniquesandNewManagementtools

Methodsofexpressing EconomicRelationships Total,Averageand MarginalRelationships OptimizationAnalysis

CaseStudy21:Optimal PolutionControl

Dominic Salvatore, Chapterno.2

ConstrainedOptimization NewManagementtoolsfor Optimization NewManagementTools andFunctionalSpecialization

Dominic CaseStudy23: Salvatore, BenchmarkingatXerox, Chapterno.2 FordandMobil CaseStudy24:Total QualityManagementinReal World

Module3:DemandAnalysis 4 TheDemandfora Commodity PriceElasticityofDemand CaseStudy31:The DemandforBigMacs CaseStudy32:Price ElasticitiesofDemandinthe RealWorld Dominic Salvatore, Chapterno.3

IncomeElasticityof Demand CrossPriceElasticityof Demand

CaseStudy33:Income ElasticitiesofDemandinthe Dominic Salvatore, RealWorld CaseStudy34:CrossPrice Chapterno.3 ElasticitiesofDemandinthe RealWorld CaseStudy35:Substitution betweenDomesticand ForeignGoods

UsingElasticitiesin ManagerialDecision Making

CaseStudy36:Gillet IntroducestheSensorand Mach3RazorsTwoTruly GlobalProducts CaseStudy37:Fords WorldCar(s)

Dominic Salvatore, Chapterno.3

7 8

DemandForecasting QualitativeForecasts

CaseStudy51:Forecasting Dominic Salvatore, thenumberofMcDonald's Chapterno.5 RestaurantsWorldwide CaseStudy52:Forecasting Dominic Salvatore, DemandofIndustrially Chapterno.5 ProducedTeainIndiawith Timeseriesanalysis GuestLecture

TimeSeriesAnalysis

Module4:ProductionTheory 10 The Organization of CaseStudy:SAIL Production and the DistributionStrategyfor ProductionFunction nonurbanmarkets The Production Function withOneVariableInput OptimalUseoftheVariable Input Dominic Salvatore, Chapterno.6

11

The Production Function withTwoVariableInputs

Dominic Salvatore, Chapterno.6 Dominic Salvatore, Chapterno.6

12

Optimal Combination of CaseStudy61: Inputs Substitutabilitybetween GasolineConsumptionand DrivingTime ReturnstoScale CaseStudy62:Returnsto ScaleinU.S.Manufacturing Industry CaseStudy63:BajajAuto Limited:SmallisBetter Production CaseStudy64:Output 5

13

Dominic Salvatore, Chapterno.6

Empirical

Dominic

14

Function (CobbDouglas ElasticityinU.S. ProductionFunction) ManufacturingIndustry

Salvatore, Chapterno.6

15 16

Midterm GuestLecture Module5:CostTheory Dominic Salvatore, Chapterno.7 Dominic Salvatore, Chapterno.7

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TheNatureofCosts ShortRunCostFunctions

18

CaseStudy71:TheLong LongRunCostCurves Relationship between short RunAverageCostCurvein ElectricityGeneration runandlongruncostcurves

19

PlantSizeandEconomiesof CaseStudy72:TheShape Dominic Salvatore, Scale oftheLongRunAverage Chapterno.7 CostCurve LearningCurves CaseStudy73:ToReduce Costs,FirmsOftenLookFar Afield CostVolumeProfit Analysis CaseStudy76 : Breakeven Dominic andOperatingLeverages Analysis for Tata Motors Salvatore, Chapterno.7 NanoCar

20

21

GuestLecture

Module6:MarketStructure 22 MarketStructureandDegree CaseStudy81: ofCompetition CompetitionintheStock Market Dominic Salvatore, Chapterno.8

PerfectCompetition Dominic Salvatore, Chapterno.8

23

Monopoly

CaseStudy84:Barriersto EntryandMonopolyby Alcoa CaseStudy85:Monopoly intheMumbaiCityTaxi Industry

24

MonopolisticCompetition

CaseStudy86:The Monopolistically CompetitiveRestaurant Market CaseStudy87:Advertiser CompetitioninIndia

Dominic Salvatore, Chapterno.8

2526

Oligopoly

CaseStudy91: Brands:ThriveorDrive CaseStudy92:Industrial ConcentrationforTwo WheelerIndustryinIndia CaseStudy93:The OrganisationofPetroleum ExportingCountries (OPEC)Cartel

Dominic Salvatore, Chapterno.9

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PricingofMultipleProduct PriceDiscrimination

Case Study 111 : Optimal Dominic Pricing and Output by Salvatore, Chapterno.11 Gillette CaseStudy112:Price DiscriminationbyBSES India

VIII.SessionDetails
Session1Inthisintroductorysession,wewillintroducethestudentstothesubjectand makethemunderstanditsimportanceinthecurrenteconomicenvironment.Thissession

providesthestudentswiththebasictoolkitthataidsunderstandingofthenatureand processofdecisionmakingbyamanager. a.Questionfordiscussionintheclass WhatistheimportanceofManagerialEconomics? b.CaseDiscussion CaseStudy12:TheManagementRevolution CaseStudy13:ProfitsinthePersonalComputerIndustry c.LearningOutcomes Asanintroductorysession,theobjectiveishelpthestudentsunderstandthe meaningofmanagerialEconomicsanditsroleinthebusinessdecisionmaking. d.Chapter DominicSalvatore,Chapterno.1 Session2Inthissessionwewillmakestudentsunderstandthelogicofoptimization anditsimportanceindecisionmaking. a.Questionfordiscussionintheclass Whatarethetoolsforexpressingeconomicrelationships? b.CaseDiscussion CaseStudy21:OptimalPolutionControl c.LearningOutcomes Theobjectiveistohelpthestudentsunderstandthedifferentwaystoexpress economicrelationshipsandtheiruseinunderstandingoptimisationtechniques. d.Chapter DominicSalvatore,Chapterno.2 Session3Inthissession,wewillintroducethetoolsdesignedtoincreasethe effectivenessbyprovidingtheanalyticalframeworkusedbymanagers.Thusemphasisis placedonoptimizationtechniques. a.Questionfordiscussionintheclass Howisafirm'sprofitmaximisationlevelofoutputdetermined? b.CaseDiscussion CaseStudy23:BenchmarkingatXerox,FordandMobil CaseStudy24:TotalQualityManagementinRealWorld c.LearningOutcomes Thestudentswillunderstandtheconstraintsthefirmsfaceintheiroptimisation decisions.Alsotheywilllearnthenewmanagementtoolsintroducedduringthepasttwo decades. d.Chapter DominicSalvatore,Chapterno.2

Session4Thissessionwillcoverdemandandelasticityofdemand.Wewillstartwith introductiontotheconceptofdemandwhichistheforcethatdrivesallbusiness.Without ademandforitsgoodsorservices,afirmcannotsurvive.Thenwewillgoastepfurther anddiscusstheimportanceofelasticitiesasmeasuresoftheresponsivenessofoneitem tochangeinanotheritem.ThissessionwillfocusonPriceElasticityofdemand. a.Questionfordiscussionintheclass Discusstherelationshipbetweenpriceelasticityofdemandandtotalrevenue? b.CaseDiscussion CaseStudy31:TheDemandforBigMacs CaseStudy32:PriceElasticitiesofDemandintheRealWorld c.LearningOutcomes Thestudentswillunderstandthemeaningofdemand,elasticityofdemand,the relationshipbetweenpriceelasticityofdemandandtotalrevenueanditsimportanceasa manager. d.Chapter DominicSalvatore,Chapterno.3 Session5Inthissessiontheothertwotypesofelasticitiesofdemandwillbecovered, namelyIncomeelasticityofdemandandCrossPriceelasticityofdemand. a.Questionfordiscussionintheclass Howwillyouusetheinformationregardingcrosspriceelasticityofdemandfor yourproduct? b.CaseDiscussion CaseStudy33:IncomeElasticitiesofDemandintheRealWorld CaseStudy34:CrossPriceElasticitiesofDemandintheRealWorld CaseStudy35:SubstitutionbetweenDomesticandForeignGoods c.LearningOutcomes Thestudentswillunderstandtheimportanceanduseoftheconceptsofincome andcrosspriceelasticityofdemandoftheproductsandservices. d.Chapter DominicSalvatore,Chapterno.3 Session6Inthissessionwewillmakethestudentsunderstandtheuseofdifferent elasticitiesofdemandintherealworldbytakingcasesofrealbusinesssituationsand alsobygivingthemsomesituationandaskingforasolutionbasesonElasticityconcept. a.Questionfordiscussionintheclass Howwillyouusetheconceptofelasticityofdemandasamanager? b.CaseDiscussion 9

CaseStudy36:GilletIntroducestheSensorandMach3RazorsTwoTrulyGlobal Products CaseStudy37:FordsWorldCar(s) c.LearningOutcomes Thestudentswillunderstandtheimportanceanduseoftheconceptselasticityof demandinrealworld. d.Chapter DominicSalvatore,Chapterno.3

Session7Thissessionwillhelpthestudentsinunderstandingtheimportanceof demandforecastinginthebusinessdecisions.Itwillintroducethemtoqualitative methodsofdemandforecasting. a.Questionfordiscussionintheclass Whatistheimportanceofdemandforecasting? b.CaseDiscussion CaseStudy51:ForecastingthenumberofMcDonald'sRestaurantsWorldwidec. LearningOutcomes Thestudentswillunderstandtheimportanceoftheconceptsofdemand forecastinginthebusinessdecisionmaking.Alsotheywilllearnaboutthequalitative methodsforthesame. d.Chapter DominicSalvatore,Chapterno.5,

Session8Inthissessionstudentswillbeintroducedtothemostfrequentlyused forecastingmethodTimeSeriesAnalysiswhichattemptstoforecastfuturevaluesof thetimeseriesbyexaminingpastobservationsofthedataonly. a.Questionfordiscussionintheclass Howdoyoumakeatrendline? b.CaseDiscussion CaseStudy52:ForecastingDemandofIndustriallyProducedTeainIndiawithTime seriesanalysis c.LearningOutcomes Thestudentswillunderstandtousethetimeseriesdatafordemandforecasting fortheproducts. d.Chapter DominicSalvatore,Chapterno.5

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IntegrationPlan:Inthisparticularlecture,facultyofMRwillalsobethereintheclass toexplaintheDemandForecastingtechniquesandstudentswillgetindepthknowledge abouttheForecastingtechniques Session9GuestLecture Session10Thissessionbeginswithadiscussionoftheproductionfunctionwhich summarizestheengineeringandtechnologicalpossibilitiesopentothefirm.Thisgeneral discussionisextendedtothespecificcasewherethereisasinglevariableinputor resourceandexamineshowmuchofthevariableinputafirmshouldemploytomaximize profit. a.Questionfordiscussionintheclass Whatistheimportanceofsupplyforaproducer? b.CaseDiscussion CaseStudy:SAILDistributionStrategyfornonurbanmarkets c.LearningOutcomes Withthehelpofthecasestudystudentswillunderstandtheroleofsupplyand maximizationofresourcesinproduction. d.Chapter DominicSalvatore,Chapterno.6 IntegrationPlan:CommoncaseonSAILtobediscussedinMEandPhysical Distribution&ChannelManagement.FromMEperspective,thiscasewillhighlightthe importanceofsupplyforcreatingdemandforaproductinanuntappedmarket.From Marketingperspective,thiscasewillstressuponthefactthatmanyorganisationsare forcedtochoosealternativeoradditionalmarketingstrategiesbasedoncompetitions' activities.AlsoitwillhighlightthedistributionchannelsavailableandchosenbySAIL andwouldtakecareofPhysicalDistributionandChannelManagement. Session11Inthissessionwewillexaminetheproductionfunctionwhentherearetwo variableinputs.Thedifferencebetweenshortrunandlongrunisexplainedfroman economistsperspective. a.Questionfordiscussionintheclass Whatisthedifferencebetweenshortrunandlongrunproduction? b.LearningOutcomes Studentswillunderstandtheprocessofproductioninshortrunaswellasinthe longrun. c.Chapter DominicSalvatore,Chapterno.6,

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Session12Inthissessionwewillexplainthestudentshowtheproductionfunctionand itsbuildingblocksareanalysedfromamanagerialperspective.Alsothestudentswill understandhowaprofitmaximisingfirmwillchooseanoptimalcombinationofinputs basedoninputprices. a.Questionfordiscussionintheclass Whataretheconditionsforprofitmaximization? b.CaseDiscussion CaseStudy61:SubstitutabilitybetweenGasolineConsumptionandDrivingTime c.LearningOutcomes Studentswillunderstandhowthemaximizationofoutputandminimizationof costbychoosinganoptimalcombinationtakesplace.. d.Chapter DominicSalvatore,Chapterno.6, Session13InthissessionwewilldiscusstheconceptofReturnstoScalewhereallthe inputsarevariable.ThethreetypesofReturnstoscale:Constant,Increasingand Decreasingwillbeexplainedindetailwiththeuseofdifferentexamplesfromthereal world. a.Questionfordiscussionintheclass WhatisReturnstoscale? b.CaseDiscussion CaseStudy62:ReturnstoScaleinU.S.ManufacturingIndustry CaseStudy63:BajajAutoLimited:SmallisBetter c.LearningOutcomes Studentswillunderstandtheconceptofreturnstoscaleanditspossibilityinthe productionprocess. d.Chapter DominicSalvatore,Chapterno.6, Session14Thissessionwillexplainthemostcommonlyusedproductionfunction whichisknownasCobbDouglasProductionfunction.Wewillalsomakethestudents understandseveralusefulpropertiesthisproductionfunctionhas. a.Questionfordiscussionintheclass ExaminetheuseofCobbDouglasproductionfunction. b.CaseDiscussion CaseStudy64:OutputElasticityinU.S.ManufacturingIndustry c.LearningOutcomes StudentswillunderstandtheuseofthefamousCobbDouglasproduction functionintheproductionprocess.

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d.Chapter DominicSalvatore,Chapterno.6, Session15Midterm Session16GuestLecture Session17Inthissession,wewillshalldiscusssomeimportantcostconceptsthatare relevantformanagerialdecisions.Weanalysethebasicdifferencebetweenthesecost conceptsandalso,examinehowaccountantsandeconomistsdifferontreatingdifferent costconcepts.Wewillcoveralltheshortruncostcurvesinthissession. a.Questionfordiscussionintheclass WhatisthedifferencebetweenaccountingcostandEconomicscost? b.LearningOutcomes Studentswillunderstanddifferentconceptsofcostandtheirrelevancein businessdecisionmaking. c.Chapter DominicSalvatore,Chapterno.7, Session18Thissessionwillcontinuethecostconceptandwillfocusonthederivation oflongruntotal,averageandmarginalcostcurves.Wethenshowtherelationship betweenthefirmslongrunaveragecostcurveandthefirmsshortrunaveragecost curves. a.Questionfordiscussionintheclass Whylongrunaveragecostcurveiscalledanenvelopetoshortruncostcurves? b.CaseDiscussion CaseStudy71:TheLongRunAverageCostCurveinElectricityGeneration c.LearningOutcomes Studentswillunderstandtheworkingofthecostinthelongrunandthe relationshipbetweenshortrunandlongruncostcurves. d.Chapter DominicSalvatore,Chapterno.7, Session19Inthissessionwewillexaminetheplantsize,economiesofscale, diseconomiesofscale,economiesofscopeandlearningcurves.Theseconceptsand analysishavealotofapplicationsinrealworlddecisionmakingprocess. a.Questionfordiscussionintheclass Howdoestheeconomiesofscaletakeplaceintheproductionprocess? b.CaseDiscussion

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CaseStudy72:TheShapeoftheLongRunAverageCostCurve CaseStudy73:ToReduceCosts,FirmsOftenLookFarAfield c.LearningOutcomes Studentswillunderstandthedifferencebetweeneconomiesanddiseconomiesof scaleandtheirimpactontheshapeoflongrunaveragecostcurves. d.Chapter DominicSalvatore,Chapterno.7, Session20Thissessionwillexaminecostvolumeprofitanalysis(oftencalled breakevenanalysis)andoperatingleverage.Thesesimpleanalyticaltechniquesare frequentlyusedinmanagerialdecisionmakingandcanbequiteusefulwhenapplien underapropersetofcircumstances. a.Questionfordiscussionintheclass Howdoestheeconomiesofscaletakeplaceintheproductionprocess? b.CaseDiscussion CaseStudy76:BreakevenAnalysisforTataMotorsNanoCar c.LearningOutcomes Studentswillunderstandtheconceptandrelevanceofthebreakevenanalysis forafirm. d.Chapter DominicSalvatore,Chapterno.7, Session21GuestLecture Session22Oneofthemostimportantdecisionmadebymanagersissettingthepriceof thefirmsproduct.Ifthepricesetistoohigh,thefirmwillbeunabletocompetewith othersuppliersinthemarket.Ontheotherhand,ifthepriceistoolow,thefirmmaynot beabletoearnanormalrateofprofit..Pricingisthusacrucialdecisionarea,which needsmuchofmanagerialattention.Theprocessbywhichpriceandoutputare determinedintherealworldisstronglyaffectedbythestructureofthemarket.Wewill makethestudentsunderstandthemeaningofmarketstructurewhichreferstothe competitiveenvironmentinwhichthebuyersandthesellersofaparticularproduct operate.Thenwewilldistinguishbetweenfourtypesofmarkets.Andfinallywewill explaintheequilibriumconditionsforafirmandtheindustryinaperfectlycompetitive situation. a.Questionfordiscussionintheclass Isthereanyexampleofperfectlycompetitivemarketstructuretoday? b.CaseDiscussion CaseStudy81:CompetitionintheStockMarket c.LearningOutcomes

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 Studentswillunderstandtheconceptofmarketandwillbeabletoanalysethe perfectlycompetitivemarketsworking. d.Chapter DominicSalvatore,Chapterno.8, Session23Inthissessionweshallanalysethebehaviourofafirmundermonopoly, examinehowthemonopolistdeterminesthebestlevelofoutputandpriceintheshortrun andinthelongrun,andcomparemonopolywithperfectcompetition. a.Questionfordiscussionintheclass Howdoesafirmundermonopolywork? b.CaseDiscussion CaseStudy84:BarrierstoEntryandMonopolybyAlcoa CaseStudy85:MonopolyintheMumbaiCityTaxiIndustry c.LearningOutcomes Studentswillunderstandtheworkingofafirmundermonopoly. d.Chapter DominicSalvatore,Chapterno.8, Session24Inthissessionwewilldiscussthemeaningandimportanceofmonopolistic competition,showhowtheequilibriumpriceandquantityaredeterminedintheshortrun andinthelongrun,explaintheconceptofproductdifferentiationwithspecialreference tomonopolisticcompetition. a.Questionfordiscussionintheclass Give5examplesoffirmsworkingundermonopolisticcompetition. b.CaseDiscussion CaseStudy86:TheMonopolisticallyCompetitiveRestaurantMarket CaseStudy87:AdvertiserCompetitioninIndia c.LearningOutcomes Studentswillunderstandtheworkingofafirmundermonopolisticcompetition andwillbeabletorelateittotherealworld. d.Chapter DominicSalvatore,Chapterno.8,

Session2526Inthesesessionwewillexamineoligopoly,studyoligopolymodelsand applythesemodelsofoligopolybehaviourtorealworldsituations. a.Questionfordiscussionintheclass Take2examplesofoligopolymarketandanalysetheworking. b.CaseDiscussion CaseStudy91:Brands:ThriveorDrive 15

CaseStudy92:IndustrialConcentrationforTwoWheelerIndustryinIndia CaseStudy93:TheOrganisationofPetroleumExportingCountries(OPEC)Cartel c.LearningOutcomes Studentswillunderstandtheworkingofafirmunderoligopolyandwiththehelp ofrealexampleswillbeabletorelateittothebusinessworld. d.Chapter DominicSalvatore,Chapterno.9, Session27Mostmodernfirmsproduceavarietyofproductsratherthanasingle product.Inthissessionwewillexpandoursimplepricingruleandexaminethefirms pricingofmultipleproducts.Wewillalsoexaminetheoptimalpricingofaproductsold bythefirminmultiplemarkets.WewillexplainthemeaningofPriceDiscriminationand examinetheconditionsunderwhichitarises. a.Questionfordiscussionintheclass Ispricediscriminationpossible?Ifyes,underwhatconditions? b.CaseDiscussion CaseStudy111:OptimalPricingandOutputbyGillette CaseStudy112:PriceDiscriminationbyBSESIndia c.LearningOutcomes Studentswillunderstandtheconditionsunderwhichthereisapossibilityof pricediscrimination. d.Chapter DominicSalvatore,Chapterno.11,

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STUDYMATERIALOFMANAGERIALECONOMICS PreliminaryIdeasofDemandandSupply Therelationshipbetweendemandandprice Whydoesthedemandforagivengoodincreasewhenpricesarefalling?The demandcurveillustratestherelationshipbetweenpriceandquantitydemanded. The lawofdemand statesthat otherthingsremainingsame,thequantityofa gooddemandedfallsasthepricerisesandrisesasthepricefalls.

DemandFunction Thedemandfunctionforaproductinamarketcanbewrittenasfollows: D=f(P1,P2,,Pn,Y,T,P,E) Where: P1=Priceofthegooditself P2,,Pn=Pricesofothergoodse.g.pricesofSubstitutesandComplements Y=Consumersincome T=Tastesandpreferencesofconsumer P=Thelevelandagestructureofthepopulation E=Priceexpectationsofconsumersforfuturetimeperiods OtherDeterminantsofDemand Changeintheincomeofconsumers Changeintastesandpreferences Populationandagedistribution Priceexpectations Productquality

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Movementsalongandshiftsinthedemandcurve Whenadeterminantofdemandotherthanpricechangesthereisashiftin demandcurve.Whenthereisachangeinpricethereisamovementalongthe demandcurve.

Supply

Thelawofsupplystatesthatallotherthingsremainingsame,whenthepriceof agoodrises,thequantitysuppliedwillalsorise,andviceversa.Supplycurves generallyslopeupwards. OtherDeterminantsofSupply Costsofproduction Profitabilityofalternativeproducts(substitutesinsupply) 19

Profitabilityofgoodsinjointsupply Natureandotherrandomshocks Aimsofproducers Expectationsofproducers

Movementsalongandshiftsinthesupplycurve Amovementalongthesupplycurveiscausedwhenthereisachangeinthe priceofthecommodityitself.Anincreaseinthepriceofthecommodityleadsto increaseinquantitysupplied,whileadecreaseinpricecausesacontractionin quantitysupplied. Ashiftinthesupplycurvetakesplacewhenthereisachangeinanynonprice determinantofsupply.Thecurvecanshifttotherightorleft.Inthediagramgiven belowarightwardshiftrepresentsanincreaseinthequantitysuppliedS1toS2, whilstaleftwardshiftrepresentsadecreaseinthequantitysuppliedS1toS3.

Reasonsformovementsinsupplycurveare: 1. Changesincostsofproduction Anincreaseinthecostsofproduction leads to declining profits and producers start producing less of it causing a leftwardshiftinthesupplycurve. 2.RoleoftechnologyWithimprovedtechnologylargerproductiontakesplace atlesscost,makingthesupplycurveshifttotheright. EquilibriumPriceandOutputDetermination Thepriceofacommodityinamarketisdeterminedbytheinteractionofmarket supplyandmarketdemand.Inthediagramgivenbellowthepointatwhichthe quantity demanded equals the quantity supplied is the equilibrium point. This pointstatesthepriceofthegood(P1)andthemarketquantity(Q1). Themarketforcesmaintaintheequilibriumifthereisnoshiftineitherdemandor supply curves.If prices rise and equilibrium is disturbed then the firmsstarts supplyingmore.Atthesametimetheconsumerswilldemandless.Thussupply outstripsdemandinthiscase.Theproducerswillthusnotbeabletosellwhat theyproducedatthispriceandtheywillhaveunsoldstocks.Thustheywillstart sellingstocksatalowerpricetherebyraisingdemand.Thisprocesscontinues untilthesupplyanddemandareagaininequilibrium. 20

Movementtoanewequilibrium: If the position of either the demand and/or supply curve shifts, then the equilibriumpriceandquantitywillchange.Forexample,ifthegoodismorein demand,thenthedemandcurvewillshiftfromD1toD2.

ThenewequilibriumquantityandpricewillbeQ2andP2. ConceptofElasticity DefiningElasticity Thedegreetowhichademandorsupplycurvereactstoachangeinpriceisthe curve'selasticity.Elasticityvariesamongproductsbecausesomeproductsmay be more essential to the consumer. Products that are necessities are more insensitivetopricechangesbecauseconsumerswouldcontinuebuyingthese products despite price increases. Conversely, a price increase of a good or servicethatisconsideredlessofanecessitywilldetermoreconsumersbecause thecostofbuyingtheproductwillbecometoohigh.
Todeterminetheelasticityofthesupplyordemandcurves,wecanusethissimpleequation:

Elasticity=(%changeinquantitydividedby%changeinprice) P Q / Q Q Alternatively, Elasticity,e= = . Q P / P P

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DemandCurveswithdifferentpriceelasticityofdemand Ifelasticityisgreaterthanorequaltoone,thecurveisconsideredtobeelastic.If itislessthanone,thecurveissaidtobeinelastic.Aswementionedpreviously, thedemandcurveisanegativeslope,andifthereisalargedecreaseinthe quantitydemandedwithasmallincreaseinprice,thedemandcurvelooksflatter, ormorehorizontal.Thisflattercurvemeansthatthegoodorserviceinquestion iselastic.Meanwhile,inelasticdemandisrepresentedwithamuchmoreupright curveasquantitychangeslittlewithalargemovementinprice.

Percentage Percentagechange Numerical Elasticity Description changeinprice indemand calculations value 10% 10% 10% 10% 10% 0% 5% 10% 20% Infinitelylarge 0/10 5/10 10/10 20/10 =0 <1 =1 >1 = Perfectly inelastic Inelastic demand Unitelasticity Elastic demand Perfectly elastic

FactorsAffectingDemandElasticity

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Therearethreemainfactorsthatinfluencepriceelasticityofdemand:

1. Theavailabilityofsubstitutes Thisisprobablythemostimportantfactor influencingtheelasticityofagoodorservice.Ingeneral,themoresubstitutes, themoreelasticthedemandwillbe.Forexample,ifthepriceofacupof coffeewentupbyRs.1.00,consumerscouldreplacetheirmorningcaffeine withacupoftea.Thismeansthatcoffeeisanelasticgoodbecausearaisein pricewillcausealargedecreaseindemandasconsumersstartbuyingmore teainsteadofcoffee. However,ifthepriceofcaffeineweretogoupasawhole,wewouldprobably seelittlechangeintheconsumptionofcoffeeorteabecausetherearefew substitutesforcaffeine.Mostpeoplearenotwillingtogiveuptheirmorning cup of caffeine no matter what the price. We would say, therefore,that caffeineisaninelasticproductbecauseofitslackofsubstitutes.Thus,while aproductwithinanindustryiselasticduetotheavailabilityofsubstitutes,the industryitselftendstobeinelastic.Usually,uniquegoodssuchasdiamonds areinelasticbecausetheyhavefewifanysubstitutes. 2.AmountofincomeavailabletospendonthegoodIfthepriceofacanof CokegoesupfromRs.5toRs.10andincomestaysthesame,theincome thatisavailabletospendoncoke,whichisRs.20,isnowenoughforonlytwo rather than four cans of Coke. In other words, the consumer is forced to reducehisorherdemandofCoke.Thusifthereisanincreaseinpriceand nochangeintheamountofincomeavailabletospendonthegood,therewill beanelasticreactionindemand;demandwillbesensitivetoachangein priceifthereisnochangeinincome. 3. Time If the price of cigarettes goes up Rs. 2 per pack, a smoker with veryfewavailablesubstituteswillmostlikelycontinuebuyinghisorherdaily cigarettes. This means that demand for tobacco is inelastic because the change in price will not have a significant influence on the quantity demanded. However,if thatsmokerfindsthathe orshe cannot afford to spendtheextraRs.2perdayandbeginstokickthehabitoveraperiodof time,thepriceelasticityofcigarettesforthatconsumerbecomeselasticinthe longrun. IncomeElasticityofDemand Inthesecondfactoroutlinedabove,wesawthatifpriceincreaseswhileincome staysthesame,demandwilldecrease.Itfollows,then,thatifthereisanincrease inincome,demandtendstoincreaseaswell.Thedegreetowhichanincreasein incomewillcauseanincreaseindemandiscalledincomeelasticityofdemand (EDy),whichcanbeexpressedinthefollowingequation:

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If EDy is greater than one, demand for the item is considered to have a highincomeelasticity.IfhoweverEDyislessthanone,demandisconsideredto beincomeinelastic.Luxuryitemsusuallyhavehigherincomeelasticitybecause whenpeoplehaveahigherincome,theydon'thavetoforfeitasmuchtobuy theseluxuryitems. DeterminantsofIncomeElasticityofDemand Degreeofnecessityofthegood Therateatwhichthedesireforagoodissatisfiedas consumptionincreases. Thelevelofincomeofconsumers. Withsomegoodsandservices,wemayactuallynoticeadecreaseindemandas incomeincreases.Theseareconsideredgoodsandservicesofinferiorquality thatwillbedroppedbyaconsumerwhoreceivesasalaryincrease.Anexample maybetheincreaseinthedemandofDVDsasopposedtovideocassettes, whichare generallyconsidered tobeoflowerquality.Productsforwhich the demanddecreasesasincomeincreaseshaveanincomeelasticityoflessthan zero.Productsthatwitnessnochangeindemanddespiteachangeinincome usually have an income elasticity of zero these goods and services are considerednecessities. Crosspriceelasticityofdemand Theresponsivenessofdemandforonegoodtoachangeinthepriceofanother iscalledCrosspriceelasticityofdemand. Crosselasticityofdemand=
ProportionatechangeinquantitydemandedforgoodA Proportionatechangeinpriceof goodB

Determinantsofcrosspriceelasticity Closenessofthesubstituteorcomplement.

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TheoryofProduction
TheOrganizationofProduction Inputs Labor,Capital,Land FixedInputs VariableInputs ShortRun Atleastoneinputisfixed LongRun Allinputsarevariable ProductionFunctionwithTwoInputs Q=f(L,K) K 6 10 24 31 36 40 5 12 28 36 40 42 4 12 28 36 40 40 3 10 23 33 36 36 2 7 18 28 30 30 1 3 8 12 14 14 1 2 3 4 5

Q 39 40 36 33 28 12 6

ProductionFunctionwithOneVariableInput TotalProduct AverageProduct MarginalProduct ProductionorOutputElasticity TPL=Q=f(L) APL= MPL= EL=

TPL L

MPL APL ProductionFunctionwithOneVariableInput

TP L

Total,Marginal,andAverageProductofLabor,andOutputElasticity
L 0 1 2 3 4 5 6 Q 0 3 8 12 14 14 12 MPL 3 5 4 2 0 2 APL 3 4 4 3.5 2.8 2 EL 1 1.25 1 0.57 0 1

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ThreeStagesofProductionwithOneVariableInput

ProductionwithTwoVariableInputs Isoquantsshowallthecombinationsoftwoinputsthatcanproducethesame levelofoutput. Firmswillonlyusecombinationsoftwoinputsthatareintheeconomicregionof production,whichisdefinedbytheportionofeachisoquantthatisnegatively sloped.

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CobbDouglasProductionFunction Thewidelyusedmultiplicativeformofproductionfunctionwhichisknownas CobbDouglasproductionfunctionisofthefollowingform. Q=AK L whereAisaconstantandand , arefractions,i.e.,lyingbetween0and1 Itiswidelyusedineconomicsbecauseithaspropertiesrepresentativeofmany productionprocesses. ConceptsofRevenueandProfit Revenue Definingtotal,averageandmarginalrevenue Revenuecurveswhenfirmsarepricetakers(horizontaldemandcurve) Averagerevenue(AR) Marginalrevenue(MR) Totalrevenue(TR) Revenuecurveswhenpricevarieswithoutput(downwardslopingdemand curve) Averagerevenue(AR) Marginalrevenue(MR) Totalrevenue(TR) Revenuecurvesandpriceelasticityofdemand Shiftsinrevenuecurves ProfitMaximisation Usingtotalcurves MaximisingthedifferencebetweenTRandTC Thetotalprofitcurve Usingmarginalandaveragecurves stage1:profitmaximisedwhereMR=MC stage2:usingARandACcurvestomeasuremaximumprofit Somequalifications longrunprofitmaximisation 27

themeaningofprofit

Whatifalossismade? lossminimising:stillproducewhereMR=MC shortrunshutdownpoint: P=AVC longrunshutdownpoint: P=LRAC Total,Average,andMarginalCost

T C ($ ) 240 180 120 60 0 0 1 2 3 4 MC Q

A C ,M C ($ )

AC

120

60

0 0 1 2 3 4 Q

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