Managerial Economics

Introduction
 Economics
The economics derived from the Greek word

(Oikos: “a house” & nomos: manager)

means a prudent management of once

house hold affairs . But, it has now come
to mean the study of business affairs in
general. So can say economics is study of
managing maximum gains out of scarce
resources
Management + Economics
 Definition
“Managerial economics is concerned with
the application of economic principles and
methodologies to the decision process
with in the organization .it seeks to
establish rules and principles to facilitate
the attainment of the desired economic
goals of management.”
- douglas
 Key points of definition
• Decision making

• Economic methodology

• Economic goals of firm

 Decision making

It is the process of selecting best out of

alternative opportunities open to the firm.
 Economic methodology

It is a relation between ideas , thoughts ,

intuitions & experience with economic
tools& techniques .
 Economic goals of firm

In the nutshell it is making maximum gains

out of available resources
Scopes of managerial economics

• Micro – when something is concerned with

individual (person firm or household)

• Macro – something related to the

environment as a whole
 Micro economic theories
• Operational issues

. Theory of production

. Theory of price determination

. Theory of profit & capital budgeting

. Theory of demand
 Macro economic theories
• Environment or external issues

• Theories of national income

• Theories of economic growth & fluctuations

• Theories of national trade &monitory mechanism

• Theories of government policies

 Why do managers need to know
managerial economics?
• What to produce?
• How to produce?
• For whom to produce?
• How much to produce?

so that can organization

generate maximum gains.
& economics has the ans to all
these problems
But economic theories are too theoretical to
applied directly to the business decision
making but when knowledge logic &
analytical tools are added to these
theories it becomes managerial
economics
which helps the manager in rational
business decision making.
 Objectives
of
business firm
 “Profit”

As a sole objective
 Profit
Different things to different people
Example- commission
salary
fees , ect
 In economic terms profit means
pure profit or economic profit

• Economic profit - It is difference

between actual earning & opportunity cost

• Opportunity cost – it is the expected

income forgone form second best
alternative
Profit theories
 Theory of rent
by , prof. F.A. walker
“profit is the rent of ability”

Rent – remuneration for the use of land to

land lord

Profit – reward for ability of entrepreneur

 According to professor walker
As rent is the difference between least & the
most fertile land similarly, profit is the
difference between earnings of the least &
the most efficient entrepreneurs
 Criticism
- Rent & profit are not similar
. rent is always positive
. profit is positive as well as negative

- Absence of marginal entrepreneur

- profit is not the rent of ability

 Dynamic theory
by , prof. J.B.clark

According to clark – profit arises in a

dynamic economy not in static .
 Criticism

• All economies are dynamic

• Profit is not the result of each change

• Theory ignores uncertainty & risk taking

Theory of risk
By , Prof. Hawley

“NO RISK NO GAIN”

 Criticism
• All risk do not lead to profits

• Profit is to avoid risk

• There is no direct relationship between

risk & profit
 Theory of innovation
by, prof. schumpeter

Profit is reward for innovation

Theory of uncertainty bearing
by, prof. knight

“Profit is the reward for

uncertainties bearing”
 Criticism

• uncertainty is not measurable

• Profit is not the reward for uncertainty

bearing only
 Other business objectives
• Sales revenue maximization
• Maximization of firms growth rate
• Consumer satisfaction
• Long run survival
• Entry prevention
 Consumer
behavior :Utility
 Meaning

“ utility is want satisfying power of

commodity’’
 Characteristics:

• Utility is subjective/not measurable

• Utility is variable

• Utility is different from usefulness

• No legal or moral connotations

 Total utility

It is sum of the utility derived by the

consumer from the number of units of
goods & services he consumed.

Tun = Ux + Uy + Uz
No. of Total total utility
units utility
consumed
70
1 30 60
2 50 50
3 60 40

4 65 30
20
5 60
10
6 45
0
1 2 3 4 5 6

total utility
 MARGINAL UTILITY
It is the change in total utility obtained from
the consumption of additional unit of
commodity .

MU = change in TU
change in Q
no.of Total utility Marginal
units 70
consumed utility
60
1 30 30 50

2 50 20 40

30 total utility
3 60 10 20 marginal utility

4 65 5 10

0
5 60 -5 -10
1 2 3 4 5 6

6 45 -15 -20
 Law of diminishing marginal utility

As the quantity consumed of a

commodity increases , the utility
derived from each successive unit
decreases , consumption of all
other commodities remaining the
same.
No. of units Marginal utility
marginal utility
consumed

35
1 30 30
25
2 20 20
15
3 10 10
marginal utility
5
4 5 0
-5 1 2 3 4 5 6
5 -5 -10
-15
6 -15 -20
 Assumption
• No small units are consumed

• Taste & preference remain same

• There must be continuity in consumption

• Consumer should be of sound mental

health
 Consumer’s Equilibrium
• Consumer will attain its equilibrium
(maximum satisfaction) at the point, where
marginal utility of a product divided by the
marginal utility of a rupee, is equal to the
price.

• Consumer’s equilibrium = Marginal utility of a product

Marginal utility of a rupee
= its price
Steps:

• Generation of alternatives

• Evaluation of alternatives

• Choice of the best alternative

Assumptions:

• Consumer behaviour is rational.

• Consumer behaviour is consistent.
• There are two commodities in consideration.
 Law of Equi-Marginal Utility
• This law states that the consumer
maximizing his total utility will allocate
his income among various
commodities in such a way that his
marginal utility of the last rupee spent
on each commodity is equal.
• Or
• The consumer will spend his money
income on different goods in such a
way that marginal utility of each good
 Limitations of Law of Equi-
Marginal Utility

• # It is difficult for the consumer to know the marginal

utilities from different commodities because utility cannot
be measured.

• # Consumer are ignorant and therefore are not in a

position to arrive at an equilibrium.

• # It does not apply to indivisible and inexpensive

commodity.
The Budget Constraint,
or Budget Line
Part of an Indifference Map
An Indifference Curve