Published on March 3, 2014
1 UNIT-I MANAGERIAL ECONOMICS Managerial economics: Managerial economics, as the name it implies, is an offshoot of two distinct disciplines: economics and management. DEFINITION: Spencer and Siegelmen define managerial economics as “the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning”. Birgham and pappasbelive that managerial economics is “the application of economic theory and methodology to business administration practice”. Michel R Baye defines managerial economics as “the study of how to direct scarce resources in a way that most efficiently achieves managerial goal” INTRODUCTION TO ECONOMICS: Economics is a study of human activity both at individual and national level. The economists of earlier age treated economics merely as the” Science of Wealth” Earning money and spending this money to satisfy our wants such as food, clothing, shelter and others. Such activities of earning and spending money are called „economic‟ activity. ADAM SMITH was the father of economics. DEFINITIONS OF ECONOMICS: 1. According to Adam Smith, “The study of nature of national wealth”. 2. Dr. Alfred Marshall, ”Economics is a study of man‟s actions in the ordinary business of life; it enquires how he get his income and how he uses it.” 3. A.C.Pigou, “the study of economic welfare that can be brought directly and indirectly, into relationship with the measuring rod of money”. 4. Prof. Lionel Robbins, “The science which studies human behavior as a relationship between ends and scarce means which have alternative uses”. Salient features of economics according to Prof. Robbins, 1. Unlimited Wants: we have unlimited no.of wants or ends and it is difficult to satisfy all these. 2. Scarce Resources: we have limited or scarce resources. The resource are said to be scarce when they are limited in supply with relation to total demand. 3. Alternative Uses: scarce resources can be put to alternative uses. In other words, a particular commodity or a good can be put to different alternative uses. 4. Choice: of the above alternatives, which one I do choose? How do I behave in satisfying my unlimited wants with the scarce resources?
2 MICRO ECONOMICS: The study of an individual consumer or firm is called micro economics. Also called ‘the theory of firm’.Micro economics deals with the problems of single individual or single problem. Managerial economics has its roots in micro economics. MACRO ECONOMICS: The study of aggregate or total level of economic activity in a country is called macro economics. it studies the flow of economic resources or factors of production. The important tools of macro economics include national income analysis, balance of payments, theories of employment, and so on. Macro economics provides the necessary framework in term of government policies etc., for the firm to act upon dealing with analysis of business conditions. Factors for production:- Land - Labour - Capital - Organization - Technology Management:-Management is the science and art of getting things done through people in formally organized groups. Functions of management are planning, organizing, staffing, directing and controlling. Manager:A manager gets things done through people in an organization. Resources: men, material, machines, money and technology. A manager is responsible for achieving the targeted results. The manager‟s task is to maximize the profits of the firm and minimizes the costs. He has to take such decisions: Planning the production, fixing the selling price, adding a particular product or dropping it from the product line. NATURE OF MANAGERIAL ECONOMICS: Managerial Economics Perhaps, the youngest of all social sciences. It has the basic features of economics. 1. close to micro economics: Managerial economics considered with finding the solutions for different managerial problems of a particular firm. Thus it is more close to micro economics. 2. Operates against the backdrop of macro economics: The macro economic conditions of the economy are also seen as limiting factor for the firm to operate. In otherwords the managerial economist has to be aware of the limits set by macro economic conditions in such as govt. industrial policy, inflation, and so on. 3. Normative statements:
3 A normative statement usually implies or include the words „ought‟ or „should‟. They reflect people moral attitudes and are expressions of what a team of people ought to do. 4.Prescriptive actions: (goal oriented). Prescriptive actions are goal oriented. Given a problem and objectives of the firm, it suggests the course of action from the available alternatives for optimal solution. 5.Applied in nature:(help to managers for decision making). „Models‟ are built to reflect the real life complex business situations and these models are of immense help to managers for decision making. The different areas where models are extensively used include inventory control, optimization, project management etc. 6. Offers scope to evaluate each alternative: managerial economics provides an opportunity to evaluate each alternative in terms of its cost and revenues. The managerial economist can decide which is the better alternative to maximum the profits for the firm. 7. Interdisciplinary: The contents, tools of managerial economics drawn from different subjects such as economics, management, statistics, accountancy, psychology, organizational behaviour, sociology, etc. 8. Assumptions and limitations: The concept and theory of managerial economics is based on certain assumptions and such as their validity is not universal. Where there is change in assumptions, the theory may not hold good. SCOPE OF MANAGERIAL ECONOMICS:The main focus in managerial economics is to find an optimal solution to give a managerial problem. The problem may relate to production, reduction or control of costs, make or buy decisions, inventory decisions, capital management or profit planning, investment decisions or human resource management. Managerial economist makes uses of the concepts, tools and techniques of economics and other related disciplines to find an optimum solution to a given managerial problem. Production analysis: Land , labour, capital and organisation are four major contributors of factors of production .rent,wages,interest, and profit are return to the factors of production.these factors are used for the people howmuch rawmateirial required for producing the products.
4 Reduction of cost: By using this managerial economics we will reduce the manufacturing cost as well as other costs of the products. Inventory decisions: Homuch inventory is required for the organisation and how we always maintain demand equal to suply it also shows by managerial economoics. Investment decisions: By using managerial economics the business people will estimate howmuch investment is required for smooth running of the organisation. Profit planning: Depending on the manufacturing cost we should code the price by considering some amount of profits. Make and buy decisions: This M.E useful to the people for howmuch rawmaterial they need for their organisation and howmuch they have s output for reaching the demand. Capitil budgeting: Long term decisions need a careful analysis expected returns ,risk,and uncertainity. Project management: how much time required for completion of project or particular work. THE MAIN AREAS OF MANAGERIAL ECONOMICS: 1. Demand decisions: The analysis and forecasting of demand for a given product and service is the first task of managerial economist. The impact of changes in price, income levels and prices of alternative products or services assessed and accordingly the demand decisions are taken to maximize the profits. 2. Input-output decisions: How much raw material we required for getting the desired output. The cots of inputs in relation to output studied to optimize the profits. it is necessary for the manager to know the relationship between the cost and output both in short run and long run to position his products in the competitive environment. 3. Price-output decisions: How to code the price for the products we will take the decision by using managerial economics. If our product is new one in the market we should code a) Equal to competitors b) Less than competitors c) Differentiate price If our product familiar in the market we should consider manufacturing or operational cost. 4. Profit-related decisions: It is necessary to any businessman has to know about whether his firm runs in a profitable way or not. for knowing the firm‟s profitability position the business man or manager take the help of some techniques they are break even analysis, ratio analysis.
5 5. Investment decisions: By using managerial economics the business people will estimate howmuch investment is required for smooth running of the organisation. Investment decisions are also called capital budgeting decisions. These decisions are irreversible. 6. Economic forecating and forward planning: Economic forecating leads to forward planning. It is necessary to forecast the trends in the economy to plan for the future in terms of investments, profits, products, products, and markets.this will minimise the risk and uncertainity about the future. LINKAGES WITH OTHER DISCIPLINES:Economics: M.E is the offshoot of economics and hence the concepts of managerial economics are basically economic concepts. Economics and managerial economics, both are concerned with the problems of scarcity and resource allocation. Economics provides the managerial economist An understanding of general economic environment within which the firm operates. A framework to solve the resource allocation problems. Operations research: Decision making is the main focus in operation research and managerial economics. Operational research focuses on solving the managerial problems. O.R is a tool for finding the solution for managerial problem. For solving the managerial problems some O.R models are extensively used they are linear programming, queuing, optimization techniques and soon. Mathematics: Managerial economist is concerned with estimating and predicting the relevant economic factors for decision making and forward planning. Extensively used mathematic techniques are algbra, exponentials, vectors, and soon. Statistics: Statistics deals with different techniques useful to analyze the cause and effect relationship in a given variable or phenomenon. It helps manager to deal with the situations of risk and uncertainty through its techniques such as correlation, regression, time series, probability and soon. Accountancy: The accountant provides accounting information relating to costs, revenues, profit/loses etc. the main objective of the accounting function is to record, classify and interpret the given accounting data. The managerial economist depends upon the accounting data for decision making and forward planning. Psychology: Consumer psychology is basis on which managerial economist acts upon. Psychology contributes towords understanding the behavioural implications, attitudes, motivations of each micro economic variables such as consumer, supplier/seller, investor, worker/ an employee. Organizational behaviour: Organization behaviour study and develop behaviour models of the firm i.e how to maintain relations with managers, peers and with workers.
6 MANAGERIAL ECONOMICS DECISION MAKING PROCESS: Business decision making is essentially a process of selecting the best out of alternative opportunities open to the firm. The steps below put managers analytical ability to test and determine the appropriateness and validity of decisions in the modern business world. Following are the various steps in decision making process: 1. 2. 3. 4. 5. 6. 7. Establish objectives Specify the decision problem Identify the alternatives Evaluate alternatives Select the best alternatives Implement the decision Monitor the performance Modern business conditions are changing so fast and becoming so competitive and complex that personal business sense, intuition and experience alone are not sufficient to make appropriate business decisions. It is in this area of decision making that economic theories and tools of economic analysis contribute a great deal. BASIC ECONOMIC TOOLS IN MANAGERIAL ECONOMICS FOR DECISION MAKING: Economic theory offers a variety of concepts and analytical tools which can be of considerable assistance to the managers in his decision making practice. These tools are helpful for managers in solving their business related problems. These tools are taken as guide in making decision. Following are the basic economic tools for decision making: 1. 2. 3. 4. 5. Opportunity cost Incremental principle Principle of the time perspective Discounting principle Equi-marginal principle 1) Opportunity cost principle: Opportunity cost refers to „costs of next best alternative foregone‟. We have scarce resources and all these have alternative uses. By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. for e.g. a) The opportunity cost of the funds employed in one‟s 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. 1000as 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.
7 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. 2) Incremental principle: Incremental costs are the „added coats of a change in the level or nature of activity‟. It is also called differential cost. It is related to the marginal cost and marginal revenues, for economic theory. Incremental concept involves estimating the impact of decision alternatives on costs and revenue, emphasizing the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or whatever may be at stake in the decisions. 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 – it increases revenue more than costs it decreases some costs to a greater extent than it increases others it increases some revenues more than it decreases others and it reduces cost more than revenues” 3) 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. The very important problem in decision making is to maintain the right balance between the long run and short run considerations. For example; Suppose there is a firm with a temporary idle capacity. An order for 5000 units comes to management‟s attention. The customer is willing to pay Rs 4/- unit or Rs.20000/- for the whole lot but not more. The short run incremental cost(ignoring the fixed cost) is only Rs.3/-. There fore the contribution to overhead and profit is Rs.1/- per unit (Rs.5000/- for the lot) Analysis: From the above example the following long run repercussion of the order is to be taken into account: 1) If the management commits itself with too much of business at lower price or with a small contribution it will not have sufficient capacity to take up business with higher contribution. 2) If the other customers come to know about this low price, they may demand a similar low price. Such customers may complain of being treated unfairly and feel discriminated against. In the above example it is therefore important to give due consideration to the time perspectives. “a decision should take into account both the short run and long run effects on
8 revenues and costs and maintain the right balance between long run and short run perspective”. 4) 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 reasonsi) 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, today‟s Rs.100/- can be invested so as to earn interest say as 8% so that one year after Rs.100/- will become 108 5) Equi – marginal Principle: This principle deals with the allocation of an available resource among the alternative activities. According to this principle, an input should be so allocated that the value added by the last unit is the same in all cases. This generalization is called the equi-marginal principle.
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