UNIT - I: INTRODUCTION TO BUSINESS ECONOMICS: Definition - Nature and Scope - The Role of economists in an organization; BASIC ECONOMIC PRINCIPLES: The concept of Opportunity Cost - Discounting principle - Time perspective - Incremental Concept – Equi-Marginalism; OBJECTIVES OF THE FIRM: Profit Maximization - Sales Maximization and other objectives.

1. UNIT 1
Introduction to Business Economics
Introduction:
Human wants are unlimited and moreover ever recurring. These wants are either basic needs
or comfort or even luxuries in respect of food, clothing, shelter, health, education and communication
etc.
The economics is concern with the study of economic activities of both individuals and
nations. Its primary deals with human wants, all sorts of resources. Their employment, the production
and exchange and consumption of goods and services.
Managerial Economics:
Managerial economics is the application of economic principles and analysis to the problem
of formulating rational managerial decisions. It is concerned with determining means of achieving the
given objectives in the most efficient manner.
Definition ofBusiness Economics
“Managerial Economics is concern with the application of economic concepts and economic analysis
to the problem of formulating rational managerial decisions”
-----Edwin Mansfield-----
managerial economics as “the integration of economic theory with business practice for the
purpose of facilitating decision making and forward planning by management”.
––––SpencerSiegel man––––
Nature of managerial Economics:
Managerial economics is concern with the Business firm and the economic problem, that that
every business management need to solved.
Managerial Economics, perhaps the youngest of all the social sciences. Since it originates
from economics. It has basic features of economic such as assuming that other things reaming the
same the assumption is made to simplify the complexity of the managerial aspects under study in a
dynamic business environment.
Managerial Economics
Micro Economics Macro Economics
Micro economics: The micro economic theory is also known as the price theory. It provides various
concepts for the determination of the prices of commodities, services and factors of production. The
micro economic analysis deals with the problems of one individual firm, industry and consumer. In
the case of managerial economics micro economics helps in study what is going in the firm. The chief
source of concept and analytical rules for management economics.
Macro Economics: We know that the decision of the firm are made all most always with in the broad
frame work of economic environment with in which the firm operates known as macro-economic
conditions with regard to these conditions we may stress 3 points.
1- In economy in which the business operates is predominantly a fire and price economy using
prices & market
2- The present day economy is the one undergoing rapid technological and economic changes.
3- The immense of government in economic affairs has increase in recent times and there is no
livelihood, the intervention will stable.
Macro Economics Micro Economics

2. Nature (OR) Characteristics (OR) Features ofmanagerial economics:
The following are the features of managerial economics
1) Close to managerial economics:
Managerial economics is concern 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 ofmacroeconomics:
The macro economic conditions of the economy are also seen as limiting factors for the firm to
operate in other words the managerial economics has to be aware of the limits set by the macro
economic conditions such as government and industrial policy, inflation and so on.
3) Normative statements:
The normative statement usually includes or implies the words “ought: or should. They reflect
peoples moral attitude’s and are expressions of what a team of people ought to do, for instance it
deals with statement such as “government of India should open up the economy”.
4) Prescriptive actions:
Prescriptive action is goal oriented. Given a problem and the objectives of the firm. It suggests the
course of action from the available alternatives for optimal solution. It is also explains whether the
concept can be applied in given context or not.
5) Applied in nature:
Models are built to reflect the real life complex business situations and these models are immense
help to managers for decision making. The different areas where models are extensively used in
inventory control, optimization, project management etc.
6) Offers scope to evaluate each alternative:
Managerial economics is provides an opportunity to evaluate each alternative in terms of its costs
and revenue. The managerial economist can decide which is the better alternative to maximize the
profits for the firm.
7) Interdisciplinary:
The contents, tools and techniques of managerial economics are drawn from different subjects
such as economics, management, mathematics, statistics, accountancy, psychology, organizational
behavior, sociology etc.
8) Assumptions and limitations:
Every concept and theories of managerial economics is based on certain assumptions and as much
their validity is not universal where there is change in assumptions the theory may not hold at all.
Scope of Managerial Economics:
As regards to the scope of managerial economics no uniform pattern followed by various
authors. However the following aspects may be said to generally farm under managerial
economics
1) Demand analysis and forecasting
2) Cost analysis
3) Production and Supply analysis
4) Pricing decision, policies and practices
5) Profit management
6) Capital management
These aspects may also call as subject matter of managerial economics.
In recent years, there is trend towards integration of managerial economics and operation research
hence techniques such as linear programming, inventory modals etc. have also come to be
regarded a part of managerial economics.

3. 1) Demand analysis and forecasting:
A business firm is an economic organism. Which transforms productive resources into goods
that of to be sold in a market. A major part of managerial economics making depends upon
accurate estimates of demand. Demand analysis helps identifying the various factors influencing
the firms for a firm’s product and thus provides guidelines to manipulating demand the chief
topics.
2) Cost analysis:
A study of economic costs combined with the data drawn from the firms accounting register
can yield significant cost estimates that are uses for management decisions. The factors cause in
variation cost must be recognize and allowed for if management is to arrive at cost estimates
which are significant for planning purposes. Discovering economic cost and being able to
measure then are necessary steps for more effective profits, planning, cost control and obtain
sound pricing practices.
3) Production and supply analysis:
Production analysis is narrower is scope than cost analysis, production analysis mainly deals
with different production functions and their managerial functions and supply analysis deals with
various aspects of supply of commodities.
4) Pricing decisions,policiesand practices:
Pricing is very important area of managerial economics. Impact price is the revenue of a firm
and as such the success of a business firm largely depend on the corrections of the price
decision taken by the important aspects deals with the price determination in various market
firms, pricing methods, product line, price forecasting mainly deals in the pricing decisions.
5) Profit management:
Business firms are generally involved in making profits and the profits are measures of
success. Uncertainty in profits exists because of variation in cost & revenue. In a word uncertainty
point of view profit planning is very difficult.
6) Capital management:
The most complex and trouble problems of business manager are capital, investment. Because
large sums are involved. Problems are so complex and their disposal requires time and labour.
Briefly capital management implies planning and control of expenditure.
The Role ofEconomist in an Organization
A managerial economist helps the management by using his analytical skills and highly
developed techniques in solving complex issues of successful decision-making and future advanced
planning.
The role ofmanagerial economist can be summarized as follows:
1. He studies the economic patterns at macro-level and analysis its significance to the specific
firm he is working in.
2. He has to consistently examine the probabilities of transforming an ever-changing economic
environment into profitable business avenues.
3. He assists the business planning process of a firm.
4. He also carries cost-benefit analysis.
5. He assists the management in the decisions pertaining to internal functioning of a firm such as
changes in price, investment plans, type of goods /services to be produced, inputs to be used,
techniques of production to be employed, expansion/ contraction of firm, allocation of capital,
location of new plants, quantity of output to be produced, replacement of plant equipment,
sales forecasting, inventory forecasting, etc.

4. 6. In addition, a managerial economist has to analyze changes in macro- economic indicators
such as national income, population, business cycles, and their possible effect on the firm’s
functioning.
7. He is also involved in advising the management on public relations, foreign exchange, and
trade. He guides the firm on the likely impact of changes in monetary and fiscal policy on the
firm’s functioning.
8. He also makes an economic analysis of the firms in competition. He has to collect economic
data and examine all crucial information about the environment in which the firm operates.
9. The most significant function of a managerial economist is to conduct a detailed research on
industrial market.
10. In order to perform all these roles, a managerial economist has to conduct an elaborate
statistical analysis.
11. He must be vigilant and must have ability to cope up with the pressures.
12. He also provides management with economic information such as tax rates, competitor’s
price and product, etc. They give their valuable advice to government authorities as well.
13. At times, a managerial economist has to prepare speeches for top management.
Basic Economic Principles
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
 Opportunity cost
 Incremental principle
 Principle of the time perspective
 Discounting principle
 Equi-marginal principle
 Opportunity cost principle:
By the opportunity cost of a decision is meant the sacrifice of alternatives required by that
decision.
Example: The opportunity cost of using a machine to produce one product is the earnings
foregone which would have been possible from other products.
It’s clear now that opportunity cost requires ascertainment of sacrifices. It a decision involves
no sacrifices, its opportunity cost is nil. For decision making opportunity costs are the only
relevant costs.
Opportunity Cost = Return of Most Lucrative Option - Return of Chosen Option
 Incremental principle:
It is related to the managerial cost and managerial 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
A decision is obviously a profitable one if
o It increases revenue more than costs
o It decreases some costs to a greater extent than it increases others
o It increases some revenues more than it decreases others and
o It reduces cost more than revenues

5.  Principle of Time perspective:
Managerial economics are also concerned with the short run and long run effects of decisions
on revenues as well as costs. The very important problem is decision making is to maintain the
right balance between the long run and short run considerations.
 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 100/- today or 100/- next
year. Naturally he will choose 100/- today. This is true for two reasons.
First one: The future is uncertain and there may be uncertainty in getting 100/- if the present
opportunity is not availed of
Second one: Even if he is sure to receive the gift in future today’s 100/- can be invested so as
to earn interest say as 8% so that one year after 100/- will become 108.
 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.
Suppose a firm has 100 units of labour at its disposal. The firm is engaged in four activities
which need labour services. Viz, A B C and D. it can enhance any one of these activities by
adding more labour but only at the cost of other activities.
Firm Objectives
Profit Maximization
In the conventional theory of the firm, the principal objective of a business firm is
profit maximisation. Under the assumptions of given tastes and technology, price and output of a
given product under perfect competition are determined with the sole objective of maximising
profits. The firm is supposed to act as one of a large number of producers which cannot influence
the market price of the product.
It is the price-taker and quantity-adjuster. Thus the demand and cost conditions for
the product of the firm are determined by factors external to the firm. In this theory, maximum
profits refer to pure profits which are a surplus above the average cost of production. It is the
amount left with the entrepreneur after he has made payments to all factors of production,
including his wages of management.
In other words, it is a residual income over and above his normal profits. It is a
necessary payment for an entrepreneur to stay in the business. The rules for profit
maximizationare (1) MC = MR and (2) MC should cut MR from below.
Baumol’s Sales Maximisation:
Baumol’s findings of oligopoly firms in America reveal that they follow the sales
maximization objective. According to Baumol, with the separation of ownership and control in
modern corporations, managers seek prestige and higher salaries by trying to expand company
sales even at the expense of profits.
Being a consultant to a number of firms, Baumol observes that when asked how their business
went last year, the business managers often respond, “Our sales were up to three million dollars”.
Thus, according to Baumol, revenue or sales maximization rather than profit maximization is
consistent with the actualbehaviour of firms.
Baumol cites evidence to suggest that short-run revenue maximization may be consistent with
long-run profit maximisation. But sales maximization is regarded as the short-run and long-run
goal of the management. Sales maximization is not only a means but an end in itself. He gives a

6. number of arguments is support of his theory. According to him, a firm attaches great importance
to the magnitude of sales and is much concerned about declining sales.
If the sales of a firm are declining, banks, creditors and the capital market are not prepared to
provide finance to it. Its own distributors and dealers might stop taking interest in it. Consumers
might not buy its products because of its unpopularity. But if sales are large, the size of the firm
expands which, in turn, means larger profits.
Baumol’s model is illustrated in Figure 2 where TC is the total cost curve, TR the total
revenue curve, TP the total profit curve and MP the minimum profit or profit constraint line. The
firm maximizes its profits at OQ level of output corresponding to the highest point В on the TP
curve. But the aim of the firm is to maximize its sales rather than profits.
Its sales maximization output is OK where the total revenue KL is the maximum at the
highest point of TR. This sales maximization output OK is higher than the profit maximization
output OQ. But sales maximization is subject to minimum profit constraint.
Suppose the minimum profit level of the firm is represented by the line MP. The output OK will
not maximize sales as the minimum profits OM are not being covered by total profits KS.
For sales maximisation, the firm should produce that level of output which not only covers
the minimum profits but also gives the highest total revenue consistent with it. This level is
represented by OD level of output where the minimum profits DC (=OM) are consistent with DE
amount of total revenue at the price DE/OD,(i.e., total revenue/total output).
Criticism:
The sales maximization objective of the firm has been criticised on a number of points.
First, Rosenberg has criticised the use of the profit constraint for maximising sales. He has
shown that it is difficult to specify exactly the relevant profit constraint for a firm, and choose the
sales maximization and minimum profit constraint in Baumol’s analysis.
Second, if expenditure on advertising is introduced in Baumol’s theory, the likelihood of sales
maximization is increased.
But this view of Baumol is not realistic because the expenditure on advertising increases or
decreases with the rise or fall in output.
Third, the objective of sales maximization subject to profit constraint implies that “the firm
will not make any sacrifice in sales no matter how large an increment in wealth would thereby be
achievable.” Despite these criticisms, the sales maximization is an important objective being
pursued by business firms.
Marris Growth Maximization:
Robin Marris in his book The Economic Theory of ‘Managerial’ Capitalism (1964)
has developed a dynamic balanced growth maximizing theory of the firm. He concentrates on the
proposition that modern big firms are managed by managers and the shareholders are the owners who
decide about the management of the firms.
The managers aim at the maximization of the growth rate of the firm and the shareholders aim
at the maximization of their dividends and share prices. To establish a link between such a growth rate

7. and the share prices of the firm, Marris develops a balanced growth model in which the manager
chooses a constant growth rate at which the firm’s sales, profits, assets,etc.,grow.
If he chooses a higher growth rate, he will have to spend more on advertisement and on R & D in
order to create more demand and new products.
He will, therefore, retain a higher proportion of total profits for the expansion of the firm.
Consequently, profits to be distributed to shareholders in the form of dividends will be reduced and
the share prices will fall. The threat of take-over of the firm will loom large among the managers.
As the managers are concerned more about their job security and growth of the firm, they will choose
that growth rate which maximizes the market value of shares, give satisfactory dividends to
shareholders, and avoid the take-over of the firm.
On the other hand, the owners (shareholders) also want balanced growth of the firm because it
ensures fair return on their capital. Thus the goals of the managers may coincide with that of owners
of the firm and both try to achieve balanced growth of the firm.
Criticism:
Marris’ growth-maximization theory has been severely criticized for its over-simplified
assumptions.
1. Marris assumes a given price structure for the firms. He, therefore, does not explain how prices of
products are determined in the market.
2. It ignores the problem of oligopolistic interdependence of firms.
3 This model also does not analyze interdependence created by non-price competition.
4. The model assumes that firms can grow continuously by creating new products. This is unrealistic
because no firm can sell anything to the consumers. After all, consumers have their preferences for
certain brands which also change when new products enter the market.
5. The assumption that all major variables such as profits, sales and costs increase at the same rate is
highly unrealistic.
6. It is also doubtful that a firm would continue to grow at a constant rate, as assumed by Marris. The
firm might grow faster now and slowly later on.
Despite these criticisms, Marris’ theory is an important contribution to the theory of the firm in
explaining how a firm maximizes its growth rate.
Output Maximization:
Milton Kafolgis suggests output maximization as the objective of a business firm.
According to him, “The performance of firms frequently is measured directly in terms of physical
output with revenue occupying a secondary position.” Thus Kafolgis prefers output maximization
both to profit maximization and revenue maximization as the objective of a firm.
Given some minimum level of profits, a firm wants to maximize its output. It will spend its
funds on increasing its production rather than on advertising. Thus the firm will produce a larger
output and its revenue sales may be less than the sales-maximization firm.
Criticism:
Kafolgis’ emphasis on output maximization as against Baumol’s sales maximization is not a
satisfactory explanation of the objective of a firm. If the firm simply aims at output maximization
without sales maximization, it may not be in a position to survive for long. Both the objectives are
complementary rather than competitive.
Second, if the firm is a multiproduct firm how the output of different products, say radio, TV, and
watches can be added. It is only the value of sales of each product that can be added together. This is
nothing but maximization of sales.
Security Profits:

8. Rothschild has put forward the view that the firm is motivated not by profit
maximization but by the desire for security profits. In his words, “There is another motive which is
probably of a similar order of magnitude as the desire for maximum profits, the desire for
security profits.”
Rothschild argues that so far as the objective of profit maximization is concerned, it is valid
only under perfect competition or monopolistic competition in which the number of firms is very
large, and the individual firm is not faced with the security problem, so is the case with the monopoly
firm.
But under oligopoly, a firm is not motivated by profit maximization. It is engaged in a
constant struggle to achieve and maintain a secure position in the market like a military strategist.
The desire to increase its security leads to the struggle for position and to the setting of a price which
will not be so low that it provokes retaliation from rivals, nor so high that it encourages new entrants,
and it must be within the range which will maintain a protection against the aggressive policies of the
rivals and brine about a reasonable profit above its cost of production Rothschild’s security-profits
motive is nothing else but profit maximization in a little different garb.
Satisfaction Maximization:
Scitovsky favors maximization of satisfaction in preference to the profit-maximization
objective of the firm. He is concerned with managerial effort and the distaste that managers have for
work. According to him an entrepreneur would maximize profits only if his choice between more
income and more leisure is independent of his income. In other words, the supply of entrepreneurship
should have zero income elasticity.
But an entrepreneur does not aim at profit maximization. He wants to maximize satisfaction
and keep his efforts and output below the level of maximum profits.
This is because as his income (profit) increases, he prefers leisure to effort (output)
Scitovsky’s maximization of satisfaction hypothesis is illustrated in Fig 3 where NP is the net profit
(income) curve, the difference between the TR and TC curves, which have not been drawn to simplify
the analysis. Thus profits are measured on the vertical axis.
Assuming managerial effort and output to be proportional output is measured along the
horizontal axis from P toward О so that at point P output is zero. Since more efforts mean less leisure,
and vice versa,leisure is also measured on the horizontal axis from О toward P.
The curves L1 and L2 are the entrepreneur’s indifference curves which represent his levels of
satisfaction yielding combinations of his money income (profits) and leisure.
The entrepreneur’s satisfaction would be the greatest at the level of output where the net
profit curve is tangential to an indifference curve. In the figure, M is his point of maximum
satisfaction where the net profit curve NP is tangent to his indifference curve L2. He will be producing
PQ1 output.
This level of output is less than the profit-maximization output PQ. The entrepreneurial
profits, Q1M1, at PQ1 output level are also less than the maximum profits QM at PQ level of output.
At Q1M1, level of profit, the entrepreneur maximizes his satisfaction because he enjoys OQ1 leisure
which is QQ1 more than he would have enjoyed under profit maximization (OQ).
Criticism:
Scitovsky has himself pointed out two weaknesses in his satisfaction maximization theory
first; it is unrealistic to assume that entrepreneur’s willingness to work is independent of his income.
After all the ambition of an entrepreneur to make money cannot be dampened by a rising income.
Second, to say that an entrepreneur maximizes his satisfaction is a perfectly general
statement, it says nothing about his psychology or behavior. Therefore, it is only a truism and is
devoid of any empirical content.