MANAGERIAL ECONOMICS & ACCOUNTANCY

Unit :I Semester IT

IIIrd

Syllabus
UNIT : I
Meaning, Nature and Scope of managerial economics. Concepts used in managerial economics such as incremental concepts, Time perspective Discounting for time, Opportunity cost equimarginalism.Law of diminishing marginal utility,' Methodology of managerial economics, Simulation.

Learning Objectives
After the successful completion of this unit, students will: - be acquainted with major topics in managerial economics, - be more confident while participating in firm decision making process, - have developed skills, that are need for strategic decision making and decision making under uncertainty,

Introduction
What is Economics ? Economics is a social science ,which studies economic phenomena & related behaviour of the people. Economic behaviour is a conscious effort to derive maximum gains from the use of scarce resources & opportunities available. It is fundamentally the study of how people allocate their limited resources, which have alternative uses ,to produce & consume goods & services to satisfy their endless wants or to maximize their gains. Economics as a branch of knowledge is concerned with the study of the allocation of scarce resources among competing ends as problems of resource allocation are constantly faced by individuals ,enterprises & nations. As a subject ,it is most closely associated with everyday life at all levels. As a voter you will make decisions on issues on government deficit ,on taxes, on free trade, on inflation & unemployment- that cannot be understood until you have mastered the rudiments of this subject.

Contd..
Economics is the study of how societies use scarce resources to produce valuable commodities & distribute them among different people. If infinite quantities of every good could be produced or if human desires were fully satisfied ,what could be the consequences? People would not worry about stretching out their limited incomes, because they could have everything they wanted Businesses would not need to worry over the cost of labour & healthcare Governments would not need to struggle over taxes or spending because nobody would care. Moreover ,since all of us could have as much as we pleased ,no one would be concerned about the distribution of incomes among different people or classes. In such a situation there would be no economic goods, that is that are scarce or limited in supply. All goods would be free, like sand in the desert or seawater. Prices & markets would be irrelevant .& Economics would no longer be a useful subject ,but goods are limited ,while wants seem limitless.
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Contd..
Economics can be studied under two heads: 1) Micro Economics : It has been defined as that branch where the unit of study is an individual, firm or household. It studies how individual make their choices about what to produce, how to produce, and for whom to produce, and what price to charge. Various micro-economic concepts such as demand, supply, elasticity of demand and supply, marginal cost, various market forms, etc. are of great significance to managerial economics.

Contd..
2) Macro Economics : The study of aggregate or total level of economics activity in a country is called macroeconomics. It studies the flow of economic resources or factors of production (such as land, labour, capital, organisation and technology) from the resource owner to the business firms and then from the business firms to the households. It deals with total aggregates, for instance, total national income total employment, output and total investment. It is aggregative in character and takes the entire economy as a unit of study. Macro economics helps in the area of forecasting. It includes National Income, aggregate consumption, investments, employment etc.

DECISION-MAKING AND FORWARD PLANNING

The chief function of a management executive in a business firm is decision-making and forward planning. Decision-making refers to the process of selecting one action from two or more alternative courses of action. Forward planning on the other hand is arranging plans for the future. In the functioning of a firm the question of choice arises because the available resources such as capital, land, labour and management, are limited and can be employed in alternative uses The decision-making function thus involves making choices or decisions that will provide the most efficient means of attaining an organisational objectives, for example profit maximization. Once a decision is made about the particular goal to be achieved, plans for the future regarding production, pricing, capital, raw materials and labour are prepared. Forward planning thus goes hand in hand with decision-making.
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Contd..
The conditions in which firms work and take decisions, is characterised with uncertainty. If the knowledge of the future were perfect, plans could be formulated without error and hence without any need for subsequent revision. In the real world, however, the business manager rarely has complete information about the future sales, costs, profits, capital conditions. etc. To execute the function of decision-making in an uncertain framework, economic theory can be applied with considerable advantage. Economic theory deals with a number of concepts and principles relating to profit, demand, cost, pricing, production, competition, business cycles and national income. The way economic analysis can be used towards solving business problems constitutes the subject matter of Managerial Economics.
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Definitions of Managerial Economics

Douglas : Managerial economics is concerned with the application of economic principles and methodologies to the decision making process within the firm or organization. It seeks to establish rules and principles to facilitate the attainment of the desired economic goals of the management. Mansfield :

He defines that managerial economics is concerned with the application of

economic concepts and economic tools to the problems of formulating rational decision making. Spencer and Seigleman :

It is the integration of economic theory with business practice for the purpose of
facilitating decision making and forward planning by management.

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Economics Theory & Methodology

Business Management Decision Problems

ME Application of Economics To solve Business Problems

Optimal Solution to Business Problems

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APPLICATION OF ECONOMICS TO BUSINESS MANAGEMENT

The application of economics to business management or the integration of economic theory with business practice, as Spencer and Siegelman have put it, has the following aspects : Estimating economic relationships: This involves the measurement of various types of elasticities of demand such as price elasticity, income elasticity, cross-elasticity, promotional elasticity and cost-output relationships. Predicting relevant economic quantities: Economic quantities such as profit, demand, production, costs, pricing and capital are predicated in numerical terms together with their probabilities. As the business manager has to work in an environment of uncertainty, the future needs to be foreseen so that in the light of the predicted estimates, decision-making and forward planning may be possible.

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Contd..
Using economic quantities in decision-making and forward planning: This involves formulating business policies for establishing future business plans. This nature of economic forecasting indicates the degree of probability of various possible outcomes, i.e., losses or gains that will occur as a result of following each one of the available strategies. Understanding significant external forces: Applying economic theory to business management also involves understanding the important external forces that constitute the business environment and with which a business must adjust. Business cycles, fluctuations in national income and government policies pertaining to taxation, foreign trade, labour relations, antimonopoly measures, industrial licensing and price controls are typical examples. The business manager has to appraise the relevance and impact of these external forces in relation to the particular business unit and its business policies.
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CHARACTERISTICS OF MANAGERIAL ECONOMICS

There are certain chief characteristics of managerial economics, which can help to understand the nature of the subject. M E is micro-economic in character. This is because the unit of study is a firm and its problems. Managerial economics does not deal with the entire economy as a unit of study. M E largely uses that body of economic concepts and principles, which is known as Theory of the Firm or Economics of the Firm. M E is concrete and realistic. It avoids difficult abstract issues of economic theory. Macroeconomics is also useful to M E since it provides an intelligent understanding of the business environment.

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DIFFFFERENCE BETWEEN MANAGERIAL ECONOMICS AND ECONOMICS

M E involves application of economic principles to the problems of a business firm whereas; economics deals with the study of these principles only. Economics ignores the application of economic principles to the problems of a business firm. M E is micro-economic in character, however, Economics is both macro-economic and micro-economic. M E, though micro in character, deals only with a firm 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 a firm.
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SCOPE OF MANAGERIAL ECONOMICS

Demand analysis and forecasting. Cost and production analysis. Pricing decisions, policies and practices. Profit management. Capital management. Inventory Management. Advertising.
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Demand Analysis and Forecasting

A business firm is an economic Organization, which transforms productive resources into goods that are to be sold in a market. A major part of managerial decision-making depends on accurate estimates of demand. because before production schedules can be prepared and resources are employed, a forecast of future sales is essential. This forecast can also guide the management in maintaining or strengthening the market position and enlarging profits. The demand analysis helps to identify the various factors influencing demand for a firms product and thus provides guidelines to manipulate demand. Demand analysis and forecasting, thus, is essential for business planning and occupies a strategic place in managerial economics.
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Cost and Production Analysis

A study of economic costs, combined with the data drawn from the firms accounting records, can yield significant cost estimates. The factors causing variations in costs must be recognized and thereby should be used for taking management decisions. The chief topics covered under cost and production analysis are: Cost concepts and classifications Cost-output relationships Economics of scale Production functions Cost control.
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Contd..
Pricing Decisions, Policies and Practices
Pricing is a very important area of managerial economics. In fact price is the origin of the revenue of a firm.
As such the success of a business firm largely depends on the accuracy of price decisions of that firm. The important aspects that are dealt under this area, are as follows: Price determination in various market forms Pricing methods Differential pricing ,product-line pricing and price forecasting.

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Profit Management
Business firms are generally founded with the purpose of making profits. In the long run, profits provide the chief measure of success.An important point worth considering is the element of uncertainty existing about profits. This uncertainty occurs because of variations in costs and revenues. These are caused by factors such as internal and external. If knowledge about the future were perfect, profit analysis would have been a very easy task. Thus profit planning and measurement make up the difficult area of managerial economics. The important aspects covered under this area are: Nature and measurement of profit. Profit policies and techniques of profit planning.

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Capital Management
Among the various types and classes of business problems, the most complex and troublesome for the business manager are those relating to the firms capital investments. Capital management implies planning and control and capital expenditure. The main elements dealt with cost management are: Cost of capital Rate of return and selection of projects.

Inventory Management
What do you mean by the term inventory? inventory is stock. It refers to stock of raw materials which a firm keeps. Now here the question arises how much of the inventory is ideal stock. Both the high inventory and low inventory is not good for the firm. Managerial economics uses methods such as ABC Analysis, simple simulation exercises, and some mathematical models, to minimize inventory cost. It also helps in inventory controlling.

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Advertising
Advertising is a promotional activity. In advertising while the copy, illustrations, etc., are the responsibility of those who get it ready for the press. The problem of cost, the methods of determining the total advertisement costs and budget, the measuring of the economic effects of advertising ---- are the problems of the manager. Theres a vast difference between producing a product and marketing it. It is through advertising only that the message about the product should reach the consumer before he thinks to buy it.

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THE ROLE OF MANAGERIAL ECONOMIST

Making decisions and processing information are the two primary tasks of the managers. Managerial economists have gained importance in recent years with the emergence of an organizational culture in production and sales activities. A managerial economist is nearer to the policy-making Equipped with specialized skills and modern techniques he analyses the internal and external operations of the firm. He evaluates and helps in decision making regarding sales, Pricing financial issues, labour relations and profitability.

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Basic Economic Tools in Managerial Economics

The most significant contribution of economics to managerial economics lies in certain principles, which are basic to the entire range of managerial economics.

Opportunity Cost Principle Incremental Principle Principle of Time Perspective

Discounting Principle
Law of Diminishing Marginal Utility
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Opportunity Cost Principle

Opportunity Cost : The opportunity cost is the opportunity lost. An opportunity to make income is lost because of scarcity of resources. Income maximizing resource owners put their scarce resources to their most productive use and thus they forego the income expected from the second best use of the resources. opportunity cost is the expected returns from the second best use of the resources that are foregone due to the scarcity of resources. It is also called alternative cost. By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. This cost arises because most economic resources have more than one use.
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Contd...
a) The opportunity cost of the funds employed in ones own business is the interest that could be earned on those funds if they have been employed in other ventures. b) The opportunity cost of using a machine to produce one product is the earnings forgone which would have been possible from other products. c) The opportunity cost of holding Rs. 1000 as cash in hand for one year is the 10% rate of interest, which would have been earned had the money been kept as fixed deposit in bank. Its clear now that opportunity cost requires ascertainment of sacrifices. If a decision involves no sacrifices, its opportunity cost is nil. For decision making opportunity costs are the only relevant costs.

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Incremental Principle
It is related to the marginal cost and marginal revenues Incremental concept involves estimating the impact of decision alternatives on costs and revenue,

The two basic components of incremental reasoning are 1) Incremental cost 2) Incremental Revenue The incremental principle may be stated as under: A decision is obviously a profitable one if a) it increases revenue more than costs b) it decreases some costs to a greater extent than it increases others c) it increases some revenues more than it decreases others and d) it reduces cost more than revenues

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Principle of Time Perspective

Managerial economists are also concerned with the short run and the long run effects of decisions on revenues as well as costs. Important problem in decision making is to maintain the right balance between the long run and short run considerations. A decision may be made on the basis of short-run considerations, but may in the course of time offer long-run repercussions, which make it more or less profitable than it appeared at first. An illustration will make this point clear. The principle of time perspective may be stated as under: A decision should take into account both the short-run and longrun effects on revenues and costs and maintain the right balance between the long-run and short-run perspectives.

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Discounting Principle
One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a rupee today. Suppose a person is offered a choice to make between a gift of Rs.100/- today or Rs.100/- next year. Naturally he will chose Rs.100/- today. This is true for two reasons i) The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present opportunity is not availed of ii) Even if he is sure to receive the gift in future, todays Rs.100/- can be invested so as to earn interest say as 8% so that one year after Rs.100/- will become 108 . whereas if he does not accept Rs. 100 today, he will get Rs. 100 only in the next year. Naturally, he would prefer the first alternative because he is likely to gain by Rs. 8 in future. Another way of saying the same thing is that the value of Rs. 100 after one year is not equal to the value of Rs. 100 of today but less than that.
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Law of Diminishing Marginal Utility

Definition and Statement of the Law: The law of diminishing marginal utility describes a familiar and fundamental tendency of human behavior. The law of diminishing marginal utility states that: As a consumer consumes more and more units of a specific commodity, the utility from the successive units goes on diminishing. Law is Based Upon Three Facts: The law of diminishing marginal utility is based upon three facts. First, total wants of a man are unlimited but each single want can be satisfied. As a man gets more and more units of a commodity, the desire of his for that good goes on falling. A point is reached when the consumer no longer wants any more units of that good. Secondly, different goods are not perfect substitutes for each other in the satisfaction of various particular wants. As such the marginal utility will decline as the consumer gets additional units of a specific good. Thirdly, the marginal utility of money is constant given the consumers wealth.
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Summary

Managerial economics is the science of directing scarce resources to manage cost effectively. It consists of three branches: competitive markets, market power, and imperfect markets. A market consists of buyers and sellers that communicate with each other for voluntary exchange. Whether a market is local or global, the same managerial economics apply. A seller with market power will have freedom to choose suppliers, set prices, and use advertising to influence demand. A market is imperfect when one party directly conveys a benefit or cost to others, or when one party has better information than others. An organization must decide its vertical and horizontal boundaries. For effective management, it is important to distinguish marginal from average values and stocks from flows. Managerial economics applies models that are necessarily less than completely realistic. Typically, a model focuses on one issue, holding other things equal.

THANK YOU

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