Module 1_ME.ppt

•Managerial economics and business economics are
used interchangeably. Of late however managerial
economics has become more popular.
•Managers have to take decisions everywhere. They
face situations daily which require decision making
ability.
•The nature of these problems mainly economic,
that is, making the best of the scarce resources.
The managers have to juggle a situation in which
they are required to maximize the output with
scarce resource viz., land ,labour, capital.

Types of problems; Problems faced by management
executives at various levels are twofold viz.,
1.Decision making
• It is process of selecting one action from two or more
alternative course of action.
• There are several alternative courses of action available to
a manager. He may have to decide in favour of one of
them to achieve desired or set of objectives of the firm.
• The managers decision must lead to the most efficient use
of available resources. Once decision is made about a
particular goal to be achieved, plans as to production,
pricing, capital, raw materials, labour etc are prepared.

2. forward planning
• All decisions are to be taken under conditions of uncertainty.
Forward planning has to be done when the future is uncertain.
• None can predict with accuracy, the nature and extent of
prospective demand in the future price trends, possible changes in the
consumer tastes and fashions, probable shift in the government
policies,
• If knowledge of the future is perfect, plan could be formulated
without error and need for revision.
•Managers are thus engaged in a continuous process decision making
through an uncertain future and the overall problem confronting them
is one of adjusting to uncertainty.
•Managerial economics is, therefore, an important aid to managers in
taking decisions under condition of uncertainty..

Managerial economics?
• According to Mc Nair and Merium, managerial
economics consists of the use of economic modes of
thought to analyse business situations.
• Spencer and Siegelman have defined managerial
economics as “ the integration of economic theory with
business practice for the purpose of facilitating decision
making and forward planning by management”.
• Managerial economics therefore defined as the
discipline which deals with the application of economic
theory to business management.Therefore managerial
economics serves as bridge between economics and
business management.

Economics-Theory
and methodology
Business management-
decision problems
Managerial Economics-
application of economics to
solve business problems
Optimal solutions to
business problems

Aspects of Application
1. Estimating economic relationships viz., measurement of various
types of elasticities of demand such as price elasticity, income
elasticity, cross elasticity promotional elasticity, cost-output
relationships etc.
3.Predicting relevant economic quantities.eg., profit, demand,
production, costs, pricing, capital etc.
4.Using economic quantities in decision making and forward
planning.
5. Understanding significant external forces constituting the
environment in business is operating and to which it must
adjust. eg. ,business cycles, fluctuations in national income and
government policies.

Characteristics of ME:
1. Managerial economics is micro-economic in character.This
is because unit of study is firm.
2. ME largely uses the that body of economic concepts and
principles which known as “theory of firm” or “economics
of firm”
3. ME is pragmatic.It considers the particular environment of
decision making
4. ME belongs to normative or prescriptive economics
5. Macro economics also useful to managerial economics since
it provides an intelligent understanding of the environment
in which the business must operate.

1. Demand Analysis and forecasting
• Managerial Decision making depends on accurate
estimates of demand for goods produced by the
firm.
• Forecast of future sales is essential. Forecast serves
as guide to management for strengthening market
position and enlarging profits.
• Demand analysis and Forecasting therefore is
essential for business planning and occupies
strategic place in managerial economics.
Eg., Demand determinants, Demand distinctions and
demand forecasting

2. Cost Analysis
• A study of economic costs combined with the data drawn from
firms’ accounting records, can yield significant cost estimates
that are useful for managerial decisions.
• Eg.,cost concepts and analysis, cost-output relationships,
economies of scale, cost control and cost reduction.
3. Production and Supply analysis
• Production analysis frequently proceeds in terms of physical
terms and mainly deals with production functions and their
managerial uses.
• Supply analysis deals with various aspects of supply of a
commodity.
• Eg., Supply schedule, curves and function, Law of supply etc.

4. Profit management
• In a world of uncertainty expectations are not always
realized so that profit planning and measurement
constitute the difficult area of managerial economics.
•Eg., Nature and Measure of profit, profit policies and
techniques of profit planning like break even analysis.
5. Capital Management
• It is most complex and troublesome for the business
manager.
• Briefly capital management implies planning and control
of capital expenditure.
•Eg., cost of capital, rate of return, selection of projects.

Managerial Economics
and
other subjects

1. Managerial economics and economics
• Price elasticity of demand
• Income elasticity of demand
• Opportunity cost
• Marginal revenue product
• Speculative motive
• Production function
• Balanced growth
• Liquidity preference
2. ME and Statistics
• Analysis of quantitative data to reach appropriate functional
relationships involved in decision making.
• Employs statistical methods of empirical testing of
economic generalization
• Theory of probability provide the logic for dealing with
uncertainty.

3. ME and Mathematics
• Managerial economics is metrical in character,
estimating various economic relationships, predicting
relevant economic quantities and using them in decision
making and forward planning.
• ME economics makes use of geometry, trigonometry,
algebra but also mathematical tools and concepts such
as Logarithms and exponentials, vectors, determinants,
matrix, calculus, integration. Operational research
closely related to ME is mathematical in character
applied to solve business problems.

4. ME and Accounting
Accounting assists in recording the financial operations
of the business firm.Accounting information is principle
source of information for managerial economist for
decision-making.
5. ME and Operational Research
Important problems of managerial economics are solved
with the help of OR techniques like linear programming,
game theory, inventory models, decision theory.
Problems like resource allocation, competitive problems,
waiting line problems, and inventory problems.

Uses of Managerial Economics.
1. It accomplishes the objective of building a suitable
tool kit for traditional economics for decision
making.
2. It takes aid of other academic disciplines having a
bearing upon the business decisions of a manager in
view of various explicit and implicit constraints
subject to to which resource allocation is to be
optimized.
3. It helps in reaching a variety of business decisions in
a complicated environment.

Cont….
4. It makes a manager a more competent model builder.
5. It serves as Integrating agent by coordinating the
different areas and bringing to bear on decisions of
each department or specialist the implications
pertaining to other functional areas.
6. It serves as an instrument in furthering the economic
welfare of the society through socially oriented
business firms.

Specific functions of managerial economist
1.Sales forecasting
2.Industrial market research
3.Economic analysis of competing companies
4.Pricing problems of Industry
5.Capital Projects
6.Production programmes
7.Investment analysis and forecasts
8.Advice on trade and public relations
9.Advice on primary commodities
10.Advice on foreign exchange
11.Economic analysis of agriculture
12.Analysis of underdeveloped economies
13.Environmental forecasting

In Indian context……..
1. Forecasting for demand and supply
2. Production planning at mico and macro levels
3. Capacity planning and product mix determination
4. Economics of various production lines
5. economic feasibility of new production lines/
processes and projects
6. Assistance in preparation of overall development plans
7. Preparation of periodical economic reports.
8. Keeping management informed about national and
international developments on economic matters
9. Preparing articles, papers, speeches for management
for various chambers, committees, seminars, conferences
etc.

Responsibilities of managerial economist
1. Keeps in mind main objectives of business o make
profit on its invested capital.
2. Responsible for successful forecasts.
3. Helping management in decision making
4.Alert management at the earliest in case errors found
in his forecast
5. Establish and maintain many contacts with individuals
and data sources which would be immediately available
to the other members of the management.

Basic Process of Decision Making
► Managerial economics serves as ‘ a link between traditional economics
and the decision making sciences ‘ for decision making.
Traditional Economics/
Economic theory.
Micro & macro economics
Managerial
economics
Optimal solution to business
problems
Decision sciences
(tools & techniques
of analysis)
Mathematical sciences
Decision-Problem

MODULE 2
FUNDMENTAL PRINCIPLES OF ME

1. Opportunity cost Principle
Opportunity cost of a decision meant the sacrifice of
alternatives required by that decision. It is the cost
involved in any decision consists of the sacrifice of
alternatives required by that decision.If There are no
sacrifices, there is no cost.
Opportunity cost of a decision is the sacrifice of the next best
alternative course of action available
Eg.,1.Opportunity cost of funds involved in ones’ own
business is the interest that could be earned on those funds
had they been employed in other ventures
2.The opportunity cost of the time an entrepreneurdevotes to
his own business is the salary he could earn by seeking
employment.
Contd…

Contd….
3.Opportunity cost of holding Rs.500 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 a
bank.
4.The opportunity cost of using a machine that is useless for
any other purpose is zero since its use requires no sacrifice
of other opportunities.
Contd…

Contd…
Points to remember
1.OC of a given sum of money can never be zero
2.All decisions which involve choice must involve OC
calculation.
3.OC may either real or monetary, implicit or explicit,
quantifiable or non-quantifiable
4.Different concepts of trade off such as indifference curves,,
Isoquants, Phillips curve are all an opportunity cost.
5.OC directly applicable to make or buy decision,
breakdown or preventive maintainance of machines,
Replacement or new investment decision.
6.Minimisation of opportuiny costs should be the decision of
a manager for optimal allocation of resources given his
objectives and constraints.
7.The accountant never considers opportunity costs:he only
considers explicit cost.
8.The opportunity cost of unutilized plant capacity is zero.

2.Incremental Principle.
This concept involves estimating the impact of decision
alternatives on costs and revenues, emphasizing the changes
in total costs and total revenue resulting from changes in
prices, procedures, investments or whatever may be at stake
in the decision.
It may be defined as change in the total cost due to specific
decision
Two basic components of Incremental reasoning are:
1. Incremental cost, defined as the change in total cost
resulting from a particular decision.
Contd….

2. Incremental Revenue, defined as change in total revenue
resulting from a particular decision
IC = dTC / dQ
A decision is obviously a profitable only if-
a) It increases revenue more than a profit
b) It decreases some costs to a greater extent than it
increases others
c) It increases some revenue more than it decreases others
d) It reduces costs more than revenue
Managerial rule of thumb
IR > IC

3. Principle of time perspective
Managerial economists are also concerned with the short run
and long run effects of decisions on revenues as well as costs.
It is important problem in decision making, is to maintain
right balance between long run and short run considerations.
A decision may be made on the basis of short run
considerations, but may as time elapses have long run
repercussions which makes more or less profitable than it at
first appeared.
Short run decisions- bus company has to maintain extra tyres
book seller keeps extra stock during
start of schools
Long Run decisions-growth, development and expansion
Just-in-time strategy adopted for successful business.

4.Discounting Principle
Fundamental idea in economics is that a rupee tomorrow is
worth less than a rupee today. similarly a bird in hand is worth
two in the bush .
Discounting principle can be stated as “ if a decision affects
costs and revenues at future dates, it is necessary to discount
those costs and revenues to present values before a valid
comparison of alternatives is possible.
Present value (V) =Amount (A) / (1+ i )

5.Equimarginal principle
This principle deals with allocation of available resources
among the alternative activities.Acc. to this principle, a facor
input should be employed in different activities in such
proportion that its value of marginal product is equal in all
theuses I.e, optimal is reached.This generalization is called
equimarginal principle.
(VMPL)a=(VMPL)b=(VMPL)c=(VMPL)d
This principle is useful in investment and allocation of
resources.

Application of equimarginal principle in the business or managerial
Activity is illustrated as below,
•Multi market Territories-Sales Revenue Maximization
MR1=MR2=MR3…MRn
•Multi plant monopolist- Cost minimization
MC1=MC2=MC3…MCn
• Multi product firm-profit maximization
MP1=MP2=MP3 …MPns
A manager has to either maximise or minimise outcome.It is
Referred as optimisation technique.This involves finding the
value of independent or determining business variable that would
resultn in maximisation of the value of the dependent variable.

Rule of maximisation
Profit of a firm is maximised when the difference between total
revenue and total cost is maximum
p = TR - TC
TR = P * Q

Aspects of equimarginal principle need clarification
1. the values of marginal products are net of incremental
costs
2. if the revenues resulting from an activity is to occur
in future, these revenues ought to be discounted in the
alternative activities are possible.
3. The measurement of value of marginal product may
have to be corrected if the expansion of an activity requires
reduction in the prices of the output.
4. This principle may break under sociological
pressures.

Module 1_ME.ppt

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