Induction on

Preliminary Econometrics
(Basics on the Use of Mathematics on Economics)
Ace Institute of Management
Executive MBA Program

Session 1: Basic Economic Relations

Instructor
Sandeep Basnyat
Sandeep_basnyat@yahoo.com
9841 892281

Course Structure
To understand basic tools needed to solve
mathematical problems related to managerial
economics and macroeconomics
4 Sessions
Session 1: Basic Economic Relations
Session 2: Use of basic calculus
Session 3: Economic application: Microeconomics
Session 4: Economic Application: Macroeconomics

Objectives of the firms

Varieties of objectives:
1. Profit maximization
2. Sales Revenue maximization
3. Utility maximization
4. Corporate growth maximization
5. Etc

Most Important economic objectiveProfit Maximization

Profit = Total revenue Total cost
the amount a
firm receives
from the sale
of its output

the market
value of the
inputs a firm
uses in
production

The most important role played is by the Total Product

(Quantity)

Total Product (Quantity): TP

Q = f (K, L)
Where,
Q = Total Product or Total Quantity
f = function of
K = capital
L = Labour
Basic Relations: Q is the output resulted
from the inputs K and L

The Production Function: The

relationship between Input and Output
A production function shows the relationship
between the quantity of inputs used to
produce a good, and the quantity of output of
that good.
It can be represented by a table, equation, or
graph.

Simple Example: Production Function

(Assume capital is fixed)
L

TPL or Q

3,000

(no. of (bushels
workers) of wheat)
Quantity of output

1000

1800

2400

500

2800

5
(i) Q = 3L

2,500
2,000
1,500

1,000

3000
(ii) Q = L0.5

No. of workers

(iii) Q = L2

Marginal Product
The marginal product of any input is the increase in
output arising from an additional unit of that input,
holding all other inputs constant.
Q
Marginal product of labor (MPL) =
L
Q = change in output, L = change in labor

EXAMPLE :Marginal Product

L

Q (bushels

(no. of
of wheat)
workers)

L = 1
1

L = 1

L = 1
L = 1

4
5

Q = 1000

1000

Q = 800

800

Q = 600

600

Q = 400

400

Q = 200

200

1000
1800

L = 1
3

MPL

2400
2800
3000

Relationship between Production Function and MPL

Q

3,000

(no. of (bushels
workers) of wheat)

MPL
2,500

0
1000

1
2

3
4
5

1000
1800

2400
2800
3000

800
600

Quantity of output

2,000
1,500
1,000

500

400
0

200

No. of workers

Diminishing MPL: This property explains why Production Function flatters as

output increases.

Average Product of the Labour (APL)

L

TP or Q
APL =
L
Q

(no. of (bushels
workers) of wheat)

MPL

0
1000

1000

1800

2400

2800

3000

1000

1000
900
1000

APL

800

1000

1000

700
600

Total Revenue
Total Revenue = Price x Quantity
TR = P x Q
Incase, P remains constant (eg. Perfectly
competitive market):
TR = f (Q)

Total Revenue and Output

Price ($) Output
1.5
1.5
1.5
1.5
1.5
1.5

1
2
3
4
5
6

Total
Revenue
1.5
3.0
4.5
6.0
7.5
9.0

Marginal and Average Revenue

The Marginal Revenue is the increase in revenue
arising from an additional unit of output.
TR
Marginal Revenue (MR) =
Q
TR = change in Total Revenue, Q = change in Output

TR
Average Revenue (AR) =
Q

Sample Data for Perfectly Competitive Market

Q

TR = P x Q

$10

$0

n.a.

$10

$10

$10

$10

Notice that
$20
$10
MR = P

$10

$30

$10

$10

$40

$10

$10

$50

$10

AR =

TR
Q

MR =

TR
Q

$10
$10
$10
$10
$10
15

A Sample Data for Monopoly Market

Q

TR

AR

$4.50

$0

n.a.

4.00

$4.00

3.50

3.50

3.00

3.00

2.50

10

2.50

2.00

10

2.00

1.50

1.50

MR
$4
3

2
1
0
1

16

Learning Exercise-Revenue
Fill in the missing data
Q
0
1
2
3
4
5
6
7
8
9
10

P ($)
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0

TR

MR

AR

Learning Exercise-Revenue
Q
0
1
2
3
4
5
6
7
8
9
10

P ($)
10
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0

TR
0
9
16
21
24
25
24
21
16
9
0

MR
9
7
5
3
1
-1
-3
-5
-7
-9

AR
0
9
8
7
6
5
4
3
2
1
0

Deriving Costs: FC, VC and TC

Q

FC

VC

TC

$100

$0 $100

100

70

170

100

120

220

100

160

260

100

210

310

100

280

380

100

380

480

100

520

620

Marginal Cost
Q

TC

0 $100
1

170

220

260

310

380

480

620

MC

$70
50
40
50

70
100
140

Marginal Cost (MC)

is the change in total cost from
producing one more unit:

MC =

TC
Q

Average Fixed Cost

Q

FC

0 $100

AFC
n.a.

100

$100

100

50

100

33.33

100

25

100

20

100

16.67

100

14.29

Average fixed cost (AFC)

is fixed cost divided by the
quantity of output:
AFC = FC/Q

Average Variable Cost

Q

VC

AVC

$0

n.a.

70

$70

120

60

160

53.33

210

52.50

280

56.00

380

63.33

520

74.29

Average variable cost (AVC)

is variable cost divided by the
quantity of output:
AVC = VC/Q

Average Total Cost

Q

TC

0 $100

ATC
n.a.

170

$170

220

110

260

86.67

310

77.50

380

76

480

80

620

88.57

A C T I V E L E A R N I N G:

Costs
Fill in the blank spaces of this table.
Q

VC

0
1

10

30

TC

AFC

AVC

ATC

$50

n.a.

n.a.

n.a.

$10

$60.00

80

16.67

100

150

210

150

20

12.50

36.67

8.33

$10
30

37.50
30

260

MC

35

43.33

60
24

A C T I V E L E A R N I N G:

Answers
Q

VC

TC

AFC

AVC

ATC

$0

$50

n.a.

n.a.

n.a.

10

60

$50.00

$10

$60.00

30

80

25.00

15

40.00

60

110

16.67

20

36.67

100

150

12.50

25

37.50

150

200

10.00

30

40.00

210

260

8.33

35

43.33

MC
$10
20
30
40
50
60
25

Profit Function
Profit () = TR - TC
Marginal profit (M) =

= change in Total Profit, Q = change in Output

Average Profit (A) =

Learning Exercise (Revenue, Cost and Profit)

Q
0
1
2
3
4
5
6
7
8
9
10

P
160
150
140

TR
0
150

MR
150

TC
0
25
55

390
90
110

80

550
600
630
640

MC
25
30
35

130
175

50
290
355

55
60

525

300
350

M
125
100
75

370
-30
285

75
600

0
125

-85

Learning Exercise (Revenue, Cost and Profit)

Q
0
1
2
3
4
5
6
7
8
9
10

P
160
150
140
130
120
110
100
90
80
70
60

TR
0
150
280
390
480
550
600
630
640
630
600

MR
150
130
110
90
70
50
30
10
-10
-30

TC
0
25
55
90
130
175
230
290
355
430
525

MC
25
30
35
40
45
55
60
65
75
95

0
125
225
300
350
375
370
340
285
200
75

M
125
100
75
50
25
-5
-30
-55
-85
-125

Numerical Exercise
Given the Total Cost function:
TC = 150Q 3Q2 + 0.25Q3
a) Find the Average Total cost function for the above
b) Compute Total, Average and Marginal costs when the
quantity produced are 5,6 and 7.

Ans.:
a) TC = 150 3Q + 0.25Q2
b) Computation
Q
Total Cost Average Cost

Marginal Cost

5
6
7

139.75
52.75

706.25
846
898.75

141.25
141
128.39

Numerical Exercise
Given the following TR and TC functions,
determine the output (Q) that would result in
break-even (zero profit).
TR = 51Q Q2
TC = 625 + Q
Ans: Q = 25

Market Mechanism
Two forces of market: Demand and Supply
Demand: willingness and ability to pay
Law of demand: Qd = f (P) (Inverse)

Supply: Willingness and ability to sell

Law of Supply: Qs = f (P) (Positive)

Equilibrium at the point where:

Demand = Supply
Qd = Qs

Supply and Demand Together

P
$6.00

$5.00

Equilibrium
Price and
Quantity

$4.00
$3.00
$2.00
$1.00
$0.00

Q
0

10 15 20 25 30 35

Numerical Problem on Demand and Supply

1) Suppose:
Demand eqn. for a product: Qd = 286 20p
Supply eqn. For a product: Qs = 88 + 40p
Find Equilibrium Quantity and Price:
Solution:
Qd = Qs
286 20p = 88 + 40p
60p = 198
P = $3.30
Q = 286 20(3.3) = 220

Disequilibrium in Automobile market- Surplus

Market demand curve: Qd = 20,500,000 500P
Market supply curve: Qs = - 42000000 +2000P
Suppose a seller is trying to sell the car at $27000.
How many cars will be bought and sold?
Answer:
Qd = 20,500,000 500(27000)= 7,000,000
Qs = - 42000000 +2000(27000) = 12,000,000
Surplus = 5 million cars.

Disequilibrium in Automobile market- Shortage

Market demand curve: Qd = 20,500,000 500P
Market supply curve: Qs = - 42000000 +2000P
Suppose a car is being sold at $23000.
How many cars will be bought and sold?

Answer:
Qd = 20,500,000 500(23000)= 9,000,000
Qs = - 42000000 +2000(23000) = 4,000,000
Shortage = 5 million cars.

Thank You