Topic 1

Economics: Concept
Economics: study of how economic agents/societies chose to use scarce productive resources that have alternative uses to satisfy wants that are unlimited and of varying degrees of importance Economic problem: identification, description, explanation and solution Problem of scarcity Job of a manager: decision making: evaluate alternatives and chose the best; one of constrained optimization

Managerial economics
Macroeconomics: study of economic system as a whole Microeconomics: focuses on behaviour of individual players like

consumers, producers and their interaction in markets Managerial economics:

applied microeconomics focuses on topics of greatest interest and importance to managers, like

demand, production, cost, pricing, market structure Assists in evaluating if resources are allocated efficiently and in responding to economic signals/ changes in variables Assists in decision making by evaluating alternatives and selecting optimal course of action, given the constraints, and profit maximisation objective of the firm

Circular flow of economic activity

Households supply factor inputs to firms thru factor markets; firms in turn manufacture and provide goods and services to households thru product markets In return, firms make payments to households for factor inputs which is used by these households to make payments for goods and services provided by firms Factor inputs/goods/services move in one circular direction, rupee payments in the other circular direction

Fundamental questions in economy

What goods and services to produce and in what quantity: demand and supply theories, costs and pricing decisions
How to produce them, ie. how the scarce resources are optimally allocated: production theories How these goods and services so produced are distributed among the households: market structure

Alternative economic systems

Market economy: market forces of demand and supply operate freely to

determine solutions to questions Command economy: govt. decides market functions/systems; govt. controls all productive resources; govt. enterprise and ownership is the rule; authoritarian methods used to determine resource use and prices; like in earlier Russia, eastern Europe economies Mixed economy: both markets and command mechanisms used, govt. may control areas like defence, roads, pensions, schooling. May also intervene in markets to control prices and correct other shortcomings

Objective of a Firm
Profit Maximization: both current and future profits Thus maximize sum of present value of all future profits (discounted

values) This equals the value of the firm Thus profit maximization same as value maximization Subject to other objectives like those of maximization of market share, revenues, salaries, social welfare etc. Thus we may talk of satisficing (satisfactory profits) rather than maximizing various management objectives Subject to constraints like legal, moral, contractual, technological etc.

 Principles of managerial economics allow accurate

predictions of decision making in business Principal-agent problem: due to possibility that owners and their managers may have different objectives: hence need to align these Invisible hand principle:
Proclaimed by Adam Smith Pursuit of self interest by players in the markets will lead to

promotion of public good, will ensure economic well being of society

Concept of Profit
Profit = total revenues total costs Accounting profit different from economic profit Economic profit takes care of all costs, explicit and implicit, while accounting profits take care of only explicit costs Implicit costs include opportunity costs Opportunity costs: cost of next best alternative

 Externalities: Benefits: enjoyed with out paying for them; eg. increased economic activity of an area where a large industry is set up Costs: paid by those who are not using the services: eg. social costs of pollution by an industrial enterprise