MANAGERIAL ECONOMICS

1.Introduction:
Nature and Scope of Managerial Economics. Role of managerial economics in decision making. Managerial Economics and Econometric Models. Opportunity cost. Discounting Principle. Time perspective. Incremental reasoning. Equi-marginal concept. Economics of risk and uncertainty Asymmetric information - Market Response Bench Marking and Total Quality Management. Objectives of a firm. Traditional, Managerial and Behavioral theories of the firm.

2.Fundamental Economic concepts to Business Analysis:

3.Theory of Firm :

NATURE AND SCOPE OF ME

Economics: Study of the behavior if human beings in producing, distributing and consuming material goods and services in a world of scare resources. Management: The discipline of organizing and allocating a firms scare resources to achieve its desired objectives. ME: It is the use of economic analysis to make business decisions involving the best use of an organizations scare resources. Economics of business or managerial decisions. Integration of economic principles with business practices. Pertains to economic analysis that can help in solving business problems, policy and planning.

Traditional Economics & Tools & Techniques of Decision Sciences

ME

Business Management in theory& Practice: Decision, Problems

 In Economic Theory:
Single Goal. Rational consumer aims at maximization of utility and a firm tries to maximize its profit. ET is based on Ceteris Paribus i.e. given conditions with certainty of actions or events or within the framework of axioms.

In Business Decision Making:

Multiple goals in running a business. Lack of certainty due to dynamic changes. Uncertainty may create disappointment in the realizations of business expectations.

ET cant provide clear cut solutions but helps in arriving at a better decision. ME helps bridge the gap between purely analytical problems dealt in ET and decision problems faced in real business.

MAIN CHARACTERISTICS OF ME Applied Micro economics Science as well as art. Concerned with the firm's behavior in optimal allocation of resources. Provides tools for best alternatives and competing activities in any productive sector. Incorporates both Micro and Macro Economics for optimal decisions. Helps Manager to understand the intricacies of the business problems which make the problem solving easier and quicker. contd.

Managerial Economics:
Uses analytical tools of mathematical and econometrics with two main approaches Descriptive Models are data based in describing and exploring economic relationships of reality in simplified abstract sense. Describe the economic forces that shape the internal and external environments of a business firm. Prescriptive models are the optimizing models to guide the decision makers about set goal. Prescribe rules for managerial decision-making that furthers the objective of the firm. DM provide a building block for developing optimizing models in solving the managerial and business problems. Helps in depth analysis of key elements involved in the business.

IS ME POSITIVE OR NORMATIVE?
+ve economics explains the economic phenomenon as what is, what was and what will be. Normative economics prescribes what it ought to be. ME is a blending of pure or +ve science with applied or normative science. +ve when confined to statements about causes and effects and to functional relations of the economic variables. It is normative when it involves norms and standards, mixing them with the cause effect analysis. ME is a mix of both consideration in scientific approach.

Role of a Managerial Economist

Also called as Business Economist/ Company Economist/Economic Adviser. To design the course of operations to maintain and improve the systems of the firm in terms of production, market share, load factor % and prepare reports to help the decisions makers to cope with the current and anticipated future problems.

DUTIES OF A MANAGERIAL ECONOMIST

Two broad aspects of his duties are

Decision Making Forward Planning

Demand Estimation and forecasting Business and sales forecasting Analysis for extent and nature of competition. Analyzing the issues and problems of the concerned industry. Assisting the bus Planning process of the firm. Discovering the new and possible fields of business endeavors and its cost benefit analysis. Advising on pricing , investment, and capital budget policy. Evaluation of capital budgets. Building micro and macro eco models for solving business problems. Directing Economic research activities. Briefing the management on current domestic and global economic issues and emergiing challenges. Keeps an eye on fast changing technological developments.

Managerial Economic analysis in Decision Making

ME adopts the scientific approach of economic analysis:
Define the problem Formulation of the hypothesis Abstraction for the model building Data collection Deduction based on data analysis Testing the hypothesis Evaluating the test results Conclusion for decisions

A Decision-Making Model
Objectives

Define the problem

Alternative Solutions Organizational and input constraints

Social constraints

Evaluation

Implement and monitor the decision

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Scope of ME
Objectives of a firm Demand Analysis and Forecasting Cost and Production Analysis Pricing Decisions, Policies and Practice Profit Management Capital Budgeting Linear Programming and the theory of games Market structure and conditions Strategic Planning Others Areas (Macroeconomic Management, Fiscal and Monetary Policy, Impact of Liberalization, Globalization, privatization, marketization, international changes, environmental degradation, socio-political, cultural and external forces on management)

Economics of Risk and Uncertainty

When future events can be defined and probabilities assigned, we have a case of risk.
Sales manager estimates sales of diet cola have a
25% probability to be 5 million 50% probability to be 6 million 25% probability to be 7 million

Sources of Business Risk

Economic conditions: Volatile economic activity Inflationary and recessionary phases of business cycles Fluctuations in specific industry Competition and technological change Changes in consumer preferences Costs and Expenses.

Decision Making Under Uncertainty

DM becomes complex under uncertainty with complete ignorance as Decision Maker is unable to determine any probability of alternate outcomes. Hence rational decision criteria is needed. Laplace Criterion Wald Decision Criterion Harwicz Decision Criterion Savage Decision Criterion

Laplace Criterion
Presumes that all possible outcomes are equally likely. Lower price strategy is less risky than raise price strategy. A risk-return indifference curve helps determine the optional strategy. It is more suitable to large firms in the long run.
RP

Accept LP

Wald Decision Criterion: It is a decision strategy of extreme pessimism of business situation. Suggests the selection of the best course from among the worst possible outcomes. Disregards decision making attitude.

Harwicz Decision Criterion: It regards decision making attitude. It averages out the max and min trade-off related to business strategies to determine optimum level. Savage Decision Criterion: Based on the opportunity cost of selectivity on inappropriate incorrect business strategy under the situation of complete ignorance (gross uncertainty) called Minimax Regret Criterion. SDC appropriate when the firm is interested in earning a satisfactory return (neither extreme optimistic/nor pessimistic). Suggests a strategy for moderate level of risks in the long run.

Asymmetric Information
Asymmetric Information leads to market uncertainty in days of knowledge explosion. A Market situation in which one party in the transaction has more information than the other party and would try to use it ot their advantage in negotiations. Leads to Adverse selection and moral hazard. Adverse selection or wrong choice happens when bad outcomes tend to drive good outcomes. It can complicate the transaction if the information is not credibly conveyed to the other party and there is a risk of cheating, negotiated price being affected and the transaction might not even take place. Ex: The Market of Lemons (Goods cars and Bad Cars) Moral Hazard occurs when it is difficult for one party to monitor the other. Ex: Insurance

Market Responses to Asymmetric Information Market Signaling: Level of education completed is a signal to potential employment. Reputation: Ebay Auctions Consumer Reports Standardization: McDonalds

Basic Economic Tools

Opportunity Cost Principle: The OC of a decision is the sacrifice of the next best alternative course of action available.
Useful for positive decision for further investment

Equi-Marginal Principal : VMPL(a)= VMPL(b)=VMPL(c)

Useful in investment decisions and in the allocation of research expenditure.

Incremental Principle: Estimates the impact of decision alternatives on costs and revenues changes. Two concepts IR and IC.
Helps in arriving at a better decision comparing between Ics ands of alternative decisions.

Principle of Time Perspective: Concept of functional time periods Short and Long run. Discounting Principle: A present gain is valued more than a future gain. If a decision affects costs and revenues at a future dates, it is necessary to discount these costs and revenues to present values before a valid comparison of alternatives is possible.
V (Present Value)= A(Annuity or returns expected in 1 year)/ 1+ i (Interest)