MANAGERIAL ECONOMICS

L.B. Deshmukh

What is Economics?
Human wants are unlimited

Resources available to satisfy these wants are scarce / limited People wants to maximize their gains Economic agents / society have some economic problems because of scarcity of resources They need to choose scare resources among alternatives (scare resources) based on choice and valuation of alternatives

What is Economics?
Thus economics is the study of how economic agents or societies choose to use scare productive resources that have alternative uses to satisfy wants (needs) which are unlimited and of varying degree of importance Scarcity is a relative term and not the absolute one (ex. excess demand means demand more than supply, unemployment means scarcity of jobs) Desired economic goods (wants) are food, clothing, household goods, education etc. and scare resources are land, natural resources, machine, human resource etc. The role of managers is decision making in evaluating various alternatives and choosing the best among them

MEANING OF MANAGERIAL ECONOMICS

The use of economic analysis in the formulation of business policies : Joel Dean Application of economic theory and the tools of analysis of decision science to examine how an organization can achieve its aims or objectives most efficiently

MANAGERIAL ECONOMICS AND OTHER

BUSINESS DISCIPLINES (Applications of ME)
MANAGERIAL ECONOMICS

MARKETING : Demand Price elasticity

FINANCE : Capital Budgeting Break even analysis Opportunity costs Economic value added

ACCOUNTING : Relevant costs Break even analysis Incremental cost analysis Opportunity costs

STRATEGY : Type of competition Structure Conduct Performance analysis

MANAGEMENT SCIENCES : Linear Programming Regression analysis Forecasting

Applications of Managerial Economics

Risk analysis: Various models are used to quantify risk and asymmetric information and to employ them in decision rules to manage risk. Production analysis: Microeconomic techniques are used to analyze production efficiency, optimum factor allocation, costs and economies of scale. They are also utilized to estimate the firm's cost function. Pricing analysis: Microeconomic techniques are employed to examine various pricing decisions. This involves transfer pricing, joint product pricing, price discrimination, price elasticity estimations and choice of the optimal pricing method.

Capital budgeting: Investment theory is used to scrutinize a firm's capital purchasing decisions.

Applications of Managerial Economics Decisions pertaining to the price of a product and the quantity of the commodity to be produced Decisions regarding manufacturing product/part/component or outsourcing to/purchasing from another manufacturer Choosing the production technique to be employed in the production of a given product

Decisions relating to the level of inventory of a product or raw material a firm will maintain
Decisions regarding the medium of advertising and the intensity of the advertising campaign Decisions pertinent to employment and training Decisions regarding further business investment and the modes of financing the investment

What is Microeconomics?
Study of economic phenomena at micro level i.e. individual and firm level When it establishes cause and effect relationship between two or more economic events at micro level and provide basis of analysis it is positive science When it gives value judgment on what is good and what is bad for society it is a normative science

Uses of Microeconomics
Explains economic behaviour of individual decision makers consumers firms industries Predicts the future course of economic events by establishing cause and effect relationships Contributes in formulating economic policies and examining appropriateness of policies Price theory is being used in business decision making Formulates propositions which maximize social welfare

Limitations of Microeconomic Theories

Assume given level of aggregate data at national level Assume free enterprise system in an economy absence of Government intervention Scope limited in the sense that it concerns with individual items

Basic Questions of an Economy

What goods and services are to produce and in what capacity? How to produce those goods and services i.e. how the scare resources are optimally allocated? How the goods and services so produced are distributed among the households? These questions give rise to another concept of economic rationality. Economic rationality means economic agents see feasible, known and alternative course of action, rank them on priority and choose the one which is highest in ranking order Here economic role of Government is important

Model of an Economy: Real Flows and Money Flows (opposite direction to each other) Factor market (sale & purchase of input) Product market (sale & purchase of goods / services)
Factor Market Determination of Factor Price

Wages & Salaries

Payments for Purchases

Households
Taxes & Fees Transfer Payments

Government Sector
Taxes & Fees Transfer Payments

Business Firms

Product Market Determination of Product Price

Different Types of Economy?

Market / Capitalist Economy: USA / European countries

Command / Socialist Economy: China, Mexico and former USSR

Mixed Economy: India

Concept of Marginalism
Change occurred due to a single unit is know is marginalism or by using additional unit and getting expected additional output It should not be confused with average. Average product of labour = total product / total labour Marginal product of labour = change in product to one unit change in labour Marginalism is used to maximize the satisfaction of net gain or satisfaction must balance sacrifice

Concept of Marginalism
Examples of marginalism are: 1. Marginal labour unit Marginal output of labour 2. Marginal revenue Additional unit sold 3. Marginal cost of production Additional unit produced Nature of relationship between the variables is to be clearly stated The independent variable is to be changed by just one unit at a time to work out the impact The absolute activity level is when marginal benefit = marginal cost (Baumol Principle) The desired activity level is when marginal benefit > marginal cost

Example of Marginalism
No. of TV Spots A: Total Benefit (Sales) Marginal Benefit (Sales) B: Total Cost Marginal Cost A-B: Net Benefit

1
2

20000
34000

14000

4000
8000

4000

16000
26000

3
4

42000
46000

8000
4000

12000
16000

4000
4000

30000 (desired activity level)

30000 (absolute activity level)

5
6

48000
49000

2000
1000

20000
24000

4000
4000

28000
25000

Concept of Incrementalism
Independent variable may change with factors which may not be measured in unit terms (exp. computerization of a firm) Either it is incremental cost or incremental revenue, incremental is more general All marginal concepts are incremental, but all incremental concepts need not be marginal

Concept of Opportunity Cost

It is the cost of sacrificed alternatives. It is by choosing one option by sacrificing the other alternative option Evaluation of one option (choosen) in terms of next best option (sacrificed) Decisions which involve choice must include opportunity cost calculation Opportunity cost may be real monetary implicit- explicit quantitative - qualitative

THE MANAGEMENT REVOLUTION

FOUR COMPONENTS Globalization of markets The spread of information technology and computer networks The dismantling of traditional managerial hierarchies The creation of a new information economy

1. 2. 3.
4.

OBJECTIVES OF A FIRM
PROFIT MAXIMIZATION MAXIMIZATION OF SALES MAXIMIZING THE WEALTH OF STOCKHOLDERS MAXIMIZATION OF SATISFACTION REASONABLE AND SECURE PROFITS AVOIDANCE OF LOSS PAYMENT OF GOOD WAGES AND PROMOTION OF WELFARE OF WORKERS GROWTH MAXIMIZATION UTILITY MAXIMIZATION BY MANAGERS

Techniques of Managerial Economics

Theory of the firm Theory of consumer behavior Theories associated with different market structures Optimization Statistical estimation Forecasting

Nature of Managerial Economics ( Brief)

Microeconomics Normative economics Pragmatic Uses theory of firm Takes the help of macroeconomics Aims at helping the management A scientific art Prescriptive rather than descriptive

Scope of Managerial Economics ( Brief)

Theory of Demand Theory of Production Theory of Exchange or Price Theory Theory of Profit Theory of Capital and Investment Environmental Issues

Importance of managerial economics:

Reconciling traditional theoretical concepts to the actual business behavior and conditions Estimating economic relationships Predicting relevant economic quantities Understanding significant external forces Basis of business policies