What Is economics :

The word Economy derived from the Greek word okios which
means household.
What is Scarcity:
Human wants are unlimited
Resources available to satisfy these wants are scarce / limited
People wants to maximize their gains
D>S Demand >supply so
Economic agents / society have some economic problems because of
scarcity of resources
They need to choose scarce resources among alternatives (scarce
resources) based on choice and valuation of alternatives
 Because of scarcity, an allocation decision must be made. The
allocation decision is comprised of three separate choices:

What and how many goods and services should be produced?

How should these goods and services be produced?
For whom should these goods and services be produced?
Economics
Thus economics is the study of how economic agents or societies
choose to use scarce productive resources that have alternative uses
to satisfy wants (needs) which are unlimited and of varying degree of
importance
 1-4

Managerial Economics
Manager
A person who directs resources to achieve a stated goal.
Economics
The science of making decisions in the presence of scare resources.
Managerial Economics
The study of how to direct scarce resources in the way that most efficiently achieves
a managerial goal.
resources financial, human, physical
management of customers, suppliers, competitors, internal organization
organizations business, nonprofit, household
Opportunity Cost
The cost of this choice is the benefit of the next best alternative foregone.
This is called opportunity cost.
This choice implies sacrifice of other alternatives, hence cost of this choice
will be evaluated in terms of the sacrificed alternatives.
Suppose a machine can produce either X or Y. The opportunity cost of
producing a given quantity of X is the quantity of Y, which the resources
would have produced.
You may be working in your hometown and suppose you have got another
job offer in a city away from your hometown. Now if you select the new
offer, you would be foregoing the benefit of staying at home. So benefit of
staying at home is opportunity cost of the new job.
Measuring and Maximizing Economic Profit

Economic Cost of Resources

Opportunity cost :What firm owners give up to use resources to

produce goods and services.

Market-supplied resources : Owned by others & hired, rented, or

leased
Owner-supplied resources: Owned & used by the firm
Total Economic Cost

Sum of opportunity costs of both market-supplied resources &

owner-supplied resources
Explicit Costs :Monetary payments to owners of market-supplied
resources
Implicit Costs: Nonmonetary opportunity costs of using owner-
supplied resources
Types of Implicit Costs

Opportunity cost of cash provided by owners Equity capital

Opportunity cost of using land or capital owned by the firm
Opportunity cost of owners time spent managing or working for the
firm
 1-9

Economic vs. Accounting Profits

Economic profit = Total revenue Total economic

cost =
Total revenue Explicit costs Implicit cost

Accounting profit = Total revenue Explicit costs

AP> EP
Example:
Consider an individual who has a MBA degree and is considering
venturing into the spare parts business rather than going for a
corporate job. He invests 3,00,000/- in the business.
The projected income statement for the year
Sales 100000
Less: Cost of goods sold 40000
Goss Profit 60,000
Less: Depreciation 5000
Utilities 4000
Advertising 10,000
Miscelleneous expenses 5000
Total (24,000)
Net accounting profit 36,000
Implicit costs

1. Could have invested money and could have got a return of 10000
monthly

2. Could have got a job of 50,000

So economic profit is ( 36000-(10000+50000)= -24000
 1-12

Profits as a Signal
Profits signal to resource holders where resources are most highly
valued by society.
Resources will flow into industries that are most highly valued by society.
 1-13

Net Benefits
Net Benefits = Total Benefits - Total Costs
Profits = Revenue - Costs
Demand and Quantity Demand
Quantity demanded: is the quantity of product (good or service) that
consumers are willing and able to buy at a certain price.
Demand: the quantities of product that consumers are willing and
able to buy it at different prices.
Demand denotes a desire to buy a product backed by ability and
willingness to pay.
A desire without sufficient resources or ability (income) to purchase is
merely a wish;
and a desire with sufficient resources or ability to purchase but
without willingness to spend is only a potential demand

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Variables Affecting Consumer Decision
There are various variables affecting the consumers decision while
purchasing a product. For a pizza market, as an example there are:
The price of that product
Income of the Consumer
The availability and the price of substitute goods such as Burger or
sandwiches
The price of complementary goods such as cold drinks or water
Consumer tastes and advertising
Consumer expectations about future prices

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Demand Schedule
Demand Schedule is a Table that shows the relationship between the
price of product and its corresponding quantity demanded by a
consumer, everything else held unchanged (ceteris paribus), i.e.
other variables are not changed
Price Quantity
Demanded/month
2 13
4 10
6 7
8 4
10 1

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Individual Demand Curve
The individual demand curve is a graphical presentation of demand
schedule. It shows the relationship between the price of a product
and the quantity demanded. Mathematically it is
Qd = Qd(p)
The slope downwards to the right means, it has a negative slope, and
has inverse relationship between price and quantity demand.

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Individual Demand Curve

P
Demand Relationship
10
A
8

B
6

4 C

2 D
Qd
1 4 7 10 13
O' Sullivan, "Economics: Principles, Application and
Tools", 7th edi.
The Law of Demand
The law of demand states that the higher the price, the smaller the
quantity demanded, ceteris paribus (everything else held fixed).

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Demand Function
Demand Function states the relationship between demand for a product
(the dependent variable) and its determinants (the independent
variables):

Qd = f (Px)

Qd is the quantity demanded for a product X (dependent variable)

Px is the price of a product X (independent variable)

We read it as: the quantity demanded for a product X, depends on its

price000

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
 The demand function can be expressed in the form of an equation as:

Qd = a - b*Px

Qd = quantity demand
a = an intercept
b = quantifies the relationship between Qd & Px
Px = price of product X

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Example 1
Assume that a = 100 and b = 5, write the demand function as an
equation?
Qd = a b x Px
Solution: Qd = 100 - 5Px
Now, if Px = 4, how much the quantity demand will be?
Solution: Qd = 100 (5 x 4)
Qd = 100 (20)
Qd = 80

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
 Exercise: From the last demand
Function, i.e. Qd = 100-5 Px Qd = 100 - 5Px Qd
Px,draw the demand curve.
4 100 - 5 X 4 80
Solution: First, we prepare the
demand schedule assigning 5 100 - 5 X 5 75
different values to Px 6 100 - 5 X 6 70
7 100 - 5 X 7 65

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Px

6
5

D
Qd
65 70 75 80
O' Sullivan, "Economics: Principles, Application and
Tools", 7th edi.
Solution
We can solve this function by putting different value of Price to find the
corresponding Quantity Demand
P Qd = 100 10P Qd
0 Qd = 100 10 (0) 100
2 Qd = 100 10 (2) 80 P Qd = 100/P Qd
4 Qd = 100 10 (4) 60 0 Qd = 100/0 Infinite
6 Qd = 100 10 (6) 40 2 Qd = 100/2 50
8 Qd = 100 10 (8) 20 4 Qd = 100/4 25
10 Qd = 100 10 (10) 0 6 Qd = 100/6 16.67
8 Qd = 100/8 12.5
10 Qd = 100/10 10

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
Exercises (2)
The sales data of an Ice-cream Company shows a demand function as
Qd = 400 10P. From this demand function, find out:
Demand schedule and demand curve.
Number of Ice creams sold at price 10Dhs.
Price for selling 200 Ice-creams.
Price for zero sales, i.e. Qd = 0
Sales at zero price, i.e. P = 0

O' Sullivan, "Economics: Principles, Application and

Tools", 7th edi.
 Demand Forecasting

Estimation of demand for a product in a forecast

year/ period is termed as Demand forecast.
Demand forecast is a must for a firm operating
its business as today's market is competitive,
dynamic and volatile.
 Purpose of Demand Forecasting

Better planning and allocation of resources

Appropriate production scheduling
Inventory control
Determining appropriate pricing policies
Setting s les targets and establishing controls and
incentives.
Planning a new unit or expanding existing one
Planning long term financial requirements
Planning Human Resource Development strategies.
Steps Involved in Forecasting

Identification of objective
Determining the nature of goods under
consideration.
Selecting a proper method of forecasting.
Interpretation of results.
 Period of forecasting
Short run forecasting: In short run
forecasting, we look for factors which bring
fluctuation in demand pattern in the market
for example weather conditions like monsoon
affecting the demand.

Medium run forecasting: In medium run

forecasting is done basically for timing of
an activity like advertising expenditure.

Long run forecasting: It is done to

ascertain the validity of trend. It is done
for decision like diversification.
 Levels of Forecasting

Macroeconomic forecasting is concerned with

business conditions of the whole economy. It is
measured with the help of indices like wholesale
price index, consumer price index.

Industry demand forecasting gives indication to

firm regarding direction in which the whole industry
will be moving. It is used to decide the way the
firm should plan for future in relation to the
industry.

contd
Methods of Forecasting

Qualitative Methods

Surveys Technique
Survey of business executives, plant and
equipment, expenditure plans. Basically compilation
of expenditure plans of related industries.

Survey of plans for inventory changes and sales

expectations.

Survey of consumer expenditure plans.

 Opinion Polls

Consumer survey: In this method the consumers

are contacted personally to disclose their future
purchase plans. This could be of two types-
Complete enumeration and sample survey.

Sales force opinion method: In this method

people who are closest to the market( sales
peoples) are asked for their opinion on future
demand. Then opinion of different people is
compiled to get overall demand forecast.
Expert Opinion (Delphi Technique):
Opinions of different experts are taken
and compiled. If there are
discrepancies between the different
viewpoints, successive rounds of
iterations are undertaken taking into
account the opinions of other experts,
until near consensus emerges
Statistical Methods

Time Series Analysis

Forecasts on the basis of an analysis of historical time
series data
Trend Projection Method
Based on the assumption that there is an identifiable
trend in the variable to be forecast which will continue in
the future
Time Series data is used to fit a trend line on the
variable under forecast either graphically or by statistical
techniques
Y = a + bt; t time
Forecasting is done by extrapolating the trend line
into the future.
 Barometric Methods

Leading Indicator Method : correlated with

the variable to be forecast. These
indicators tend normally to anticipate
turning points in a business cycle.
Coincident indicators: These are
indicators which move in step or coincide
with movements in general economic activity
or business cycle.
Lagging indicator: These are indicators
which lag the movements in economic
activity or business cycle.
 Regression Method
Identification of variables which influence the
demand for the good whose function is under
estimation.

Collection of historical data on all relevant

variables.

Choosing an appropriate form of the function.

Estimation of the function

 Simultaneous Equation Method
(Econometric Models)
Econometric forecasting models range from
single equation models of the demand that the
firm faces for its product to large multiple
equation models describing hundreds of sectors
and industries of the economy. Use estimating
equations based on Economic Theory
 Input Output Forecasting

Input output analysis was introduced by Prof.

Leontief. With this technique the firm can also
forecast using Input output tables. It shows the
use of the output of each industry as input by
other industries and for final consumption. Input
and output analysis allow us to trace through all
these inter industry input and outputs flow though
out the economy and to determine the total
increase of all the inputs required to meet the
increased demand.
Risks in Demand Forecasting

Overestimation of demand

Underestimation of demand

First risk arises from entirely unforeseen

events such as war, political upheavals and
natural disasters. The second risk arises
from inadequate analysis of the market.
Defining the Elasticity
Elasticity is a measure of response (the change) in one variable
(Quantity Demand/Supply) resulting from a change in another
variable (Price/Income/Incentive).
Types of Elasticity:
Price Elasticity of Demand.
Price Elasticity of Supply.
Income Elasticity of Demand.
Cross Price Elasticity (Substitute and Complement Goods)

O' Sullivan, "Microeconomics: Principles, Application and

Tools"
Price Elasticity of Demand
A measure of the responsiveness (change) of the quantity demanded resulting from changes in price.
It is computed by dividing the percentage change in quantity demanded by the percentage change in price.

% Change in Quantity Demanded)

% Change in Price
= ( Qd / P) * P0 / Q0 where Qd = New demand-old
demand=Q1-Q0 and P= P1-P0

Example: A 10% increase (from UAE Dhms 2.0 to 2.20) in the milk prices decreases the quantity demanded
of milk by 15% (from 100 to 85 liter). The Price Elasticity of Demand will be: -15% divided by10% = -1.5%
This means the quantity demanded will decrease by 1.5% if the price is increased by 1%.

O' Sullivan, "Microeconomics: Principles, Application and

Tools"
Price Elasticity of Demand
Its the change in Quantity Demanded of a good or service resulting
from change in its Price.
The Price Elasticity of Demand is usually negative, because of the
negative relation between price and the quantity demanded of the
good.
Exercise:
The weekly Quantity Demand for bread was 2000 at the price of
Dhms 10, now the price is increased to Dhms 15 and the quantity
demand is 1800. Calculate the price elasticity of demand for bread.
Also Define whether the demand is Elastic or Inelastic for this
product.
O' Sullivan, "Microeconomics: Principles, Application and
Tools"
The Variety of Demand Curves
Inelastic Demand
Quantity demanded does not respond strongly to price changes.
Price elasticity of demand is less than one.
Elastic Demand
Quantity demanded responds strongly to changes in price.
Price elasticity of demand is greater than one.
The Variety of Demand Curves
Perfectly Inelastic
Quantity demanded does not respond to price changes.
Perfectly Elastic
Quantity demanded changes infinitely with any change in price.
Unit Elastic
Quantity demanded changes by the same percentage as the price.
The Variety of Demand Curves
Because the price elasticity of demand measures how much quantity
demanded responds to the price, it is closely related to the slope of
the demand curve.
The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0

Price
Demand

4
1. An
increase
in price . . .

0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

Copyright2003 Southwestern/Thomson Learning

The Price Elasticity of Demand
(b) Inelastic Demand: Elasticity Is Less Than 1

Price

4
1. A 22% Demand
increase
in price . . .

0 90 100 Quantity

2. . . . leads to an 11% decrease in quantity demanded.

The Price Elasticity of Demand
(c) Unit Elastic Demand: Elasticity Equals 1
Price

4
1. A 22% Demand
increase
in price . . .

0 80 100 Quantity

2. . . . leads to a 22% decrease in quantity demanded.

Copyright2003 Southwestern/Thomson Learning

Price elasticity of demand
(d) Elastic Demand: Elasticity Is Greater Than 1
Price

4 Demand
1. A 22%
increase
in price . . .

0 50 100 Quantity

2. . . . leads to a 67% decrease in quantity demanded.

The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price

1. At any price
above 4, quantity
demanded is zero.
4 Demand

2. At exactly 4,
consumers will
buy any quantity.

0 Quantity
3. At a price below 4,
quantity demanded is infinite.
Determinants of Elasticity of Quantity
Demanded
1) Time period the longer the time under consideration the more
elastic a good is likely to be
Example:
If the price of TV set decrease, demand will not immediately increase
unless people possess excess purchasing power. But over time,
people may be able to adjust their expenditure pattern, so that they
can buy a TV set at the new lower price.

O' Sullivan, "Microeconomics: Principles, Application and

Tools"
Determinants of Elasticity of Quantity
Demanded
2) Number and closeness of substitutes : the greater the number of
substitutes the more elastic
Example 1:
Coffee and tea may be considered as close substitutes; therefore, the
elasticity of demand for both these goods is higher.
Example 2:
Soaps, toothpaste, and cigarettes, are available in different brand names,
So, the price elasticity of demand for each brand is higher.
Example 3:
Sugar and salt do not have their close substitute; hence their price
elasticity is lower.

O' Sullivan, "Microeconomics: Principles, Application and

Tools"
Determinants of Elasticity of Quantity
Demand
3) The Proportion of Income taken up by the product the smaller
the proportion the more inelasticExample The demand for matches,
books, toothpastes, and salt is generally inelastic, because increase in
the price of such goods does not significantly affect consumers
budget.
4) Luxury or Necessity:For luxury goods elasticity is very high.
Example: jewelry, costly cars, and decoration items. For necessary
goods elasticity is very low. Example: medicine, bread, sugar, clothes,
and vegetables.

O' Sullivan, "Microeconomics: Principles, Application and

Tools"
Exercise
Suppose a demand schedule is
given as follows:
Price (Dhs) 0 20 40 60 80 100

Quantity 600 500 400 300 200 100

Demanded
1. Find the elasticity for the fall in price from
Dhs. 80 to Dhs. 60.
2. Calculate the elasticity for the increase in price
Dhs. 20 to Dhs. 40.