Nature and Scope of Managerial Economics

ME: Unit 1 , Cap: 1

Presented By: Pawan Kumar

Economics
Body of knowledge which deals with the management of money

Managerial Economics
According to Milton H Spencer and Louis Siegelman Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by the management.

THE ROLE OF ME IN MANAGERIAL DECISIONMAKING

Management Decision Problems
Product Price and Output Make or Buy Production Technique Internet Strategy Advertising Media & Intensity Investment & Financing

Economic Concepts Framework for Decisions

Theory of Consumer Behavior Theory of Firm Theory of Market structure and Pricing

Decision Sciences
Tools and Techniques of Analysis
Numerical Analysis Statistical Analysis Forecasting Game Theory Optimization

THE ROLE OF ME IN MANAGERIAL DECISIONMAKING

Management Decision Problems
Economic concepts Decision Sciences

Managerial Economics

Nature of Managerial Economics

Micro
Concerned with the study of the problems of the firm.

Pragmatic
Aims at solutions to problems considering the environment in which the business operates.

Prescriptive rather than descriptive

Aims at prescribing solutions to business problems rather than describing theories.

Uses Macro-Economics too

Enables an executive to understand the business environment and adjust with the uncontrollable external factors

Scope of Managerial Economics

Demand Analysis and Forecasting Cost Analysis

Production and Supply Analysis

Pricing decisions, policies and practices

Profit Management

Capital Management

Scope of Managerial Economics

Demand Analysis and Forecasting
Forecasting future sales of products and services. Identify demand determinants Guidelines to manipulate demand

Scope of Managerial Economics

Cost Analysis
Discovering and measuring them for effective profit planning and cost control Covers cost-output relationships Economies and diseconomies of scale Cost control and cost reduction

Scope of Managerial Economics

Production and Supply Analysis
Deals with planning production and its managerial uses Supply analysis deals with various aspects of supply of a commodity Maximize firms revenue through proper planning of production and supply.

Scope of Managerial Economics

Pricing decisions, policies and practices

Correct pricing decisions form the backbone of success of the firm Covers price determination in various market conditions, pricing methods and price forecasting.

Scope of Managerial Economics

Profit Management
High level of uncertainty in variation of costs caused by sudden change in the internal and external factors ME helps in estimating considerably such uncertainties by manipulating costs Covers break even analysis, measurement of profit, profit policies and techniques etc

Scope of Managerial Economics

Capital Management
Most complex decisions of business often revolve around planning and allocation of capital Decisions irreversible in nature ME helps in planning and control of capital expenditure. Covers cost of capital, rate of return and selection of projects

Fundamental Concepts
1) Opportunity Cost Principle - The interest or the income that could have been earned had the money been employed on other ventures instead of the current venture. - Represents the income foregone/sacrificed as a result of investing in the current venture. Example: Bank FD@ 7.25% Vs Childs marriage

2) The Concept of incremental reasoning:

Incremental/marginal=one extra unit Two components 1. Incremental cost- change in total cost resulting from a particular decision 2. Incremental revenue- change in total revenue resulting from a particular decision

 A decision is a profitable decision if, (i) It increases revenue more than costs (ii) Decreases some costs to a greater extent than it increases other costs (iii) Increases some revenues more than it decreases others (iv) Reduces costs more than revenues

Illustration:
Estimated Revenue from a new order is Rs 5000 Estimated costs on execution (in Rs) Labour 1500 Materials 2000 Overhead 1800 S&D 700 Full Cost 6000 Loss on execution 5000 6000= 1000

Change in circumstance
1. Existence of idle capacity 2. Incremental Overhead New Estimated costs (in Rs) Labour 1000 Materials 2000 Overhead 500 Incremental cost 3500 Incremental Profit= 5000-3500= Rs. 1500 , Depends upon existence of idle capacity

3) Principle of time perspective:

Its account both the short run and long run effects on revenues and costs A decision may be made based on short run considerations/gains but it may boomerang in the long run. Ex. Reduction in price to gain customers in the short run may affect the image of the firm in the long run when it increases prices owing to an increase in costs in the future.

4) The Discounting Principle:

Any decision which affects costs and revenues at future dates should discount those costs and revenues to present values before comparing the alternatives. Thumb rule: A rupee received today is more worth than if it is received tomorrow. - Uncertainty of receipts in future - Inflation/Price Rise

Illustration:
Formula: NPV= Ct/(1+i) Assume a cash flow of rent of Rs.500 every year for 2 years on an asset let out for rent Bank Interest rate: 10% p.a NPV= 500/(1+0.10) + 500/(1+0.10) = 500/1.10+500/1.21 = 454.5+413.2 = Rs. 867.70 /-

5) The concept of Contribution:

The concept explains about contribution of unit of output to the overheads and profit. Helps in determining the best product mix when scarce resources are involved Fresh order Vs Shut down Vs Continue with existing product Unit contribution is the per unit difference between incremental revenue and incremental cost

Managerial Economics and Economics - Differences

Concept of risk and return:

Risk: -The element of uncertainty about the occurrence of a desired event in future. Return: -The profit which the entrepreneur gets for his function of bearing risk and uncertainty.

Thank U!