1.
Introduction to Economics and Its Importance in Managerial Decisions
Economics = Study of how people use limited resources to satisfy unlimited wants.
Managerial Economics applies these principles to business decision-making.
It helps managers:
1. Allocate scarce resources efficiently.
2. Decide what, how, and for whom to produce.
3. Control costs and increase profits.
4. Forecast demand and plan production.
Example: A car company decides whether to produce petrol or electric cars based on customer
demand and production cost.
2. Definition and Subject Matter of Economics
Lionel Robbins: “Economics is the science which studies human behavior as a relationship between
ends and scarce means which have alternative uses.”
Meaning: People must choose between alternatives because resources are limited.
Subject Matter of Economics:
1. Consumption – using goods (e.g., buying food).
2. Production – creating goods (e.g., making mobiles).
3. Exchange – buying/selling (e.g., trading online).
4. Distribution – sharing income among workers, owners, etc.
5. Public Finance – government taxes and expenditure.
Example: A farmer must choose whether to grow wheat or rice on limited land.
3. Scarcity, Rational Choice Theory, and Central Problems
Scarcity: Resources are limited but human wants are unlimited.
Rational Choice Theory: People make logical decisions to maximize satisfaction or profit.
3 Central Problems of Every Economy:
1. What to produce? – e.g., food or weapons?
2. How to produce? – by hand (labour-intensive) or by machine (capital-intensive)?
3. For whom to produce? – for rich or poor?
Economic Activity: All actions related to production, consumption, exchange.
Economic Agents: Consumers, producers, and government.
Example: A shoe company decides whether to use handwork (more jobs) or machines (less cost).
4. Want, Desire, and Demand
Desire: Wish to have something (e.g., a car).
Want: Desire backed by a reason or need (need transport).
Demand: Want backed by ability and willingness to pay (you buy a scooter).
Example: You may desire a BMW, but demand only an Activa because you can afford it.
5. Factors Influencing Individual Demand
1. Price – Lower price → higher demand.
2. Income – Higher income → more demand for luxury goods.
3. Prices of Related Goods –
o Substitute goods (tea-coffee): if tea price rises, coffee demand ↑.
o Complementary goods (car-petrol): if petrol price rises, car demand ↓.
4. Tastes & Preferences – Fashion, trends, habits.
5. Future Expectations – If people expect prices to rise, they buy more now.
6. Population – More people → higher demand.
7. Advertisement – Strong ads increase demand.
Example: When movie tickets become cheaper, more people go to theaters.
6. Law of Demand, Expansion, and Market Demand
Law of Demand: When price ↓ demand ↑, when price ↑ demand ↓ (inverse relation).
Expansion of Demand: Demand ↑ due to price fall (movement down on same curve).
Contraction of Demand: Demand ↓ due to price rise.
Increase/Decrease in Demand: Change due to other factors (shift of curve).
Market Demand: Total demand of all consumers.
Example: When iPhone price drops, more people buy it; overall market demand increases.
7. Elasticity of Demand
Measures how demand responds to changes in price, income, or price of related goods.
Types:
1. Price Elasticity: Change in demand due to change in price.
Example: Price of chips ↑ 10%, demand ↓ 20% → elastic.
2. Income Elasticity: Change in demand due to income.
Example: Income ↑ → more demand for ACs.
3. Cross Elasticity: Change in demand for one good due to change in price of another.
Example: Tea price ↑ → coffee demand ↑.
High Elasticity: Big response (luxury goods).
Low Elasticity: Small response (necessities like salt).
8. Nature of Goods & Violation of Law of Demand
Normal Goods: Demand ↑ when income ↑ (e.g., branded clothes).
Inferior Goods: Demand ↓ when income ↑ (e.g., local rice).
Giffen Goods: Poor people buy more even when price ↑ (e.g., coarse grains).
Veblen Goods: Expensive items bought for show-off (e.g., Rolex watch).
Snob Effect: Some buy goods to feel superior (e.g., limited edition car).
Bandwagon Effect: People buy because everyone else is (e.g., trending phone).
9. Supply and Law of Supply
Supply: Quantity sellers are willing to sell at different prices.
Law of Supply: When price ↑ → supply ↑, when price ↓ → supply ↓ (direct relation).
Example: Farmers grow more wheat if price increases.
Factors affecting Supply: Cost of production, technology, govt. policy, climate, expectation.
10. Market Equilibrium
Equilibrium: When quantity demanded = quantity supplied.
If price > equilibrium → surplus → price falls.
If price < equilibrium → shortage → price rises.
Example: During Diwali, high sweet demand raises prices until supply meets demand.
11. Cardinal Utility Analysis (Marshall’s Theory)
Based on measurable satisfaction (in utils).
Assumptions:
1. Consumer is rational.
2. Utility can be measured.
3. Marginal utility of money is constant.
4. Law of Diminishing Marginal Utility applies.
Example: First apple gives 20 utils, second gives 15 utils → measurable satisfaction.
12. Concept of Utility
Utility: Satisfaction from a good or service.
Total Utility (TU): Total satisfaction from all units consumed.
Marginal Utility (MU): Extra satisfaction from one more unit.
Marginal Utility of Money: Satisfaction per rupee spent.
Example:
o 1st pizza = 30 utils
o 2nd = 20 utils
o 3rd = 10 utils → MU decreases each time.
13. Law of Diminishing Marginal Utility
As you consume more of a product, the extra satisfaction from each additional unit decreases.
Example:
o 1st glass of water = very satisfying
o 2nd = less
o 5th = no satisfaction
Conclusion: MU decreases → people pay less for more units → demand curve slopes downward.
14. Consumer’s Equilibrium (Cardinal Approach)
A consumer is in equilibrium when satisfaction is maximum with limited income.
One Commodity: Equilibrium when MU = Price.
Two Commodities:
Meaning: Utility per rupee is equal for all goods.
Example:
o MU of chocolate/₹10 = 5
o MU of chips/₹5 = 5 → equilibrium reached (equal satisfaction per rupee).
1. Introduction to Economics and its importance in Managerial
Decisions
Economics is the study of how people, firms, and governments make decisions to allocate scarce resources.
It helps managers make rational business decisions — what to produce, how much to produce, and at
what price.
Economics gives tools to analyze costs, demand, prices, and profits.
Importance in Managerial Decisions:
Helps in forecasting demand for products.
Assists in pricing strategies.
Aids in production and cost analysis.
Helps choose the best alternative when resources are limited.
🧩 Example: A smartphone company decides how many phones to produce based on consumer demand and
production cost.
2. Definition and Subject Matter of Economics
Definition:
Economics is the study of how people and societies use limited resources to satisfy unlimited wants.
– Lionel Robbins: “Economics is the science which studies human behaviour as a relationship between ends and
scarce means which have alternative uses.”
Subject Matter of Economics:
Microeconomics: Studies individual units (consumers, firms, markets).
→ e.g., Price of a single product, individual demand.
Macroeconomics: Studies the economy as a whole.
→ e.g., Inflation, national income, unemployment.
3. Scarcity of Resources and Rational Choice Theory
Scarcity: Resources (money, time, land, labour) are limited, but human wants are unlimited.
Because of scarcity, people must make choices.
Rational Choice Theory: Assumes consumers make decisions that give them maximum satisfaction
(utility) from limited resources.
Three Central Questions of Economics
1. What to produce? – Which goods/services should be made?
2. How to produce? – Which method: labour-intensive or capital-intensive?
3. For whom to produce? – How to distribute goods among people?
Economic Activities: Activities related to production, distribution, and consumption of goods and services.
Economic Agents: Consumers, producers, and government — all make economic decisions.
4. Want, Desire, and Demand
Desire: A wish to have something. (e.g., “I want an iPhone.”)
Want: Desire backed by willingness. (e.g., “I wish to buy an iPhone soon.”)
Demand: Desire + Willingness + Ability to pay.
(e.g., “I have ₹80,000 to buy an iPhone.”)
🔹 Formula:
Demand = Desire + Ability to Pay + Willingness to Pay
5. Factors Influencing Individual Demand
1. Price of the commodity
2. Income of the consumer
3. Prices of related goods (Substitutes & Complements)
4. Tastes and preferences
5. Expectations of future price
6. Population and demographics
🧩 Example: If coffee’s price rises, demand for tea (substitute) increases.
6. Law of Demand
The Law of Demand states that when the price of a good falls, its demand increases, and when price rises,
demand decreases — other things remain constant.
📉 Inverse Relationship:
Price ↑ → Demand ↓
Price ↓ → Demand ↑
Expansion & Contraction of Demand:
Expansion: More is demanded due to fall in price (movement along same curve).
Contraction: Less is demanded due to rise in price.
Change in Demand: Entire demand curve shifts due to factors other than price.
Derivation of Market Demand:
Add all individual demand curves horizontally to get total (market) demand curve.
7. Elasticity of Demand
Elasticity means responsiveness of demand to change in price, income, or price of related goods.
Types:
🧩 Example: If price of coffee rises by 10% and tea demand increases by 5%,
Cross Elasticity = +0.5 → Substitute goods.
8. Nature of Goods & Violations of Law of Demand
Normally, price and demand are inversely related — but some goods violate this law:
Type of Good Explanation Example
Giffen Good Inferior goods whose demand rises with price (due to income effect) Low-quality rice
Veblen Effect Luxury goods where high price = prestige Rolex, iPhone
Snob Effect People avoid what common masses buy Limited-edition sneakers
Bandwagon Effect People buy because others are buying Trendy clothes
9. Supply and Law of Supply
Supply: Quantity of a good producers are willing to sell at a given price and time.
Law of Supply: There is a direct relationship between price and quantity supplied.
📈 Price ↑ → Supply ↑; Price ↓ → Supply ↓
10. Market Equilibrium
Equilibrium Price: The price where quantity demanded = quantity supplied.
If Price > Equilibrium, → surplus → price falls.
If Price < Equilibrium, → shortage → price rises.
📊 The intersection of demand and supply curves gives Equilibrium Price & Quantity.
11. Cardinal Utility Analysis: Theory and Assumptions
Cardinal Utility Theory (proposed by Alfred Marshall) assumes that utility (satisfaction) can be
measured in numbers (utils).
Assumptions:
1. Utility is measurable.
2. Marginal utility of money is constant.
3. Independent utilities.
4. Rational consumer behavior.
12. Concept of Utility
Utility: Satisfaction obtained from consuming a product.
Total Utility (TU): Total satisfaction from consuming all units.
Marginal Utility (MU): Additional satisfaction from consuming one more unit.
🔹 Relation:
MU = Change in TU / Change in Quantity
🧩 Example:
Eating 1st slice of pizza gives 10 utils, 2nd gives 6 utils → MU = 6.
Marginal Utility of Money:
Utility obtained from each additional unit of money remains constant.
13. Law of Diminishing Marginal Utility
As more units of a commodity are consumed, additional satisfaction (MU) decreases.
🧩 Example:
First glass of water when thirsty gives high satisfaction; second less; third may give no satisfaction.
Implication: Consumers buy more only when price falls — basis of Law of Demand.
14. Consumer’s Equilibrium (Cardinal Utility Approach)
A consumer is in equilibrium when he gets maximum satisfaction given his income and prices.
Condition for Equilibrium:
Where:
MUx = Marginal utility of good X
Px = Price of good X
If MUx/Px > MUy/Py → buy more of X until equality is restored.
🧩 Example:
If chocolate gives 10 utils and costs ₹5 (MU/P = 2), and chips give 6 utils and cost ₹3 (MU/P = 2), consumer is
in equilibrium.