MANAGERIAL ECONOMICS

Course Code: MS 105

Batch: MBA (First Semester)

Classes held from 22th-27rd August, 2024

 Course Content
• Unit 1: Introduction
• Unit 2: Demand Analysis and theories of
Production
• Unit 3: Theory of Cost and Market Structures
• Unit 4: Introduction to Macroeconomics
Unit 1: Introduction to Managerial
Economics
 Topics to be covered
❑Cardinal Approach to consumer choice
❑Law of Diminishing Marginal Utility
❑Law of Equi Marginal Utility
❑Consumer Equilibrium
1. Why study cardinal and ordinal approach or
theory of consumer choice?

❑Theory of consumer choice helps to predict the

consumer's responses to change in prices, income,
tastes and preferences, prices of related goods, and
advertising expenditure.
❑With the above understanding, manager of a firm is
better able to know the changes in firm’s revenue
consequent to changes in variables that the firm
can control such as price of its product.
 2. Some basic concepts
• Utility is the degree of satisfaction or pleasure a consumer
gets from an economic act. Ex: when hungry, a consumer can
purchase a sandwich to eat so they are no longer hungry.
• Marginal Utility: Utility consumer gets from each additional
unit of consumption. Ex: If you buy a bottle of water and then
a second one, the utility gained from the second bottle of
water is the marginal utility.
• Relation between the two:
Suppose, U = f(Q)
where q is the quantity of some good a household consumes,
and U is the total utility the household gets from consuming
the good.
• Then, MU = d(U)/d(q)
 3. Cardinal Approach
❑ Given by Alfred Marshall
❑ Utility is measured cardinally or numerically in terms of money.
❑ The assumptions of this approach:
➢ Cardinal measurement of utility: Utility is measureable and
can be compared.
➢ Hypothesis of Independent Utility: Utility derived from
consumption of good is the function of the quantity of that
good consumed.
➢ Constancy of the MU of money: When a consumer spends his
on various goods, the MU of money remains unchanged.
➢ Introspective Method: MU of the good diminish as we have
more of something, less utility is derived by having more of a
good.
❑ Two Major concepts in cardinal approach:
➢ Diminishing Marginal Utility
➢ Principle of Equi- marginal Utility
 4. Law of Diminishing Marginal Utility
❑MU of the good diminishes as an individual consumes more
units of a good.
❑Extra utility or satisfaction derives from the good diminishes as
it is consumed more and more.
 4.1 Significance of Diminishing Marginal Utility
❑Determination of price of the product:
➢ total utility does not determine price of the
commodity.
➢Marginal utility determine price .
➢Ex. Diamond Water Paradox

Why Diamonds are expensive and not water when it

is crucial for life?
 5. Principle of Equi-Marginal Utility
▪ Consumer will distribute his money income between the
goods in such a way that the utility derived from last rupee
spent on each good is equal.
▪ Consumer is in Equilibrium when MUm expenditure on each
good is same.
▪ MU of money expenditure on a good is equal to the MU of a
good divided by the price of the good.

▪ Consumer in equilibrium in respect of purchase of two goods:

 5.1. Numerical Illusatration
• The following table gives an individual’s marginal
utility schedules for goods X1 and X2. If the prices of
X1 and X2 are Rs. 2.00 each and that the individual
has Rs. 20.00 of Income, which she spends on X1 and
X2 , what is the individual’s equilibrium purchase of
X1 and X2 ?
5.2. Numerical Illustration-Solution
6. Derivation of Demand Curve Under Cardinal Utility
Analysis
 6.1. BASIS OF THE LAW OF DEMAND IN THE CARDINAL
APPROACH
❑ M= P1 X1 + P 2 X2 …………(i)
❑ MU x /Px = MUy/Py ………(ii)
❑ Now the price of X1 falls to PX1.
❑ The consumer will be out of equilibrium, i.e.,
MUX/PX1 > MUY/PY
❑ To derive the demand curve for X, we assume that tastes, money income and
prices of other goods, say Y, remain constant
❑ To restore equilibrium, the consumer must buy more of X and less of Y.
MUX must fall because of the hypothesis of diminishing marginal utility.
❑ As the consumer purchases more of X, he must buy less of Y. Consequently,
MUY will rise.
❑ To reach equilibrium, the consumer transfers his given money income from Y to
X, that is, buy more of X and lowers its marginal utility and buy less of Y and
raises its marginal utility.
❑ What we have thus seen is that a fall in the price of a good, ceteris paribus,
leads to an increase in its demand. Thus, the demand curve for the commodity in
question is negative sloping.
 7. Concept of Consumer Surplus
❑ The concept of consumer surplus was first formulated by
Dupuit in 1844 to measure social benefits of public goods
such as canals, bridges, national highways.
❑ Dr. Alfred Marshall further refined and played a significant
role in providing it a theoretical structure.
❑ Consumer’s surplus is the difference between what ‘one is
willing to pay’ and ‘what one actually pays’ to acquire a
particular good.
❑ The quintessence of the concept of consumer’s surplus is
that people generally get more utility from the consumption
of goods than the price they actually pay for them. This extra
satisfaction, which the consumers obtain, from buying a good
has been called consumer’s surplus.
❑ The concept of consumer’s surplus is derived from the law of
diminishing marginal utility
 7.1. Concept of Consumer Surplus
❑ OM units of the good the
consumer will be prepared to
pay the sum equal to Rs. ODSM.
❑ But given the price equal to OP,
the consumer will actually pay
the sum equal to Rs. OPSM for
OM units of the good.
❑ Consumer derives extra utility
equal to ODSM minus
OPSM=DPS.
❑ Given the marginal utility curve
of the consumer, the higher the
price, the smaller the
consumer’s surplus and the
lower the price, the greater the
consumer’s surplus.
 8. Limitations of the Law of Equi- Marginal Utility
❑ Hypothesis of Independent Utilities is wrong.
➢ Hypothesis implies that utility which consumer obtains from a
good does not depend upon the quantity consumed of other
goods.
➢ In real life, the utility or satisfaction derived from a good
depends upon the availability of some other goods which may be
either substitutes or complementary. Ex. Utility of pen and ink
(complementary) and tea and sugar (substitutes).
❑ Cardinal measurability of utility is unrealistic.
➢ In real life, consumers are only able to compare the satisfactions
derived from various goods or various combinations of the goods.
❑ Assumption of constant MU of Money is not valid
➢ In case the consumer has to has to spread his money income on a
number of goods, there is a necessity for revision of MU of
money with every change in price of a good.
➢ As a consumer spends his money income on the goods, money
income left with him declines, the MU of remaining money rises.
 8.1. Limitations of the Law of Equi- Marginal Utility

❑ Cardinal Utility Analysis: does into split the price effect into
the substitution effect and income effects.
➢ Income effect (I.E): When price of a good falls, the
consumer becomes better off than before, i.e., a fall in
price of a good brings about an increase in real income of
the consumer. With extra income , more of this good as
well other goods can be purchased.
➢ Substitution effect (S.E.): When price of a good falls, it
becomes relatively cheaper than other goods and as a
result, the consumer is induced to substitute that good
for others, resulting an increase in quantity demanded for
that good.
➢ Example: In case of Normal good: Fall in price –quantity
demanded increase due to both S.E and I.E.