Managerial Economics 10 MBA 12

Shalini H S

Managerial Economics
Branch of Economics Managerial Economics is the study of Economic Theories, Principles and Concepts which is used in Managerial Decision Making Managerial Economics is the Application of various Theories, Concepts and Principles of Economics in the Business Decisions. It also Includes The Application of Mathematical and Statistical tools in Management decisions.
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Managerial Economics
Application of Mathematical And Statistical tools

Economic Theories, Principles and Concepts

Application

Application

Managerial Decision Making

Managerial Economics
Managerial Decisions Choice of product Choice of production method Choice of price, Etc

Application of Economic concepts, Theories and Principles in decision Making

Application of Analytical tools such as, Mathematical and Statistical tools

Managerial Economics Application of Economic Concepts, Theories and Analytical tools to find solutions for managerial problems

Managerial Economics
Economics.
-Theories -Principles -Concepts Decision Making. -Selection of best alternative out of various possible alternatives. Risk & Uncertainty
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Economics
Economics: A Queen of Social Sciences Economics=OIKOS+NOMOS (Greek Words) OIKOS=HOUSE NOMOS=MANAGEMENT According to J.S. Mill Economics is The practical science of production and distribution of wealth. It is the study of How people produce and spend income .

Economics
It talks about Economic Activity and Economic Problem. It is the Study of Logic choice between Scarce resources and unlimited wants Economics is to get the answer to the basic questions of an economy such as, What to produce?, How to produce? And for whom to produce? Economics is the social science that is concerned with the production, distribution, and consumption of goods and services. 7

Economics
There are Two Branches Micro Economics: Means Small or Individual . The term MICRO comes from the Greek word MIKROS Which means Small or Individual. Macro Economics: Means Group or Whole. The term MACRO comes from the Greek word MAKROS Which means Large or Whole.
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Micro Economics
Micro Economics: It is the study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular industries. Some of the theories which come under Micro Economics,
Theory Theory Theory Theory of of of of Individual/Market Demand. Production and Cost. Markets and price. profit, Etc
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Macro Economics
Macro Economics : It deals not with individual quantities as such but with aggregates of these quantities, not with individual incomes but with national income. Some of the theories which come under Macro Economics,
Theory of total output and employment. General price level. Theory of Inflation. Theory of trade cycles Economic growth, Etc

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Difference between Managerial Economics and Economics Managerial Economics Narrow and limited Economics scope Comprehensive and It is essentially Micro wider scope in nature and Macro in It has both Micro and analysis Macro in nature It is mainly a It is both Normative Normative science and positive science It is concerned with It is concerned with the application of the formulation of theories and theories and principles of principles economics It discusses general It discusses Individual problems problems
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Nature of Managerial Economics

Science as well as Art of decision making. It is essentially Micro in nature but Macro in analysis. It is mainly a Normative science but positive in analysis. It is concerned with the application of theories and principles of economics. It discusses Individual problems. It is dynamic in nature not a Static. It discuss the economic behavior of a firm. It concentrates on optimum utilization of resources. 12

Managerial economics
Positive or normative science Positive study of things as they are Normative study of things as they should be

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Scope of Managerial Economics

Objectives of a Firm. Demand Analysis and Forecasting. Production and cost analysis. Pricing decisions. Profit management. Capital management. Market structure. Inflation and economic conditions.
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Managerial economics and Decision Making

Decision making:
-Decision making on internal affairs . -Decision making on external affairs . Internal affairs talk on internal environment which consists of internal factors such as, Production, Financial, Marketing and Human resource related decisions. External Affairs talk on external environment which consists of external factors such as, PEST related decisions.
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Decision Making
Uncertainty :
Nothing can be expectable because of the constant changes in the environment both internally as well as externally.

Risk :
It is the situation which comes under uncertainty.
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Decision???????????????
How to take decision????????????

By using. Economic Models

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Economic Models
Economic model Is the structural and scientific method of constructing or developing Solutions by using basic economic principles , concepts, theories and Quantitative techniques such as mathematical and statistical tools .
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Conclusion for decisions Evaluating results

Testing of Hypothesis

Analysis of data

Data collection

Formulation of hypothesis Defining the problem

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Basic Principles of Managerial Economics

Opportunity cost principle. Marginalism principle. Equi-marginalism principle. Incremental principle. Time perspective principle. Discounting principle.

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Opportunity Cost Principle

Choice involves sacrifice. The cost involved with the sacrifice It is the cost of an next best opportunity which is lost will be called as Opportunity cost. Ex: 100 Rs can be used for purchasing book or eating in pizza corner or purchasing of stationeries. Now the cost of purchasing book is also include the cost of Eating pizza.
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Opportunity cost in management

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Marginalism Principle
Marginal cost and Marginal profit/benefit Marginal cost is the cost which is incurred to produce the next or one more unit. Marginal Revenue is the benefit which is got by producing one more or next unit. Cost will be less and benefit will be more.

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Marginalism Principle
Marginal cost (MC)= (TC) n - (TC) n- 1 Marginal Revenue (MR)=(TR) n (TR) n-1 Decision Rule : MR > MC..MR=MC..MR<MC
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Equi-marginalism Principle
An input should be allocated in such a way that the value added by the last unit is the same in all uses

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Equi-marginalism Principle
Allocation of scarce resources on different alternative uses should be equally distributed. i.e.. VMPa = VMPb = VMPc =VMPd Or VMPLA = VMPLB = VMPLC = VMPLD

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Incremental Principle
Incremental principle gives an idea to increase the production not only with one more product it could be any quantity till the profit exists. According to this principle profit can be made either by increasing sales or total revenue or by decreasing total cost Decision Rule, i.e. TC<TR TC=TR TC>TR
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Time Perspective Principle

According to the principle all decisions should be under two formats i.e. short run and long run, because of the decisions characteristics. So each decision should be made in Short run basis as well as long run basis. According to short run decision the long run decision will get change.
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Discounting Principle
According to this principle, if a decision affects costs and revenues in long-run, all those costs and revenues must be discounted to present values before valid comparison of alternatives is possible. This is essential because a rupee worth of money at a future date is not worth a rupee today. Money actually has time value.
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Discounting Principle
This could be understood using the formula, FV = PV*(1+r) t And PV = FV/ (1+r) t Where, FV is the future value, PV is the present value, r is the discount (interest) rate, and t is the time between the future value and present value.
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Basic Definitions
Present Value earlier money on a time line Future Value later money on a time line Interest rate exchange rate between earlier money and later money Discount rate Cost of capital Opportunity cost of capital Required return 31

Future Values
Suppose you invest Rs. 1000 for one year at 5% per year. What is the future value in one year?
Interest = 1000(.05) = 50 Value in one year = principal + interest = 1000 + 50 = 1050 Future Value (FV) = 1000(1 + .05) = 1050

Suppose you leave the money in for another year. How much will you have two years from now?
FV = 1000(1.05)(1.05) = 1000(1.05)2 = 32 1102.50

Future Values: General Formula

FV = PV(1 + r)t
FV = future value PV = present value r = period interest rate, expressed as a decimal T = number of periods

Future value interest factor = (1 + r)t

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Effects of Compounding
Simple interest (interest is earned only on the original principal) Compound interest (interest is earned on principal and on interest received) Consider the previous example
FV with simple interest = 1000 + 50 + 50 = 1100 FV with compound interest = 1102.50 The extra 2.50 comes from the interest of .05(50) = 2.50 earned on the first interest payment 34

Present Values
How much do I have to invest today to have some amount in the future?
FV = PV(1 + r)t Rearrange to solve for PV = FV / (1 + r)t

When we talk about discounting, we mean finding the present value of some future amount. When we talk about the value of something, we are talking about the present value unless we specifically indicate that we want the future value.
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PV One Period Example

Suppose you need Rs. 10,000 in one year for the down payment on a new car. If you can earn 7% annually, how much do you need to invest today? PV = 10,000 / (1.07)1 = 9345.79

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Discount Rate
Often we will want to know what the implied interest rate is in an investment Rearrange the basic PV equation and solve for r
FV = PV(1 + r)t r = (FV / PV)1/t 1

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Quantitative Techniques used in Managerial Economics Variables Functions Schedules Graphs Derivatives Correlation Integration

etc
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Role of a managerial economist in the firm

Demand estimation and forecasting Preparation of business /sales forecasts Analysis of market survey to determine the nature and extent of competition Analyzing the issues and problems of concerned industry

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Contd.
Assisting the business planning process of the firm Discovering new possible fields of business endeavor and its cost-benefit analysis Advising on prices, investment and capital budgeting policies Evaluation of capital budgeting etc.

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Decision Making Areas

Demand forecastin g

Producti on planning and cost revenue decision

Study of econo mic environ ment

Pricing and related decision s

Invest ment decisio ns

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DEMAND FORECASTING
QUALITATIVE QUANTITATIVE CONSUMER SURVEY JURY OF EXPERT OPINION SALESFORCE COMPOSITE METHOD DELPHI METHOD
TIMESERIES METHODS

CAUSAL METHODS

NOMINAL GROUP METHOD

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PRODUCTION PLANNING AND COST REVENUE DECISIONS Production Function : The production function is a technological relationship between output and various inputs used in production viz., land, labour, capital and technology. The output depends on the increasing function of all the factor inputs Q=f(S,L,K,T)
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The following types of cost are useful in the decision areas: Average, Marginal and Total Costs Fixed and Variable Cost Direct and Indirect Cost Replacement and Original Cost Opportunity and Industrial Cost Sunk Cost and Outlay Cost
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STUDY OF ECONOMIC ENVIORNMENT

Economic environment is the most significant component of the business environment. It affects the survival and success of a business organization.
Economic environment

General conditions

Industrial conditions

Stage of supply of resources of production

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PRICING AND RELATED DECISIONS

The Price-output decisions are taken under various market structures. The structure of the market refers to the degree of competition in the market for the firms goods and services.
Perfect competition Monopoly market

Market
Monopolistic market Oligopoly market
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INVESTMENT DECISION Business firms invest large money in their projects. Therefore, capital expenditure for different project proposals compete within themselves for their claim on scarce resources. Generally , in business sector itself, individual firms compete against access to financial resources that are scarce .
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The investment decisions are important as  Not easily reversible  Generally involves large sums of money  Highly futuristic and future is full of uncertainty  Long gestation periods Thus, careful financial appraisal of each project involves larger investments. Due to above reasons, capital decisions fall in the category of investment and known as capital budgeting decisions made by highest level of management.
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STEPS IN DECISION MAKING

Managerial economics is concerned with decision making at the level of firm. These decisions have far reaching effects on the firm. Delay in taking decisions or implementing decisions might turn in to losses.

Various steps in the decision making by a business firm are as fallows :

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Defining business problem

Determining objective

Exploring available alternatives Assessing consequences of various alternatives Choosing best alternative

Performing sensitive analysis

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Consumer Behavior

Consumer behavior
Consumption- end of economic activity Refers to the study of consumer while he is engaged in the process of consumption Equilibrium position-Highest level of satisfaction 1. The utility analysis 2. The indifference curve 52 analysis

Utility concept
Utility - amount of satisfaction derived from the consumption of a commodity .measurement units- utils

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1. The utility analysis

Cardinal utility theory Introduced by Jevons, Walras & Menger in 1970s Alfred Marshall Principles of Economics 1890 Assumption-The volume of utility of a commodity can be measured exactly in terms of numbers E.g., derive 100 utils from eating a slice of pizza 54

2. Indifference curve analysis

Ordinal utility theory Introduced by Edgeworth in 1881 Refined by Pareto in 1906 Perfected by R.G.D Allen and J.R Hicks in 1934 Roman numerical are used and they are ordered and ranked Takes the level of satisfaction instead of measuring utility
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Total utility and marginal utility Total utility (TU) - the overall level of satisfaction derived from consuming a good or service Marginal utility (MU) additional satisfaction that an individual derives from consuming an additional unit of a good or service.
(TU MU ! (Q
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The law of diminishing marginal utility

The additional benefit which a person derives from a given increase of his stock of a thing diminishes with every increase in the stock that he already has - Marshall
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The law of diminishing marginal utility - Assumptions

Various units of a commodity are homogeneous There is no time gap b/n the consumption of different units Every consumer wants to maximize utility The tastes and preferences of the consumer remains the same during the period of consumption Marginal utility of the money remains the same
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Total utility and marginal utility

Example (Table 4.1): Q 0 1 2 3 4 5 6 7 TU 0 20 27 32 35 35 34 30 MU --20 7 5 3 0 -1 -4

TU, in general, increases with Q At some point, TU can start falling with Q (see Q = 6) If TU is increasing, MU > 0 From Q = 1 onwards, MU is declining Principle of diminishing marginal utility As more and more units of a good are consumed, the process of consumption will (at some point) yield smaller and smaller additions to utility 59

Total Utility Curve

TU 35 Total utility(in utils) 30 25 20 15 10 5 0 1 2 3 4 5 Quantity 6 Q
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Marginal Utility Curve

MU Marginal utility (in utils) 20 15 10 5 0 1 -5 Quantity
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Q 2 3 4 5 6

Limitations
Homogeneity Suitable time No change in the taste of the consumer Normal persons Constant income
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Uses
Determining the price of a commodity Help in explaining paradox of value namely water-diamond paradox Explains the downward sloping of a demand curve Used in direct taxation
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Exceptions
Alcoholics Misers Money Reading Hobbies and rare collections Arts
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The law of equi-marginal utility

The consumer would distribute his money income between the goods in such a way that the utility derived from the last rupee spent on each good is equal

Marginal utility of X commodity Price of X commodity

Marginal utility of Y commodity Price of Y commodity

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Assumptions
There is perfect competition in the market Utility is measurable in terms of money Income remains constant and it is limited The consumer behaves rationally The MU of money remains constant Utility schedules are independent for different commodities The law of diminishing marginal utility operates
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Illustration
Units MU Of MU of Y X commo commo dity dity Units MU of MU of X/Price Y/Price

1 2 3 4 5 6

10 9 8 7 6 5

8 7 6 5 3 2
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1 2 4

20 18 14 10

24 21 18 15 9 3

3 (Y) 16 5(X) 12 6

Theory of consumers equilibrium

M

Price/ Utility

P U 0 1 2 3 4 5 X
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Units of commodity

Theory of Consumers equilibrium

Y

Mu of X Mu of Y
P

Utility/ Price

X
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Units of commodity X and Y

Significance
Helps in the determination of optimum budget Helps in distribution of earnings Entrepreneur can apply this law to maximize his profits Can distribute assets among alternatives Applicable to taxation Useful to a person with limited time
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Limitations
Purchase may take place due to desire than rational thinking MU varies with rich and poor Law cannot be applied if certain commodities are not available in the market Utility is subjective concept Works only if the goods are divisible
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REFERENCES 1.MANAGERIAL ECONOMICS -D.N.DWIVEDI 2. BUSINESS ECONOMICS -D.D. CHATURVEDI S.L. GUPTA SUMITRA PAUL 3.MICRO ECONOMICS -JHON KENNADY 4.MANGERIAL ECONOMICS MITHANI 72