Transcript File

UNIT I
INTRODUCTION TO
MANAGERIAL ECONOMICS
Organization : Two or more people who work together in a
structured way to achieve a specific goal or set
of goals.
Goal : The purpose that an organization strive to achieve.
Plan : The programme or methods to achieve goals.
Management : The process of planning, organizing, leading
and controlling the work of organization
members and of using all available resources
to reach stated organizational goals.
Manager : People responsible for directing the efforts aimed at
helping organizations to achieve their goals.
Fundamental Resources OR
Factors of Production
• Man
• Money
• Material
• TIME
What Else - Which is available
to all of us in exactly same
amount/quantity??
Economics Defined :
What is Difference Between
Science and Art??
Adam Simth defined “economics as the science of wealth”.
J. B. Say defined “the study of the laws which govern wealth”.
Marshall defined “economics is the study of mankind in the ordinary
business of life; it examines that part of individual
and social action which is most closely connect
with the attainment and with the use of requisites
of well being”.
Ferguson defined “a study of economical allocation of scarce
physical and human resources (means) among
competing ends; an allocation that achieves a
stipulated optimizing or maximizing objectives”.
Concluding Definition : “Economics is a social science concerned
with the proper use and allocation of
resources for the achievement and
maintenance of growth and stability”.
ECONOMICS
Microeconomics : is the study of
economic action of individuals and
small groups. It is concern with the
study of particular firm, particular
households, individual prices,
wages, incomes and individual
industry etc.
Macroeconomics : is the study of
aggregate or average covering the
entire economy such as total
employment, national income, total
investment/consumption/savings,
aggregate demand & supply, wage
level, general price level and cost
structure etc.
Managerial Economics :
It should be thought of as “applied microeconomics”.
It is defined as “the discipline which deals with the
application of economic theory and decision science
tools to find the optimal solution to managerial decision
making problems”.
Management decision problems
Economic Theory
Microeconomics
Macroeconomics
Decision Science
Mathematical economics,
Econometrics
Managerial Economics
Application of economic theory &
decision science tools to solve
managerial decision problems.
Optimal solution to Managerial
Decision problems
The Nature of Managerial Economics
Difference between M E and Economics
 Economics deals with the body of principle itself but ME deals
with the application of that principles.
 Basically ME is microeconomic theory but Economics is both
micro and macro.
 ME, though micro in character, deals only with the firm and
nothing to do with individual but microeconomics as a branch of
economics deals with economics of individual and firm.
 Under microeconomics different theories viz. wages, interests,
profits etc. are dealt but in ME mainly profit theory of the firm is
used.
Scope of Managerial Economics
 Demand analysis and forecasting.
- like demand determinants, demand forecasting etc.
 Cost analysis.
- like cost-output relationship, economies & diseconomies of
scale etc.
 Production and supply analysis.
- like production function, law of supply etc.
 Pricing decisions, policies & practices.
- like price determination, pricing methods etc
 Profit management.
- like profit policies, techniques of profit planning etc.
 Capital management.
- like cost of capital, rate of return, selection of projects
etc.
MACROECONOMICS
1. What is an ECONOMY:
An economy refers to the economic system of an area, region
or country. It is system by which people get a living.
Vital Processes of An Economy:
- Production
- Consumption
- Growth (population, demand, saving, technology, capital)
Five Fundamental Questions
• What is to be produced and in What
Quantities?
• How to produce these Goods?
• For Whom are the goods produced?
• How Efficiently are the Resources being
Utilised?
• Is the Economy Growing?
2. Economic System:
It refers to the mode of production and the distribution of
goods and services within which economic activity takes place.
In other words, it refers to the way different economic elements
(individual workers and managers, firms, govt. agencies etc)
are linked together to form an organic world.
Mainly there are three different economic systems –
- Socialism
- Capitalism
- Mixed Economy
3. National Income :
Normally it means the total value of goods and services produced
annually in a country.
In other words, the total amount of income accruing to a country
from economic activities in a year’s time.
Different concepts of national income are GDP, GNP, NNP, NI,
PI, DI GDP: Gross Domestic Product. The total market value of all
final goods and services produced in a country in a given
year, equal to total consumer, investment and government
spending, plus the value of exports, minus the value of
imports.
GNP : Gross National Product. GDP plus the income accruing
to domestic residents from productive activities abroad,
minus the income earned in domestic markets accruing
to foreigners abroad.
There are two methods to calculate GNP – Expenditure
method and Income Method.
It is important to differentiate GDP from GNP. GDP includes
only goods and services produced within the geographic
boundaries of a country, regardless of the producer's nationality.
GNP doesn't include goods and services produced by foreign
producers, but does include goods and services produced by
domestic firms operating in foreign countries.
WHAT IS THE GDP/GNP OF INDIA??
4. Inflation:
The overall general upward price movement of goods and
services in an economy, usually as measured by the Consumer
Price Index and the Producer Price Index. Over time, as the cost
of goods and services increase, the value of a money is going to
fall because a person won't be able to purchase as much with
that money as he/she previously could.
Or in other words, The rate at which the general level of prices for
goods and services is rising, and, subsequently, purchasing power
is falling.
Price Index:
Index that tracks inflation by measuring price changes. Examples
include the Consumer Price Index and the Producer Price Index.
Consumer Price Index:
CPI. An inflationary indicator that measures the change in the
cost of a fixed basket of products and services, including housing,
electricity, food, and transportation. The CPI is published monthly
also called as cost-of-living index.
Producer Price Index:
An inflationary indicator to evaluate wholesale price levels in
the economy, also called as wholesale price index (WPI).
WHAT IS THE CURRENT LEVEL OF CPI AND WPI??
DID YOU NOTICED ANYTHING NEW ABOUT THESE INDICES?
5. Monetary and Fiscal Policy:
Monetary Policy:
The actions of a central bank, currency board, or other regulatory
committee, that determine the size and rate of growth of the
money supply, which in turn affects interest rates.
Fiscal Policy:
Decisions by the President and Cabinet, usually relating to
taxation and government spending, with the goals of full
employment, price stability, and economic growth. By changing
tax laws, the government can effectively modify the amount of
disposable income available to its taxpayers.
6. Unemployment :
An economic condition marked by the fact that individuals
actively seeking jobs remain unhired. Unemployment is
expressed as a percentage of the total available work force.
The level of unemployment varies with economic conditions
and other circumstances.
Underemployment:
A situation in which a worker is employed, but not in the desired
capacity, whether in terms of compensation, hours, or level of
skill and experience
7. Exchange Rate :
Rate at which one currency may be converted into another,
also called as rate of exchange or foreign exchange rate or
currency exchange rate.
(Rs.)
Goods and Services
(Rs.)
Product Market Goods and Services
Firms
Households
Economic
Resources
Income
Economic
Resources
Factor Market
Factor Payment
Circular Flow Of Economic Activity
 Rationale of the Firm
 The Objective of the Firm
 Maximizing Vs Satisficing
 The Principal – Agent Problem
 Constrained Decision Making
The Cost Concept
Explicit Cost : also called as accounting cost.
like wages, interests, rent etc.
Implicit Cost : also called as Opportunity cost.
like opportunity costs.
Basic Economic Theories In Managerial Economics
1. Opportunity Cost Principle
2. Incremental Principle
3. Principle of Time Perspective
4. Discounting Principle
5. Equi-marginal Principle
1. Opportunity Cost Principle :
It is stated as “the cost involved in any decision consist of the
sacrifices of alternatives required by that decision. If there is no
sacrifice, there is no cost”. Thus by the opportunity cost of a
decision is meant that the cost of sacrifice of second best
alternative.
EX. Consider Mr. X has MCA degree and is considering investing
Rs 2,00,000 in a business and the projected income
statement, shown by his accountant, for the year is as follows :
Sales :
Less: cost of goods sold
Gross Profit:
Less:
Advt.
Depr.
Utilities
Property tax
Misc. Exp.
10,000
10,000
3,000
2,000
5,000
Net Accounting Profit:
90,000
40,000
50,000
30,000
20,000
Now suppose interest rate is 5% on Rs. 2,00,000 and he would have got the
job of Rs. 60,000 p.a. Thus considering the opportunity cost :
Net Accounting Profit:
20,000
Return on capital 10,000
Salary Forgone 60,000
- 70,000
Net Economic Profit:
- 50,000
Thus on the basis of O.C.P. he should leave his business and do the job for
others.
2. Incremental Principle :
It involves estimating the impact of decision alternatives on cost
and revenues, emphasizing the changes in the total cost and total
revenue resulting from changes in prices, products, procedures,
investments or whatever may be the conditions.
The Incremental principle may be stated as under:
“A decisions is obviously profitable one if –
i). It increases revenue more than cost.
ii). It decreases some costs to a greater extent than it increases
others.
iii). It increases some revenue more than it decreases others.
iv). It reduces costs more than revenues.”
3. Principle of Time Perspective :
It is stated as “a decision should take into both the short-run and
long-run effects on revenues and costs, and maintain the right
balance between the long-run and short-run perspective”.
4. Discounting Principle :
The process of reducing a future amount to its present value is
termed as “Discounting” because the present value is always less
than the future amount; and the interest rate used is termed as
“Discounting rate”.
The principle is 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”.
How to calculate Present Value :
A1
A2
An
PV

 ........... 
1
2
n
(1  r)
(1  r)
(1  r)
n
At

t
t  1 (1  r)
Where PV = Present Value
A1, A2 = Stream of cash flow
r = rate of interest
time periods = 1,2,……..n
4. Discounting Principle
• There may be two cases – Single Amount
and Annuity.
• Single Amount means one amount for one
period of time:
– for example – Rs20,000 after 3 years;
Rs50,000 after 8 years and so on.
– another example: more than one amount, but
all different, at different point of time – like
Rs10,000 at the end of 2nd year, Rs30,000 at
the end of 5th year and Rs60,000 at the end of
10th year
Calculation of PV of Single
Amount
• Rs20,000 after 3 years – PV =
20000/(1+r)3
• Rs50,000 after 8 years – PV =
50000/(1+r)8
Calculation of PV of Single
Amount
• Rs10,000 at the end of 2nd year, Rs30,000
at the end of 5th year and Rs60,000 at the
end of 10th year
PV = 10000/(1+r)2 + 30000/(1+r)5 +
60000/(1+r)10
Calculation of Annuity
• Annuity means stream of cash flow, i.e.,
same amount of cash is flowing after same
interval of time (every year).
– for example: Rs15,000 each year from 1st to
10th year
r
– PV = 15000 ∑ 1/(1+r)i
i=1
5. Equi-marginal Principle :
This principle deals with the allocation of the available resources
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 as equi-marginal principle.