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UNIT I
INTRODUCTION
ECONOMICS
Economics is the study of how societies use scarce resources to produce
valuable commodities and distribute them among different people.
SCOPE OF ECONOMICS
1. Consumption: Satisfaction of human wants is called consumption which
forms one of the important branches of economics. This tells how people
behave in consumption of goods and services in order to maximize their
satisfaction.
2. Production: Goods and services have to be produced with the help of
factors of production. So, production is another branch of economics. It
concerned with how maximum goods are produced with minimum cost or
how the scarce factors could be utilized economically for better results.
3. Exchange: Goods and services cannot be produced at one place or at
one point of time. Goods produced by one are exchanged for the goods
produced by the others. So, exchange forms another branch of study in
economics.
4. Distribution: Goods and services are produced with efforts, i.e., by
combining the factors of production. These efforts have to be paid for or
rewarded. The land gets rent, the labor get wages, the capital gets interest
and the organizer gets profit. This branch of study is called distribution in
economics.
5. Public Finance: This branch of study in economics studies about the
sources of revenue to the government and the principles governing the
expenditure for the benefit of the people. It also studies about public debt
and financial administration.
ECONOMICS IS A SCIENCE OR AN ART
Economics as a Science: A science is a systematized body of knowledge
ascertainable by observation experimentation. It is a body of generalizations,
principles, theories or laws which traces out a casual relationship between
cause and effect. Economics is a systematized body of knowledge in which
economic facts are studied and analyzed in a systematic manner. For
instance, economics is divided into consumption, production, exchange,
distribution and public finance which have their laws are theories on whose
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the capitalists and the workers take the form of the class conflict with the
further development of capitalism.
SOCIALISM
Under socialism not only is there social ownership of the means of production
but also the functioning of the economy is such so as to maximize social
benefit rather than private benefit. Unlike capitalism in a socialist society the
market mechanism does not play the all dominating role of determining the
type and quantity of various commodities produces their priority sequence
and the necessary allocation of resources.
Characteristics (or) Salient features of the socialist economic
system:
1. Social ownership of the means of production: In a socialist society
private ownership of the means of production is abolished in the various
sectors of the economy.
2. Predominance of public sector: An important precondition for the
establishment of socialism is the existence of the public sector which is
founded on the principle of social ownership of the means of production
3. Decisive role of economic planning: Economic planning under
socialism plays exactly the same role as is played by the price mechanism in
a capitalist economy.
4. Production guided by social benefit: In a socialist economy, however,
income inequalities are drastically reduced so that everyone has an
adequate amount of disposable income. While determining the pattern and
size of output the planning commission has to see to it that its decisions in
this regard are such that they ensure the availability of commodities for all in
the market.
5. Abolition of exploitation of labor: Once the development of human
society reaches the stage of socialism. Exploitation of man by man comes to
an end.
MIXED ECONOMY
According to Samuelson, a mixed economy is characterized by the existence
of both public and private institutions exercising economic controls.
CHARACTERISTICS OF A MIXED ECONOMY:
1. Private and state ownership of the means of production and profit
induced private business:
In a mixed economy people enjoy right of property through constitutional
provisions.
2. Decisive role of market mechanism: Market mechanism has a
predominant position in a mixed economy. In such an economy markets exist
not only for various products, but also for productive factors, such as labor
and capital.
3. Interventionist role of the state: The market mechanism is a mixed
economy may not be entirely free from state control. Often legislative
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MANAGERIAL ECONOMICS
Managerial Economics has been described as economics applied to decisionmaking. It may be viewed as a special branch of economics bridging the gulf
between pure economic theory and managerial practice.
CHIEF CHARACTERISTICS
1. Managerial Economics is micro-economic in character. This is because the
unit of study is a firm;it is the problems of a business firm which are studied
in it. Managerial Economics does not deal with the entire economy as a unit
of study.
2. Managerial Economics largely uses that body of economic concepts and
principles which is known as Theory of the Firm or Economics of the Firm.
In addition, it also seeks to apply Profit Theory which forms part of
Distribution Theories in Economics.
3. Managerial Economics is pragmatic. It avoids difficult abstract issues of
economic theory but involves complications ignored in economic theory to
face the overall situation in which decisions are made. Economic theory
appropriately ignores the variety of backgrounds and training found in
individual firms but Managerial Economics considers the particular
environment of decision-making.
4. Managerial Economics belongs to normative economics rather than
positive economics (also sometimes known as descriptive economics). In
other words, it is prescriptive rather than descriptive. The main body of
economic theory confines itself to descriptive hypothesis, attempting to
generalize about the relations among different variables without judgment
about what is desirable or undesirable.
5. Macro-economics is also useful to Managerial Economics since it provides
an intelligent understanding of the environment in which the business must
operate. This understanding enables a business executive to adjust in the
best possible manner with external forces over which he has no control but
which play a crucial role in the well-being of his concern.
SCOPE OF MANAGERIAL ECONOMICS
1. Demand Analysis and Forecasting: A major part of managerial
decision-making depends on accurate estimates of demand. Before
production schedules can be prepared and resources employed, a forecast of
future sales is essential.
2. Cost Analysis: A study of economic costs, combined with the data drawn
from the firms accounting records, can yield significant cost estimates that
are useful for management decisions.
3. Production and Supply Analysis: Production analysis mainly deals with
different production function and their managerial uses. Supply analysis
deals with various aspects of supply of a commodity. Certain important
aspects of supply analysis are: Supply schedule, curves and function. Law of
supply and its limitations, Elasticity of supply and Factors influencing supply.
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principle, an input should be so allocated that the value added by the last
unit is the same in all cases. This generalization is called the equi-marginal
principle.
RELATIONSHIP
OF
MANAGERIAL
ECONOMICS
WITH
OTHER
DISCIPLINES
1. Managerial Economics and Economics: Managerial Economics has
been described as economics applied to decision-making. It may be viewed
as a special branch of economics bridging the gulf between pure economic
theory and managerial practice. Economics has two main divisions: microeconomics and macro-economics. Micro-economics has been defined as that
branch where the unit of study is an individual or a firm. Macro-economics,
on the other hand, is aggregative in character and has the entire economy as
a unity of study.
2. Managerial Economics and statistics: Managerial Economics employs
statistical methods for empirical testing of economic generalizations. These
generalizations can be accepted in practice only when they are checked
against the data from the world of reality and are found valid.
3. Managerial Economics and Mathematics: Mathematics is yet another
important tool-subject closely related to Managerial Economics. This is
because Managerial Economics is metrical in character, estimating various
economics relationships, predicting relevant economic quantities and using
them in decision-making and forward planning.
4. Managerial Economics and Accounting: Managerial Economics is also
closely related to accounting which is concerned with recording the financial
operations of a business firms. Indeed, accounting information is one of the
principal sources of data required by a managerial economist for his
decision-making purpose.
5. Managerial Economics and Operations Research: The significant
relationship between managerial economics and operations research can be
highlighted with reference to certain important problems of managerial
economics which are solved with the help of or techniques. The problems
are: allocation problems, competitive problems, waiting line problems and
inventory problems.
DIFFERENCE BETWEEN MANAGERIAL ECONOMICS AND ECONOMICS
1. Managerial Economics involves application of economic principles to the
problems of the firm. Economics deals with the body of the principles itself.
2. Managerial Economics is micro-economic in character; Economics is both
macro-economic and micro-economic.
3. Managerial Economics, though micro in character, deals only with firms
and has nothing to do with an individuals economic problems. But microEconomics as a branch of Economics deals with both economics of the
individual as well as economics of the firm.
4. Under Micro-Economics as a branch of Economics, distribution theories,
viz., wages, interest and profit, are also dealt with but in Managerial
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Economics, mainly Profit Theory is used: other distribution theories have not
much use in Managerial Economics. Thus, the scope of Economics is wider
than that of Managerial Economics.
5. Economic theory hypothesizes economic relationships and builds
economic models but Managerial Economics adopts, modifies and
reformulates economic models to suit the specific conditions and serves the
specific problem solving process. Thus Economics gives the simplified model,
whereas Managerial Economics modifies and enlarges it.
6. Economic theory makes certain assumptions whereas Managerial
Economics introduces certain feedbacks such as objectives of the firm, multiproduct nature of manufacture, behavioural constraints, environmental
aspects, legal constraints, constraints on resource availability, etc., thus
embodying a combination of certain complexities assumed away in economic
theory and then attempts to solve the real-life, complex business problems
with the aid of tool subjects, e.g., mathematics, statistics, econometrics,
accounting, operations research, marketing research and so on.
ROLE OF MANAGERIAL ECONOMISTS IN BUSINESS
1. Decision Making and Forward Planning: Managerial economists play
a vital role in managerial decision making and forward planning.
2. Inventory Schedules of the Firm: He plays an effective role in price
fixation, location of a plant, quality improvement, etc. and inventory
schedules of the firm.
3. Demand Forecasting: The most important role of the managerial
economist relates to demand forecasting.
4. Economic Analysis: The managerial economists undertake an economic
analysis of the industry.
5. Price Fixation: Another role played by a managerial economist is to
fixing prices for new as well as existing products of a firm.
6. Environmental Issues: A managerial economist is also undertakes the
analysis of environmental issues.
7. Cost of the Firm: He is also responsible and playing a vital role in input
cost of the firm.
8. Governments Economic Policies: Lastly, managerial economist has
also to keep in touch with the governments economic policies and the
central banks monetary policies annual budgets of the government.
DECISION MAKING ENVIRONMENTS
The decisions are also categorized in terms of the degree of certainty that
exists in a situation. Thus every decision making situation falls into one of
the four categories that exist along a certainty continuum namely Certainty,
Risk, Uncertainty and Ambiguity
1. Certainty: This is a state of certainty that exists only when the decision
maker knows the available alternatives and the conditions and consequences
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of those actions. Making decisions under certainty assumes that the decision
maker has all the necessary information about the problem situation.
2. Risk: A state of risk exists when the decision maker is aware of all the
alternatives, but is unaware of their consequences. In this situation, the
decision maker at best can make guess as to which alternative to choose.
The decision in order risk usually involves clear and precise goals and good
information, but future outcomes of the alternatives are just not known to a
degree of certainty. However, sufficient information is available to allow the
decision maker to ascribe the probability of successful outcomes for each
alternative.
3. Uncertainty: Most significant decisions made in todays complex
environment are formulated under a state of uncertainty, where there is an
unawareness of all the alternatives and so also the outcomes even for the
known alternatives. Such decisions demand creativity and the willingness to
take a chance in the face of such uncertainties. In such situations, decision
makers do not even have enough information to calculate degree of risk.
4. Ambiguity: The most difficult decision situation is the state of ambiguity,
in which the decision problems are not at all clear. The alternative courses of
action are difficult to identify, and the information about consequences is not
available. In this state, nothing is known for sure and the risk of failure is
quite high.
PROFIT MAXIMIZATION AS BUSINESS OBJECTIVE
Profit maximization objective of the firm has been the traditional approach to
the study of a firm in equilibrium analysis. Profit maximization means the
largest absolute amount of profits over a time period, both short-term. And
long term. The short run is a period where adjustments cannot be made
quickly in matters of supply and demand. Long run however enables
adjustment to changed conditions. Profit can be defined as the difference
between total revenue (TR) and total cost (TC).
Profit=TR-TC
CRITISIMS OF PROFIT-MAXIMISING THEORIES
1. Separation of Ownership from Control: The rise of corporate firm of
organization has resulted in a separation of ownership and control.
Ownership is vested with the shareholders and control is wielded by the
managers. It has not been empirically proved that shareholders are more
concerned with profitability than anything else.
2. Difficulties in Pursuing Profit Maximization: The modern firm faces
lot uncertainties. As a result, short run profit maximizing behaviour is
subordinated to the more important objective of long-run survival of the firm,
for example, the firms objective to pursue good-will in the long-run may
clash with short-run profit objective.
3. Problems in the Measurement of Profit: There are some problems
about the measurement of profit as a measure of firms efficiency. Profit may
be the result of imperfection in the market and profits may be the reward of
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available; where data are available managers have little time and ability to
process them; and managers work under a number of terms of rationality
postulated under profit maximization hypothesis. Nor do the firms seek to
maximize sales, growth or anything else. Instead they seek to achieve a
satisfactory profit a satisfactory growth, and so on. This behaviour of firms
is termed as Satisfaction Behaviour. Cyert and March added that, apart
from dealing with an uncertain business world, managers have to satisfy a
variety of groups of people-managerial staff, labour, shareholders,
customers, financiers, input suppliers, accountants, lawyers, authorities etc.
All these groups have their interest in the firms-often conflicting. The
managers responsibility is to satisfy them all. Thus, according to the CyertMarch, firms behaviour is satisfying behaviour. The satisfying behaviour
implies satisfying various interest groups by sacrificing firms interest or
objective. The underlying assumption of Satisfying Behaviour is that a firm
is a coalition of different groups connected with various activities of the
firms, e.g., shareholders, managers, workers, input supplier, customers,
bankers, tax authorities, and so on. All these groups have some kind of
expectations-high and low- from the firm, and the firm seeks to satisfy all of
them in one way or another in sacrificing some of its interest. In order to
reconcile between the conflicting interests and goals, managers form an
aspiration level of the firm combining the following goals: (a) Production goal,
(b) Sales and market share goals, (c) Inventory goal, and (d) Profit goal.
These goals and aspiration level are set on the basis of the managers past
experience and their assessment of the future market conditions. The
aspiration levels are modified and revised on the basis of achievements and
changing business environment. The behavioural theory has, however, been
criticized on the following grounds. First, though the behavioural theory deals
realistically with the firms activity, it does not explain the firms behaviour
under dynamic conditions in the long run. Secondly, it cannot be used to
predict exactly the future
course of firms activities; thirdly, this theory does not deal with the
equilibrium of the industry. Fourthly, like other alternative hypotheses, this
theory too fails to deal with interdependence of the firms and its impact on
firms behaviour.
SOURCES OF BUSINESS RISK
1. Risk of Market Fluctuation: General economic conditions are rarely
stable. Firms face booms and depressions. Though with the help of certain
forecasting techniques the firm can somewhat hedge itself against cyclical
fluctuation, but there is no way the firm can generally know with certainty
the timing and volatility of changes. The firm is, therefore, unstable to
completely prepare itself for these changes.
2. Risk of Industry Fluctuations: There may be fluctuations specific to the
industry, which are least as uncertain and may not always coincide with
those of the overall market.
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3. Competition risks: These are the risk arising from the policy changes of
the rivals, which include things like changes in prices, product line,
advertisement expenditure, etc.
4. Risk of technological change: This is also called the risk of
obsolescence, which grows with advancement of an economy. These risks
arise from the possibility of newly installed machinery becoming obsolete
with the discovery of new and more economical process of production.
5. Risk of taste fluctuation: In many cases, vagaries of consumer demand
create uncertain
conditions. Successful product of one season may become discarded in the
next season. These risks are most common in fashion and entertainment
industries.
6. Risk of cost fluctuation: Unless contractually agreed upon, the future
prices of labour, material etc. may change. Thus estimates of future
expenditure are subject to uncertainty.
7. Risk of public policy: Government policy regarding business undergoes
a change over time, some of which cannot be precisely predicted. These
relate to price control, foreign trade policy, corporate taxation etc.
THE THREE CATEGORIES OF DECISION-MAKERS
1. Risk-neutral: A decision-maker is risk-neutral if each added rupee of
wealth gives him the same additional utility.
2. Risk-averse: A decision-maker is considered risk-averse if addition of
each successive rupee to his wealth gives him lesser utility than the earlier
rupee.
3. Risk-preferer: A decision-maker is considered as risk-preferrer when
addition of each successive rupee to decision-makers wealth gives him
greater utility each time.
DECISION MAKING
Decision making is the process of selection from a set of alternative courses
of action which is thought to fulfil the objective of the decision problem more
satisfactorily than other.
FEATURES OF DECISION MAKING
1. Selection process: Decision making is a selection process. The best
alternative is selected out of many available alternatives.
2. Goal-oriented process: Decision making is goal-oriented process.
Decisions are made to achieve some goal or objective.
3. End process: Decision making is the end process. It is preceded by
detailed discussion and selection of alternatives.
4. Human and Rational process: Decision making is a human and rational
process involving the application of intellectual abilities. It involves deep
thinking and foreseeing things.
5. Dynamic process: Decision making is a dynamic process. An individual
takes a number of decisions each day.
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