Managerial Economics and Business Environment
This domain tests microeconomic decision tools - demand, elasticity, cost, pricing and market structure - plus the macroeconomic and policy environment in which firms operate.
Core rules
- Opportunity cost is the value of the next best alternative; sunk costs are irrelevant to forward decisions.
- Price elasticity of demand (PED) = %Δ quantity / %Δ price. Midpoint formula: ΔQ/[(Q1+Q2)/2] ÷ ΔP/[(P1+P2)/2]. |PED|>1 elastic; <1 inelastic.
- Income elasticity: normal >0; inferior <0. Cross elasticity: substitutes >0; complements <0.
- Short-run costs: fixed + variable. Shut down if price < average variable cost; exit if price < average total cost in the long run.
- Market structures: perfect competition (price taker), monopoly (price maker, entry barriers), monopolistic competition (differentiated, free entry), oligopoly (interdependence, kinked demand).
- Macro: real GDP adjusts for inflation; CPI measures consumer inflation; monetary policy uses repo rate, CRR and open market operations; fiscal policy uses spending and taxation; exchange rates affect net exports.
- PESTEL scans political, economic, social, technological, environmental and legal forces.
Worked example. Price falls from 100 to 90; quantity rises from 1,000 to 1,200. Midpoint %ΔQ = 200/1,100 = 18.18%; %ΔP = −10/95 = −10.53%; PED = −1.73, elastic. Revenue rises from 100,000 to 108,000, so a price cut pays when demand is elastic.
Traps. Do not mix base periods in elasticity. Fixed costs do not determine short-run shutdown. Nominal GDP can rise while real output falls. A monopoly need not earn supernormal profit if costs are high.