Introduction to Introduction to Managerial EconomicsManagerial Economics

Prepared byPrepared by::Pankaj KumarPankaj Kumar

Rai Business SchoolRai Business School

Contents:

• What is Economics.• What is Management.• What is Managerial Economics• Definition of Managerial Economics.• Definition of Economics.• Scope of Managerial Economics.• Nature of Managerial Economics.• Its relationship with other Economics.• Introduction to Firm.

Origin of the term Economics

The term economics lies in the Greek word oikon and nomos, which mean ‘law of households’.

What is Economics?

According to Alfred Marshall “Economics is the study of mankind in the ordinary business of life.

Lionel Robbins says “Economics is a social science concerned with allocation of scarce resources among competing ends.

Economics as a science is considered with the problem of allocation of scarce resources among competing ends.

What is Managerial Economics?

Mc Nair and Meriam says “Managerial Economics is the use of economic modes of thought to analyze business situation.”

Brigham and Pappas says “Economic is the application of economic theory and methodology to business administration practices.”

Hague says “Managerial Economics is a fundamental academic subject which seeks to understand and to analyze the problem of decision making.”

Decision Problem

Managerial EconomicsTraditionalEconomics

Decision Sciences(Tools and tech-

niques of analysis

Optimal Solution to Business Solution

Nature of Economics?

Main Features of economics are as follows: Assumptions based: One cannot perform controlled

experiments in economics to deduce theories. Two branches of study: Micro and Macro Economics Positive and normative: Positive economics deals

with the study of the things what they are. Another is concerned with value judgments about what ought to be.

Interdisciplinary: Economics is closely related to other disciplines such as Politics, History, Psychology, Ethics, Anthropology, mathematics and Statistics.

Nature and Scope of Managerial Economics

Brigham and Pappas believe “ Managerial Economics is the application of economic theory and methodology to business administration practice.”

Pappas and Hirschey “Managerial Economics applies economic theory and methods to business and administrative decision making.”

Michael R Baye “The study of how to direct scarce resources in a way that most efficiently achieves a managerial goal.”

From the above definitions:

Managerial economics refers to the applications of principles of economics to solve managerial problems such as minimizing cost or maximizing production and productivity.

Directs the utilization of scarce resources in a goal-oriented manner.

Facilitates forward planning and decision-making. Examine how an organization can achieve its aim and objectives

most efficiently.

Nature of managerial economics:

Features of managerial economics: Close to microeconomics: Concerned with finding solution for

managerial problems. Operates against the backdrop of macroeconomics: It has to be

aware of the limits set by the macroeconomic conditions such as the government’s industrial policy.

Normative Statement: It reflects people’s moral attitude and expressions are of what a team of people ought to do.

Perspective Action: Business Economics is Goal Oriented. Applied in Nature: Models are built to reflect the real life

complex business situation and these models are of immense help to decision-making.

Nature of Managerial Economics contd…

Offers scope to evaluate each alternative: Managerial Economics can decide which is the better alternative to maximize profits of the firm.

Interdisciplinary: The contents, tools and techniques of managerial economics, are drawn from different subjects.

Assumptions and limitation: Every concept is based on assumption and as such their validity is not valid.

Scope of Managerial Economics.

Focus is to find an optimal solution to a given managerial problem.

Problem may relate to production, reduction or control of cost, determination of price of a given product or service, make or buy decision, inventory decision.

Problems may also relate to capital management or profit planning and management, investment decision or human resource management.

Concepts and Techniques of

ManagerialEconomics

Managerial decision areas:Managerial decision areas:•Production•Control of Cost•Determination of price•Make or buy decision•Inventory decision•Capital management•Profit Planning Control•Investment Decisions

Optimum Solutions

Appliedto for

Areas of Managerial Economics

The main areas of managerial economics are: Demand Decision: The impact of change in prices, income level

and prices of alternative products/services are assessed and, accordingly, the decisions are taken to maximize profits.

Input-Output decision: The cost of input in relation to output are studied to optimize profits. The behaviour of cost at different levels of production is assessed here.

Price-output Decision: Here production is ready and the task is to determine the price in different market situations as perfect and imperfect markets ranging from monopoly to oligopoly.

Profit-related Decision: Here the techniques such as break-even analysis cost reduction and control, and ratio analysis, to ascertain the level of profit.

Areas of Managerial Economics contd…

Investment Decision: This is also called capital budgeting decisions. These involve commitment to large funds, which determine the fate of the firms.

Economic forecasting and forward forecasting: It leads to forward planning. The firm operates in an environment which is dominated by the external and internal factors.

External Factors such as government policy, competition, etc.

Internal Factors such as policies and procedures relating to finance, people, market and products.

Introduction to Firm

What is a Firm?

A firm is understood as an organization which converts input into output.

Inputs are: Plants, machinery, tools, inventories which includes unsold finished and semi-finished goods and raw-material.

Outputs are: Goods and services they produce.

Classification of firmsClassification of firms

Private PublicJoint

SectorFirms

Proprietor-ship

Partner-ship

CorporationsCorporations

Firms Objectives

Profit maximization.1. Innovation Theory2. Risk Bearing Theory3. Monopoly Theory4. Friction Theory5. Managerial Efficiency Theory

Firms Value maximization Sales Maximization Subject to some predetermined profit Size maximization Long run survival Management entity Maximization Satisfying Non-Profit Objectives

Firms Constraints

Decision making by firms are often subject to certain restrictions or constraints. Those restrictions are of the following type:

1. Resource constraints

2. Output quality constraints

3. Legal constraints

4. Environmental Constraints

Principles for profit maximization

Profit Maximization means the generation of largest absolute amount of profit over the time period being analyzed.

There are two types of time period: Short run and Long run.

Consequently there are Short run Profit maximization and Long run Profit maximization.

Short Run

Short run is defined as a period where adjustments to changed conditions are only partial. E.g. If demand for the product for a firm increases, in the short run it can meet the increased demand through changes in man-hours and intensive use of existing machinery but it cannot increases its production capacity.

Long Run

Long run is a period where adjustments to changed circumstances is complete. E.g. The above mentioned firm can meet the increased demand in the long run by making changes in its production capacity or by setting up an additional plant, besides changes in man-hours and intensive use of its existing machinery.

Opportunity Cost Principle

Opportunity cost principle means the sacrifice of alternative required by that decision.

Opportunity cost requires ascertainment of sacrifices.

For decision making the opportunity cost is the only relevant cost.

An input should be so allocated that, the value added by the last unit is the same in all the cases. The generalizations is called as the “Equi-Marginal Principle.”

Discounting Principles

The fundamental ideas in economics is that a Re. 1 tomorrow is worth less than a Re 1 today.

Incremental Principle

Incremental concepts involve, estimating the impact of decision alternative on cost and revenues, emphasizing the changes in total cost and total revenue resulting from changes in prices, product, producers, investment or whatever may be at stake in the decision.