MANAGERIAL ECONOMICS

UNIT I

Nature and scope of managerial economics – definition of economics –

important concept of economics – relationship between micro and macro
economics objectives of firm.

MEANING OF ECONOMICS

Economics is a social science that focuses on the production, distribution, and

consumption of goods and services. The study of economics is primarily
concerned with analyzing the choices that individuals, businesses,
governments, and nations make to allocate limited resources.

The word "economics" is derived from a Greek word "oikonomia" which

means "household management" or "management of house affairs" i.e., how
people earn income and resources and how they spend them on their
necessities, comforts and luxuries

Adam Smith is known as the father of economics for his pioneering ideas in
the field of free gross domestic product and free trade.

Economics

Economics is the study of scarcity and how it affects the use of resources, the
production of goods and services, the growth of production and well-being
over time, and many other important and complicated issues that affect
society.

Definition of economics given by Adam Smith

“Economics is the science of wealth ” This definition was given by Adam

Smith. He is also known as the 'father of economics. According to this
definition, economics is a science of the study of wealth only. It deals with
production, distribution, and consumption.
British economist Alfred Marshall defined economics as the study of man in
the ordinary business of life. Marshall argued that the subject was both the
study of wealth and the study of mankind.

Economics according to Karl Marx.

Marxian economics is a school of economic thought that's based on the work

of 19th-century economist and philosopher Karl Marx. Marx claimed that two
major flaws in capitalism lead to exploitation: the chaotic nature of the free
market and surplus labor.

Economics according to David Ricardo.

Ricardo suggests, in the comparative advantage theory, that nations fare

better when they focus on producing goods with the lowest production
opportunity costs.

What is Managerial Economics?

Managerial economics is a stream of management studies that emphasizes

primarily on solving business problems and decision-making by applying the
theories and principles of microeconomics and macroeconomics.

It is a specialized stream dealing with an organization’s internal issues using

various economic tools. Economics is an indispensable part of any business.
This single concept derives all the business assumptions, forecasting, and
investments.

Nature of Managerial Economics

You need to know about the various characteristics of managerial economics

to get more knowledge about it. Let’s read about the nature of managerial
economics.

Nature of Managerial Economics

1. Art and Science

Management theory requires a lot of critical and logical thinking and analytical
skills to make decisions or solve problems. Many economists also find it a
source of research, saying it includes applying different economic concepts,
techniques, and methods to solve business problems.

2. Microeconomics

Managers typically deal with the problems relevant to a single entity rather
than the economy as a whole. It is, therefore, considered an integral part of
microeconomics.

3. Uses of Macro Economics

A corporation works in an external world, i.e., serving the consumer, an

important part of the economy. For this purpose, managers must evaluate the
various macroeconomic factors, such as market dynamics, economic changes,
government policies, etc., and their effect on the company.

4. Multidisciplinary

Managerial economics uses many tools and principles that belong to different
disciplines, such as accounting, finance, statistics, mathematics, production,
operational research, human resources, marketing, etc.

5. Prescriptive or Normative Discipline

By introducing corrective steps managerial economics aims at achieving the

objective and solves specific issues or problems.

6. Management Oriented

This serves as an instrument for managers to deal effectively with business-

related problems and uncertainties. This also allows for setting priorities,
formulating policies, and making successful decisions.

7. Pragmatic

The solution to day-to-day business challenges is realistic and rational.

Different individuals take different views of the principles of managerial
economics. Others may concentrate more on customer service and prioritize
efficient production.
Scope of Managerial Economics

The definition of managerial economics is commonly used to deal with various

business problems within organizations. Both microeconomics and
macroeconomics have an equal effect on the organization and its work. The
following points illustrate its significance:

Micro-economics Applied to Operational Matters

The various theories or principles of microeconomics used to solve the internal

problems of the organization arising in the course of business operations are as
follows:

Demand Theory: Demand Theory emphasizes the consumer’s behavior toward

a product or service. This considers the customers’ desires, expectations,
preferences, and conditions to enhance the manufacturing process.

Decisions on Production and Production Theory: This theory is primarily

concerned with the volume of production, process, capital and labour, costs
involved, etc. It aims to optimize the production analysis to meet customer
demand.

Market Structure Pricing Theory and Analysis: It focuses on assessing a

product’s price considering the competition, market dynamics, production
costs, optimizing sales volume, etc.

Exam and management of profit: the companies are operating for assets;
hence, they aim to maximize profit. It also depends on demand from the
market, input costs, level of competition, etc.

Decisions on capital and investment theory: Capital is the most important

business element. This philosophy takes priority over the proper distribution of
the resources of the company and investments in productive programs or
initiatives to boost operational performance.

Macro-Economics Applied to Business Environment

Any organization is greatly affected by the environment in which it operates.

The business climate can be defined as:
Economic environment: A country’s economic conditions, GDP, government
policies, etc., have an indirect effect on the company and its operations.

Social environment: The society in which the organization works, like

employment conditions, trade unions, consumer cooperatives, etc also affect
it.

Political environment: A country’s political system, whether authoritarian or

democratic, political stability, and attitude towards the private sector, impact
the growth and development of the organization.

Importance of Managerial Economics

1. Business Planning and Forecasting: Managerial economics plays an
efficient role in formulating business policies by forecasting future
demands and uncertainties. It assists in the effective decision making of
an organization by supplying all information using economic tools and
techniques.
2. Analyze Cost and Production level: Managerial economics focuses on
minimizing the cost of business. It determines the cost associated with
different business processes and finds out the cost-minimizing level of
 output. Managerial economics enables business managers in ensuring
that there is no resource wastage which reduces the overall cost.
3. Formulate pricing policies: It helps in determining the right pricing
policies for organizations. Pricing method affects the profitability and
revenue of the business organization and therefore fixing the right price
is essential. Managerial economics analyses the market pricing structure
and strategies for deciding the firm prices.
4. Manages profit: Managerial economics monitor and control the
profitability of the business organization. Profit is the ultimate goal of
every business and determines its success or growth. It ensures that the
desired profit is earned by making an estimate of the revenue and
expenses of an organization at different levels of outputs.
5. Capital Management: Capital management is one of the important
functions played by managerial economics. It manages and analyses all
capital expenditures of business which involves huge expenditures.
Before investing any amount anywhere it measures the profitability of
such a source for allocating funds.

MEANING OF MICRO ECONOMICS

Microeconomics is the study of individuals, households and firms'
behavior in decision making and allocation of resources. It generally
applies to markets of goods and services and deals with individual and
economic issues.

Why is microeconomics important?

Microeconomics shows how and why different goods have different
values, how individuals and businesses conduct and benefit from
efficient production and exchange, and how individuals best coordinate
and cooperate with one another.

Microeconomics studies the economic actions and behaviour of

individual units and small groups of individual units. It is the study of
small components of the economy. It establishes the relationship
between facts and results, which are called economic laws.
Microeconomics is also called “The Price Theory”, because it deals with
the price of goods and services, rewards of the factors of production and
interaction of the markets.
Microeconomics is the study of households, firms and industry. It
explains the working of market for individual commodities and
behaviour of individual buyer and seller in such market. There are two
types of markets that are product market and factor market These
markets are dependent on each other. The factors of production are
earning in factor market but they are spending in product market. The
change in one market is reflected in other market. There are differences
in the working of these markets.

In product market. demand comes from households and supply comes

from firms. A group of similar firms is called an industry. In product
pricing the forces behind demand are examined. A household can get
maximum satisfaction through allocation of its expenses. A firm can get
maximum profit when marginal revenue is more than marginal cost. An
industry is in equilibrium when new firm does not enter the market or
old firm does not leave the market. It is a matter of resource allocation.

The factor market is examined because of supply of factors and derived

demand from product market. In fact, microeconomics deals with
individual consumer and a firm or industry. Therefore, it is concerned
with behaviour of individual consumers and producers and principles
relating to organisation and operations of firms and industries.

Microeconomics is based on full employment in the economy so it

examines the equilibrium position of consumer and producer. It is called
price theory because it deals mainly with prices of products and prices of
productions factors.

Definition:
According to K. E. Boulding

Microeconomics is the study of particular firm, particular household,

individual price, wage, income, industry and particular commodity.

According to R. H. Leftwitch

Microeconomics is concerned with the economic activities of such

economic units as consumers, resource Owners and business firms.
According to Gardner Ackley

“Microeconomics deals with the division of total output among

industrialists, producers and firms and the allocation of resources among
competing groups. It considers problems of income distribution. Its
interest is in relative prices of particular goods and services.”

According to Prof. Samuelson

“Micro economics studies the behaviour of individual parts and units of

any economy, e. g., determination of the price of a product or study and
observation of the behaviour of a consumer or a firm”.

Scope of Microeconomics:
In micro economics the following problems and theories are discussed:

1. Price Theory
According to Prof. Robbins, human wants are unlimited but the
resources to satisfy them are limited. Therefore, we face the problem of
choice in wants and economy in means. This problem is solved by the
price mechanism automatically. In other words, prices of all goods are
determined by the equilibrium of demand and supply. So, demand and
supply are discussed in micro economics.

Each economic system has to make the decisions regarding what is to

produced, how it is to be produced and how the resources to be
allocated amongst the different competing uses. Such all, under
capitalism, is performed with the help “Price Mechanism” i.e., those
goods will be produced by the producers which maximize their profits;
those techniques will be adopted which minimize their cost of
production and the resources will be allocated in those uses where the
resource command higher prices etc. Thus, in the micro economics, we
deal with the problem of production, consumption, distribution and
resource allocation.

2. Theory of Consumer Behaviour and Demand

In this part, consumer’s behaviour is studied. It is examined how he
satisfies his multiple ends with his scarce means e.g., why consumers
purchase goods and which factors influence their decisions. In other
words, theory of utility, concepts of demand and elasticity of demand
are studied in it.

As everyone has to face the problem of multiplicity of wants and limited

money income. In such state of affairs, it is the desire of each consumer
to maximize his satisfaction, when so happens the consumer is said to be
in equilibrium. Much the micro economics deals with the problem of
equilibrium.

In order to describe consumer equilibrium basically we have two school

of thoughts-Classical and Neo-classical. The classical economists
presented the “Utility Approach” or “Cardinal Approach”, while the Neo-
classical economists presented”. Indifference Curve Approach” or
“Ordinal Approach”. In addition to these two approaches Professor Paul.
A. Samuelson has also presented a theory of consumer behaviour which
is known as “Revealed Preference Theory”.

After having discussed the theories of “Satisfaction Maximization” the

demand behaviour of a consumer with respect to a particular
commodity is also considered in micro economic theory.

3. Theory of Production Behaviour

In capitalism factories are in private ownership. Therefore, quantity of
production of goods is decided by different firms individually. Every firm
tries to get equilibrium or maximize its profit. For this purpose, a firm
tries to find optimum combination of factors. Each student of Economics
is well aware of with the four factors of production like land, labor,
capital and entrepreneur.

These factors are responsible for production activities. According to

classical economists, in short run, the production depends upon the
units of labor only while the capital etc. is kept fixed, In such state of
affairs the total production increases at different rates. This
phenomenon is known as “Law of Variable Proportions” in micro
economic theory.

4. Theory of firm Behaviour:

Like a consumer, the firm also wants to attain equilibrium. While the
equilibrium of the firm is attached with “Minimization of Costs” or
“Maximization of Output”. Both these situations are also known as
“Optimum Factor Combination of a firm”, Thus to describe firm’s
equilibrium or “optimum factor combination”, we have two approaches
in micro economics (1) Classical’s Marginal Productivity theory (2 Neo-
Classical’s “Isoquant – Iso Cot Approach”.

5. Theory of Costs and Revenues:

In micro economics we study different types of costs of production. The
analysis of costs of production may be from short run point of view as
well as from long run point of view. In this context the traditional and
modem approaches are adopted. Moreover, different types of revenues
arc also considered in microeconomics.

6. Theory of Market Structure and Behaviour:

The types of market like Perfect Competition, Monopoly, Duopoly and
Monopolistic Competition are of greater significance for the readers of
micro economics. Accordingly, here it is analyzed that how the firms
under different market conditions make decisions regarding the
determination of price and output.

7. Theory of Income Distribution:

The national income of a country is the result of joint efforts of land,
labor, capital and organization. Accordingly, the national income, has to
be distributed amongst these factors. OR it is to be seen that how the
factor prices like wages will determined in the competitive and nor
competitive markets. Thus, for this purpose we have the classical and
neo classical theories in microeconomics.

8. Theory of General Equilibrium:

The Consumer equilibrium and the Producer equilibrium are the
representatives of partial equilibria. But the existence of equilibrium of
all the consumers of the economy or all the producers of the economy
generates General equilibrium of consumption or production. Such all
along with different criteria of welfare economics are the important
issues of microeconomics.

9. Theory of Welfare Economics:

In the present time, social as well as economic welfare has attained
greater importance. Accordingly, the economists have to devise those
measures and criteria which are aimed at creating efficiency and
optimality in the economic system. Therefore, in microeconomics, we
study different techniques which bring welfare to the people.

10. Economics of Uncertainty:

Most of the traditional or classical economics is based upon certainty,
i.e., the economic agents do not have to face risk while making
decisions. But in the present time the element of risk has attained a lot
of importance. Accordingly, economic theories are also being devised on
the basis of uncertainty. Therefore, in microeconomics, we also study
the economics of uncertainty.

Uses / Importance / Advantages of Microeconomics:

We can realize the importance of the study of micro economics from the
following points.

1. Utility Maximization:
It teaches us to purchase the required products in most suitable
quantities so that the total utility obtained is maximized. Hence, Micro
economic analysis explains us the optimum use of our income and by
virtue of it enables us to avoid the wastage of hard-earned income.

2. Resource Allocation:
By the study of micro economics we come to know how millions of
consumers and producers allocate their consumption and production
resources in an attempt to achieve their optimum level.

3. Income Distribution:
By the distribution theories we learn the determination of rewards to
factors of production in the form of rent, interest, wages and profit by
which distribution of wealth takes place. Unequal distribution of income
will lead to unequal distribution of wealth. It will then consequently
provoke reaction to achieve fair and relatively equal distribution of
income/wealth in a society.

4. Price Determination:
The study of micro economics is highly helpful in understanding the
determination of relative prices for the productive services rendered by
different factors of production.
5. Optimization:
It also helps entrepreneurs to achieve optimum production point with
their budget constraint. By this, they can maximize their profit or at least
they will minimize their losses.

6. Welfare Policies:
It also helps to frame economic policies aimed at achieving public
welfare e.g. tax exemption for the poor, determination of rewards
according to qualification and productive capabilities, minimum wage
laws etc.

7. Guidance for Consumers:

It enables the consumers to allocate their 1ncome on different goods in
such a way that total utility is maximized; thus, helping them to avoid
the wastage of resources.

8. Guidance for Producers:

It enables entrepreneurs to achieve the optimum combination of factors
of production and thereby it enables them to maximize their profit: or at
least minimize their losses. When the rewards of factors of production
are determined in accordance with their marginal productivity, the
chances of their exploitation are minimized. Thus, it enables labourers as
well to achieve suitable rewards for their productive services.

9. Coordination Between Small Units of Economy:

It also provides guidance for small segments of an economy to bear
them well coordinated with each other. Moreover, the study of micro
economics is essential to achieve the best outcome of macro policies.

10. Working of Economy:

Microeconomics provides idea about working of the economy. It tells us
about behaviour of consumer or firm. All such consumers and firms are
part of the whole economy.

11. Predictions:
Microeconomics is based on certain predictions. There are certain
conditions that become basis of predictions. It explains that if some
event happens then what. will be the result. If demand goes up the
prices will go up.
12. Economic Policies:
Microeconomics is used to formulate policies. it tells us effect of
government policies on allocation of resources. The people can oppose
new taxes. The government can adjust its policies through reaction of
individuals.

13. Basis of Welfare Economics:

Microeconomics is the basis of welfare economics. The individual firms
and organisations pay taxes to the government. They can check whether
the government has used that money for welfare of the people.

14. Management Decisions:

Business decisions re made with the help of microeconomics. The
analysis of demand and cost is essential. The management can use facts
and figures to arrive at most suitable decision.

15. Basis of Whole Economy:

Microeconomics is the basis of whole economy. Microeconomics studies
small and individual units of the economy which later on becomes a
base to study the economy as a whole.

16. Solves Problems of Firms:

Microeconomics is helpful in solving the problems of individual firms.
The working of firm is examined to know the real problem. The solution
is made to handle such problem.

Disadvantages / Limitations of Microeconomics:

1. Free Market Economy:

Microeconomics is based on the idea of free market economy. In fact,
there Is no free market economy after great depression of 1930.

2. Study of Parts:
Microeconomics is concerned with study of parts but not the whole. In
terms of individual terms, it is impossible to describe large and complex
universe of facts like economic system.
3. Misleading for Analysis:
Microeconomics is inadequate and misleading for analysis of economic
problems. The principles relating to an individual household cannot be
applied to the whole. economic system.

4. Full Employment:
Microeconomics assumes that there is full employment. There is no full
employment at all times in this world. Full employment is an exception
in practical life.

5. Economic Instability:
When every single firm it allowed to operate freely in an open economy,
it would naturally go for self-interest; even at the cost of national
interest. Thus, it would disrupt the cohesion between different
productive units which will ultimately force the economy to move into
depression. A free enterprise economy is therefore an unstable
economy i.e. the economy which keep: on fluctuating with boom: and
depressions.

6. Exploitation of Consumers:
Inspite of proper guidance for the consumers the real-life situation
reveals that they are exploited. This happens with the rising rate of
inflation iii an economy. With the pace of inflation, on one hand, wealth
keeps on concentrating in a few hands while, on the other hand,
consumers are deprived of their purchasing power. The natural
inequality of income distribution in a free enterprise economy leads to
exploitation of consumers.

7. Exploitation of Labourers:
Entrepreneurs exploit their labourers by keeping their wage rate low or
even lower than their marginal productivity. This happens in three ways:
(i) By forcing labourers to work for more hours than required under
labour laws.

(ii) By installing automatic and computerized plants to increase the

marginal productivity of labour which is not followed by increase in their
wage rate.

(iii) By setting up production units in remote areas to employ labour at

notoriously low wage rate.
8. Absence of Large-Scale Production:
Micro economic analysis encourages setting up of small units for growth
of economy. This could possibly be achieved more efficiently by initiating
and encouraging large scale production.

Macroeconomics / Macro Economic Analysis:

The word “MACRO“. is derived from the Greek word “MAKROS“, which
means large. Macroeconomics studies the economic actions and
behaviours of an economy at aggregate or average levels and explains
the problems at national and international levels. Macroeconomics is
also called “The Theory of Income and Employment “, because it deals
with the matters of unemployment, economic fluctuations, inflation,
deflation, economic development, and international trade etc.

The concept of macroeconomics was introduced during 1930 when

economies were facing economic crisis. Macroeconomics studies the
economy as a whole. It is concerned with total income, total output,
employment, total consumption, total saving, total investment and
general price level. It, is aggregative economics that provides whole view
of the economy.

Macroeconomics is called income and employment theory. It deals with

the problems of unemployment, trade cycles, general price level and
international trade and economic growth. It studies the causes of
unemployment and different determinants of employment. It is
concerned with trade cycles so it examines the effect of investment on
total output, total income and total employment.

It deals with monetary matters in order to check effect of total quantity

of money on general price level in the field of internl.

MEANING OF MACRO ECONOMICS

Macroeconomics / Macro Economic Analysis:
The word “MACRO“. is derived from the Greek word “MAKROS“, which
means large. Macroeconomics studies the economic actions and
behaviours of an economy at aggregate or average levels and explains
the problems at national and international levels. Macroeconomics is
also called “The Theory of Income and Employment “, because it deals
 with the matters of unemployment, economic fluctuations, inflation,
deflation, economic development, and international trade etc.

The concept of macroeconomics was introduced during 1930 when

economies were facing economic crisis. Macroeconomics studies the
economy as a whole. It is concerned with total income, total output,
employment, total consumption, total saving, total investment and
general price level. It, is aggregative economics that provides whole view
of the economy.

Macroeconomics is called income and employment theory. It deals with

the problems of unemployment, trade cycles, general price level and
international trade and economic growth. It studies the causes of
unemployment and different determinants of employment. It is
concerned with trade cycles so it examines the effect of investment on
total output, total income and total employment.

It deals with monetary matters in order to check effect of total quantity

of money on general price level in the field of international.

IMPORTANCE OF MACRO ECONOMICS

Importance of Macro Economics:

We can realize the importance of the study of macroeconomics from the

following points.

1. Working of Economy:

Macroeconomics is helpful to understand working of economy. Economic

system is complicated. Many interdependent-economic factors affect the
economy. Microeconomics cannot provide clear picture of whole economy.

2. Making Economic Policies:

Macroeconomics is used to make economic policies. There is need facts and

figures about national income, total employment, total investment, total
saving and general price level. Macroeconomics can provide statistics about
such variables.

3. Solves Economic Problems:

An economy can face problems like overproduction, unemployment, and rising

price level. The government can solve its problems with the help of
macroeconomics.

4. Studies Trade Cycles:

The capitalistic economies can face problem of trade cycles or ups and downs,
in business activities. Such problems upset the proper working of economy.
Macroeconomics provides solution to overcome difficulties of trade cycles.

5. Widens Scope of Microeconomics:

The laws of microeconomics are framed with the help of macroeconomics. The
law of diminishing marginal utility is derived from analysis of aggregate
behaviour of people.

6. Changes in Price Level:

Macroeconomics deals with the problems of changes in price level. There may
be inflation, deflation, or stagflation. The changes in price level create
disturbance for proper working of economy.

7. Study of National Income:

The study of national income explains various problems of economy. National

income of any Country can show its economic conditions. The population
control program or defense program depend upon national income.
Macroeconomics is used to calculate national income.

8. Behaviour of Individual Firms:

Microeconomics studies behaviour of individual firms. Demand for a product

depends upon total of such product in the economy. The causes for decrease
in total demand are analyzed to note decrease in demand of a product.
RELATIONSHIP BETWEEN MICRO AND MACRO ECONOMICS

BASIS FOR
MICROECONOMICS MACROECONOMICS
COMPARISON
Meaning The branch of economics The branch of economics that
that studies the behavior of studies the behavior of the
an individual consumer, firm, whole economy, (both national
family is known as and international) is known as
Microeconomics. Macroeconomics.
Deals with Individual economic Aggregate economic variables
variables
Business Applied to operational or Environment and external
Application internal issues issues
Tools Demand and Supply Aggregate Demand and
Aggregate Supply
Assumption It assumes that all macro- It assumes that all micro-
economic variables are economic variables are
constant. constant.
Concerned with Theory of Product Pricing, Theory of National Income,
Theory of Factor Pricing, Aggregate Consumption,
Theory of Economic Welfare. Theory of General Price Level,
Economic Growth.
Scope Covers various issues like Covers various issues like,
demand, supply, product national income, general price
pricing, factor pricing, level, distribution, employment,
production, consumption, money etc.
economic welfare, etc.
Importance Helpful in determining the Maintains stability in the
prices of a product along with general price level and
the prices of factors of resolves the major problems of
production (land, labor, the economy like inflation,
capital, entrepreneur etc.) deflation, reflation,
within the economy. unemployment and poverty as
a whole.
Limitations It is based on unrealistic It has been analyzed that
assumptions, i.e. In 'Fallacy of Composition'
microeconomics it is involves, which sometimes
assumed that there is a full doesn't proves true because it
employment in the society is possible.
which is not at all possible.
 UNIT II

DEMAND ANALYSIS- Meaning of Demand – Law of Demand –Types of Demand

–Determination of Demand –Elasticity of Demand – Demand forecasting,
Theories of consumer behaviour – Managerial utility analysis-indifference
curve analysis.

Meaning of Demand

Demand is an economic concept that relates to a consumer's desire to

purchase goods and services and willingness to pay a specific price for them.
An increase in the price of a good or service tends to decrease the quantity
demanded.

What is demand, according to economics?

Demand can be defined as the ability and willingness of an individual to buy a

good or service of their choice at any one given price.

What is an example of a demand?

Amanda loves coffee and is willing to go to the same coffee shop every
morning to make her purchase. The ability and willingness to buy coffee from a
beverage shop at a given price is demand.

Demand theory is an economic principle relating to the relationship between

the demand for consumer goods and services and their prices in the market.

LAW OF DEMAND

the law of demand is that it is a basic law of economics that states that all
other things being equal, people will purchase more of a good when the price
is lower and less of a good when the price is higher.
What is the law of demand?
Law of demand states that there is an inverse relation between the price of a
commodity and its quantity demanded, assuming all other factors affecting
demand remain constant. It means that when the price of a good falls, the
demand for the good rises and when price rises, the demand falls.

7 types of demand

As a business, you need to understand the different types of demand to be

able to best anticipate how much product you need. Demand characteristics
provide a picture of how well the industry is thriving and offers ideas as to
where new service can be introduced. The following list details seven types
of demand in economics:

1. Joint demand

Joint demand is the demand for complementary products and services. These
can be products that are accessories for others or that people commonly
purchase together. For example, cereal and milk or peanut butter and jelly.
The two are linked, but the demand for one is not necessarily dependent on
the demand for the other.

2. Composite demand

Composite demand happens when there are multiple uses for a single
product. For example, corn can be used as animal feed, ethanol and food in
its whole form. The rise in demand for any of these products leads to a
shortage in supply for the others. This shortage can lead to a rise in price.

Related: Learn About Being a Business Analyst

3. Short-run and long-run demand

Short-run demand refers to how people will immediately react to price

changes while elements are fixed. For example, if the demand for a product
drastically decreases and a manufacturer has high overhead costs, they have
no choice but to absorb the profits lost. Over time, or in the long run,
companies have a chance to adjust to the new situation by decreasing labor
or increasing prices and supplies.
4. Price demand

Price demand relates to the amount a consumer is willing to spend on a

product at a given price. Businesses use this information to determine at
what price point a new product should enter the market. Consumers will buy
items based on their perception of that product's value. Price elasticity refers
to how the demand will change with fluctuations in price.

5. Income demand

As consumers make more income, quantity demand increases. This means

people will buy more overall when they earn more income. Tastes and
expectations also change with an increase in income, reducing the size of one
market and increasing the size of another. Consumers will often buy a
product or service because it is what they can afford but may deem it lower
quality. The demand for those lower-quality products will decrease as
income increases.

6. Competitive demand

Competitive demand occurs when there are alternative services or products a

customer can choose from. From a business's perspective, they can use
fluctuations in the price of their competitors to determine how their own will
sell. An example of this is between name-brand and store-brand medicine. If
a consumer prefers a name brand but it is out of stock or the price increases
significantly, the store brand will see a rise in sales.

7. Direct and derived demand

Direct demand is the demand for a final good. Food, clothing and cell phones
are an example of this. Also called autonomous demand, it's independent of
the demand for other products.

Derived demand is the demand for a product that comes from the usage of
others. For example, the demand for pencils will result in the demand for
wood, graphite, paint and eraser materials. In this example, the demand for
wood is dependent on the demand for its uses.

Derived demand is similar to joint demand because of its connection to other

products. It is different from joint demand because it is dependent on the
final product to generate a need. Without the need for those end products,
there is no demand for the intermediate product.

DETERMINATIONS OF DEMAND

Demand is the quantity of a good or service that consumers are willing to

purchase at a certain price point.

Determinants are factors that affect the outcome of something.

Determinants of demand are factors that either positively or negatively affect

the demand for a good or service in the market.

The five main determinants of demand are income, price, tastes and
preferences, prices of related goods and services, and expectations. Each of
these determinants can cause the demand curve for a good or service to shift
to the left or right, which would indicate an increase or decrease in demand.

Price
One of the most obvious determinants of demand is price. All else being equal,
as the price of a good or service increases, consumers typically demand less of
it. This relationship is represented by the downward-sloping demand curve on
a demand curve graph. A demand curve graph is a visual representation of
how price changes affect the quantity of a good or service demanded by
consumers. The direction of the curve or slope (positive or negative) of the
graph indicates the relationship between price and quantity demanded. When
the price of a good becomes higher, the quantity demanded by consumers
typically falls.

Consumer Taste

Let's say we are viewing the market for computers. Recently, consumers'
preferences have shifted to Windows computers over Apple computers. In this
instance, demand would increase for Windows computers and decrease for
Apple computers. But if consumers' preferences shifted to Apple computers,
then demand would increase for Apple computers and decrease for Windows
computers.
Number of Buyers

Let's say that the number of car buyers increases in the United States due to
immigration. Specifically, used cars seem to be affected the most by the
increased number of buyers. Given that there are more buyers in the market,
this will increase the overall demand for used cars. If the number of car buyers
decreases in the United States, the demand for used cars would decrease since
there are fewer buyers in the market.

Consumer Income

Let's imagine that consumer income in the United States increases

ubiquitously. Every individual in the country suddenly makes $1000 more than
they did before — incredible! Let's say that since people have a higher income
than before, they can afford to purchase healthier food options that cost more
than unhealthier food options. This increase in consumer income will result in
an increase in demand for healthier food options (fruits and vegetables). On
the other hand, if consumer income decreases in the United States, this will
result in a decrease in demand for healthier food.

Price of Related Goods

Whether a good is a substitute good or complementary good for the related

good determines whether the demand increases or decreases for the related
good. If good A and good B are substitute goods, an increase in the price for
good A will result in an increase in demand for good B. Conversely, a decrease
in the price for good A will result in a decrease in demand for good B.

ELASTICITY OF DEMAND

What Is Price Elasticity of Demand?

Price elasticity of demand is a measurement of the change in the demand for

a product in relation to a change in its price. Elastic demand is when the
change in demand is large when there is a change in price. Inelastic demand
is when the change in demand is small when there is a change in price.

Factors That Affect Price Elasticity of Demand

Availability of Substitutes
The more easily a shopper can substitute one product for another, the more
the price will fall. For example, in a world in which people like coffee and tea
equally, if the price of coffee goes up, people will have no problem switching
to tea, and the demand for coffee will fall. This is because coffee and tea are
considered good substitutes for each other.

Urgency

The more discretionary a purchase is, the more its quantity of demand will
fall in response to price increases. That is, the product demand has greater
elasticity.

Say you are considering buying a new washing machine, but the current one
still works; it’s just old and outdated. If the price of a new washing machine
goes up, you’re likely to forgo that immediate purchase and wait until prices
go down or the current machine breaks down.

The less discretionary a product is, the less its quantity demanded will fall.
Inelastic examples include luxury items that people buy for their brand
names. Addictive products are quite inelastic, as are required add-on
products, such as inkjet printer cartridges.

Duration of Price Change

The length of time that the price change lasts also matters. Demand response
to price fluctuations is different for a one-day sale than for a price change
that lasts for a season or a year.

Clarity of time sensitivity is vital to understanding the price elasticity of

demand and for comparing it with different products. Consumers may accept
a seasonal price fluctuation rather than change their habits.

What Makes a Product Elastic?

If a price change for a product causes a substantial change in either its supply
or its demand, it is considered elastic. Generally, it means that there are
acceptable substitutes for the product. Examples would be cookies, luxury
automobiles, and coffee.

What Makes a Product Inelastic?

If a price change for a product doesn’t lead to much, if any, change in its
supply or demand, it is considered inelastic. Generally, it means that the
product is considered to be a necessity or a luxury item for addictive
constituents. Examples would be gasoline, milk, and iPhones.

What Is the Importance of Price Elasticity of Demand?

Knowing the price elasticity of demand for goods allows someone selling that
good to make informed decisions about pricing strategies. This metric
provides sellers with information about consumer pricing sensitivity. It is also
key for makers of goods to determine manufacturing plans, as well as for
governments to assess how to impose taxes on goods.

DEMAND FORECASTING

Demand forecasting is the prediction of the quantity of goods and services

that will be demanded by consumers at a future point in time. More
specifically, the methods of demand forecasting entail using predictive
analytics to estimate customer demand in consideration of key economic
conditions.

6 types of demand forecasting

There are several methods of demand forecasting. Your forecast may differ
based on the demand forecasting models you use. Best practice is to do
multiple demand forecasts. This will give you a more well-rounded picture of
your future sales. Using more than one forecasting model can also highlight
differences in predictions. Those differences can point to a need for more
research or better data inputs.

1. Passive demand forecasting

Passive demand forecasting is the simplest type. In this model, you use sales
data from the past to predict the future. You should use data from the same
season to project sales in the future, so you compare apples to apples. This is
particularly true if your business has seasonal fluctuations.

The passive forecasting model works well if you have solid sales data to build
on. In addition, this is a good model for businesses that aim for stability rather
than growth. It’s an approach that assumes that this year’s sales will be
approximately the same as last year’s sales.
Passive demand forecasting is easier than other types because it doesn’t
require you to use statistical methods or study economic trends.

2. Active demand forecasting

If your business is in a growth phase or if you’re just starting out, active

demand forecasting is a good choice to help you make informed decisions. An
active forecasting model takes into consideration your market research,
marketing campaigns, and expansion plans.

Active projections will often consider external factors. Considerations can

include the economic outlook, growth projections for your market sector, and
projected cost savings from supply chain efficiencies. Startups that have less
historical data to draw on will need to base their assumptions on external data.

3. Short-term projections

Short-term demand forecasting looks just at the next three to 12 months. This
is useful for managing your just-in-time supply chain. Looking at short-term
demand allows you to adjust your projections based on real-time sales data. It
helps you respond quickly to changes in customer demand.

If you run a product lineup that changes frequently, understanding short-term

demand is important. For most businesses, however, a short-term forecast is
just one piece of a larger puzzle. You’ll probably want to look further out with
medium- or long-term demand forecasting.

4. Long-term projections

Your long-term forecast will make projections one to four years into the future.
This forecasting model focuses on shaping your business growth trajectory.
While your long-term planning will be based partly on sales data and market
research, it is also aspirational.

Think of a long-term demand forecast as a roadmap. Using this forecasting

technique, you can plan out your marketing, capital investments, and supply
chain operations. That will help you to prepare for future demand. Being ready
for your business growth is crucial to making that growth happen.

5. External macro forecasting

External macro forecasting incorporates trends in the broader economy. This
projection looks at how those trends will affect your goals on a macro-level. An
external macro demand forecast can also give you direction for how to meet
those goals.

Your company may be more invested in stability than expansion. However, a

consideration of external market forces is still essential to your sales
projections. External macro forecasts can also touch on the availability of raw
materials and other factors that will directly affect your supply chain.

6. Internal business forecasting

One of the limiting factors for your business growth is internal capacity. If you
project that customer demand will double, does your enterprise have the
capacity to meet that demand? Internal business demand forecasts review
your operations.

The internal business forecasting type will uncover limitations that might slow
your growth. It can also highlight untapped areas of opportunity within the
organization. This forecasting model factors in your business financing, cash on
hand, profit margins, supply chain operations, and personnel.

Internal business demand forecasting is a helpful tool for making realistic

projections. It can also point you toward areas where you need to build
capacity in order to meet expansion goals.

5 demand forecasting methods

There are many different ways to create forecasts. Here are five of the top
demand forecasting methods.

1. Trend projection

Trend projection uses your past sales data to project your future sales. It is the
simplest and most straightforward demand forecasting method.

It’s important to adjust future projections to account for historical anomalies.

For example, perhaps you had a sudden spike in demand last year. However, it
happened after your product was featured on a popular television show, so it
is unlikely to repeat. Or your eCommerce site got hacked, causing your sales to
plunge. Be sure to note unusual factors in your historical data when you use
the trend projection method.
2. Market research

Market research demand forecasting is based on data from customer surveys.

It requires time and effort to send out surveys and tabulate data, but it’s worth
it. This method can provide valuable insights you can’t get from internal sales
data.

You can do this research on an ongoing basis or during an intensive research

period. Market research can give you a better picture of your typical customer.
Your surveys can collect demographic data that will help you target future
marketing efforts. Market research is particularly helpful for young companies
that are just getting to know their customers.

3. Sales force composite

The sales force composite demand forecasting method puts your sales team in
the driver’s seat. It uses feedback from the sales group to forecast customer
demand.

Your salespeople have the closest contact with your customers. They hear
feedback and take requests. As a result, they are a great source of data on
customer desires, product trends, and what your competitors are doing.

This method gathers the sales division with your managers and executives. The
group meets to develop the forecast as a team.

4. Delphi method

The Delphi method, or Delphi technique, is one of the qualitative methods of

demand forecasting that leverages expert opinions on your market forecast.
This method requires engaging outside experts and a skilled facilitator.

You start by sending a questionnaire to a group of demand forecasting experts.

You create a summary of the responses from the first round and share it with
your panel. This process is repeated through successive rounds. The answers
from each round, shared anonymously, influence the next set of responses.
The Delphi method is complete when the group comes to a consensus.

This demand forecasting method allows you to draw on the knowledge of

people with different areas of expertise. The fact that the responses are
anonymized allows each person to provide frank answers. Because there is no
in-person discussion, you can include experts from anywhere in the world on
your panel. The process is designed to allow the group to build on each other’s
knowledge and opinions. The end result is an informed consensus.

5. Econometric

The econometric method requires some number crunching. This quantitative

type of forecasting combines sales data with information on outside forces
that affect demand. Then you create a mathematical formula to predict future
customer demand.
The econometric demand forecasting method accounts for relationships
between economic factors. For example, an increase in personal debt levels
might coincide with an increased demand for home repair services.

THEORIES OF CONSUMER BEHAVIOUR

The theory of consumer behavior is a discipline in the social sciences that

focuses on understanding why consumers buy or do not buy products or
services.

Theory provides concepts to name what we observe and to explain

relationships between concepts. Theory allows us to explain what we see and
to figure out how to bring about change. Theory is a tool that enables us to
identify a problem and to plan a means for altering the situation.

The consumer behavior theory by Schiffman and Kanuk describes the actions
that consumers take to find, acquire, use, assess, and discard goods, services,
and concepts

Understanding Consumer Theory

Individuals have the freedom to choose between different bundles of goods

and services. Consumer theory seeks to predict their purchasing patterns by
making the following three basic assumptions about human behavior:

Utility maximization—Individuals are said to make calculated decisions when

shopping, purchasing products that bring them the greatest benefit, otherwise
known in economic terms as a maximum utility.

Non-satiation—People are seldom satisfied with one trip to the shops and
always want to consume more.
Decreasing marginal utility—Consumers lose satisfaction with a product the
more they consume it.

MANAGERIAL UTILITY ANALYSIS

Utility analysis compares costs and outcomes which are measured in different
units. This differs from cost-benefit analysis, which uses a common unit (ie.
financial value) to compare costs and benefits. Utility analysis is often referred
to in the health sector as a cost-effectiveness or cost-utility analysis.

The managerial utility function includes such variables as salary, security,

power, status, prestige, professional excellence. Of these variables only the
first (salary) is measurable.

What is utility?

A customer is the one who usually determines his demand for goods on the
basis of the satisfaction (utility) that he procures from them. So, what is a
utility?

Utility of goods is their want-satisfying capability. More is the aspiration to

have the goods, the more is the utility procured from them. Utility is
instinctive. Distinct people can get different degrees of utility from the same
goods. For instance, someone who likes sweets will get much higher utility
from a sweet than someone who doesn’t like sweets.

Measures of utility

Total utility: Total utility of a determined quantity of goods or commodities

(TU) is the total contentment procured from utilising the given amount of
some goods ‘p’.

Marginal utility: MU is the difference in total utility due to the utilisation of one
extra unit of goods or commodities.

Ordinal utility analysis: The customer does not quantify utility in numerals. The
theory of customer decision-making under constraints of certitude can be, and
mostly is, conveyed in terms of ordinal utility.
INDIFFERENCE CURVE ANALYSIS

An indifference curve is a graphical representation of a combined products that

gives similar kind of satisfaction to a consumer thereby making them
indifferent.Every point on the indifference curve shows that an individual or a
consumer is indifferent between the two products as it gives him the same
kind of utility.

What are the different types of indifference curves analysis?

Perfect substitutes refer to products that are identical, and a consumer is,
therefore, indifferent between them. Perfect substitutes have linear
indifference curves. Perfect complements refer to goods that can't be
consumed without each other. Perfect complements' indifference curves are
right-angled

Indifference Curve Analysis

Indifference curves are based on a number of assumptions, such as that each

indifference curve is convex to the origin and that no two indifference curves
ever overlap. When obtaining bundles of commodities on indifference curves
that are farther from the origin, consumers are supposed to be more satisfied.

The majority of the time, indifference curve analysis assumes that all other
variables are stable or constant.

The slope of the indifference curve is referred to by the MRS. The MRS
measures how eager a consumer is to trade one product for another. If a
customer values a banana, for example, the rate of substitution for
watermelon will be slower, and the slope will reflect this rate of substitution.

Criticisms and Complications of the Indifference Curve

Many components of current economics, like indifference curves, have been

criticised for oversimplifying or making unreasonable assumptions about
human behaviour. Consumer tastes, for example, might change dramatically
over time, rendering accurate indifference curves useless.

Others argue that concave indifference curves, as well as circular curves that
are convex or concave to the origin at specific points, are theoretically
possible. Consumer preferences can change substantially over time, making
accurate indifference curves obsolete.