MANAGERIAL
ECONOMICS
1
Managerial + Economics
• Managerial
Economics
is
economics
applied
in
decision-making
• Link between abstract theory
and managerial practice.
• Analysis
for
identifying
problems,
organizing
information and evaluating
alternatives.
2
Managerial Economics &
Business Decision-making
Decision Problem
Traditional
Economics
Managerial Economics
Tools &
Techniques
of Analysis
Optimal Solution to Business Problems
3
Nature of Managerial Economics
Spencer and Siegelman point to the fact
that
“Managerial
Economics..
is
the
integration of economic theory and business
practice for the purpose of facilitating
decision-making and forward planning by
management.”
4
Chief Characteristics of
Managerial Economics/Nature
• Managerial economics is micro-economic in character
as it concentrates only on the study of the firm and not
on the working of the economy.
• Managerial economics takes the help of macroeconomics to understand and adjust to the
environment in which the firm operates.
• Managerial economics is normative rather than positive
in character.
• It is both conceptual (theory) and metrical
(quantitative techniques).
• The contents of managerial economics are based mainly
on the “theory-of firm’.
• Knowledge of managerial economics helps in making
wise choices.
5
Significance of Managerial
Economics
• In order to enable the manager to
become a more competent model
builder,managerial economics provides
a number of tools and techniques.
• Managerial economics provides most of
the concepts that are needed for the
analysis of business problems.
• Managerial economics is helpful in
making decisions.
• Evaluating choice of alternatives.
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Scope of Managerial Economics
Following aspects constitute its subject matter:







Objectives of a Business Firm
Demand Analysis and Demand Forecasting
Production and Cost
Competition
Pricing and Output
Profit
Investment and Capital Budgeting and
Product Policy, Sales Promotion and Market Strategy.
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Managerial Economics & Other
Disciplines
• Managerial Economics & Traditional Economics
• Managerial Economics & Operations Research
• Managerial Economics & Mathematics
• Managerial Economics & Statistics
• Managerial Economics
Decision-making
&
the
Theory
of
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FUNDAMENTAL
CONCEPTS
9
Fundamental Concepts
•
•
•
•
•
Incremental Reasoning
Opportunity Cost
Contribution
Time Perspective
Time Value of Money – Discounting
Principle &
• Equi-Marginal Principle
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1.Incremental Reasoning
The two basic concepts in the incremental analysis
are : incremental cost and incremental revenue.
• Incremental cost may be defined as the
change in total cost as a result of change in the
level of output, investment, etc
•Incremental Revenue is change in total
revenue resulting from change in level of output ,
price etc.
Use of Incremental Reasoning
While taking a decision, a manager always
determines the worthwhile ness of a decision on
the basis of criterion that the incremental revenue
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should exceed incremental cost.
Illustration:
The firm gets an order
which can get it an
additional revenue of Rs.
2000. The normal cost
of production of this
order is:
Labour
Rs.600
Materials
800
Overheads
720
Selling &
280
administrati
on expenses
Full cost
Rs.2400
The addition to cost due
to new order is the
following:
Labour
Rs.400
Materials
800
Overheads
200
Full cost
Rs.1400
• Firm would earn a net
profit of Rs 2,000 – Rs.
1400 = Rs. 600 while at
first it appeared that the
firm would make a loss
of Rs.400 by accepting
the order.
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A course of action should be
pursued up to the point where its
incremental benefits equal its
incremental costs.
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2.Opportunity Cost
• Opportunity
cost, therefore, represents the
benefits of revenue forgone by pursuing one
course of action rather than another.
For e.g:
(a) The opportunity cost of the funds employed
in one’s
own business is the amount of interest
which could have been earned had these funds
been invested in the next best channel of
investment
(b) The opportunity cost of using an idle
machine is zero, as its use needs no sacrifice of
opportunities.
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Opportunity Cost
•Opportunity cost includes both the explicit and
implicit costs:Explicit costs are recognized in the accounts , e.g.,
the payments for labour, raw materials, etc
Implicit (or imputed) costs are sacrifices that are
not recorded in accounting e.g. cost of capital
supplied by owners of business.
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3.Contribution
•Contribution tells us about the contribution of a
unit of output to overheads and profit.
•It helps in determining the best product mix when
allocation of scarce resources is involved.
•It also indicates whether or not it is advantageous
to accept a fresh order, to introduce a new product,
to shut down to continue with the existing plant
etc.
•Unit contribution is the per unit difference of
incremental revenue from incremental cost
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4.Time Perspective
Economists often make a distinction between short
run and long run.
•Short run means that period within which some
of the inputs (called fixed inputs) cannot be altered.
•Long run means that all the inputs can be
changed.
Economists try to study the effect of policy
decisions on variables like prices, costs, revenue,
etc, in the light of these time distinctions.
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5.Discounting Principle
•The concept of discounting future is based on the
fundamental fact that a rupee now is worth more than a rupee
earned a year after.
•Unless these returns are discounted to find their present
worth, it is not possible to judge whether or not it is worth
undertaking the investment today.
Illustrations
Suppose a sum of Rs.100 is due after 1 year. Let the rate of
interest be 10% . We can determine the sum to be invested
now so as to produce the return (R) of Rs.100 at the end of 1
year. The present value of the discounted value of Rs. 100
will then be,
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R
100
V1 

 Rs.90.90
1  i  1.10
T hesame reasoningcan be used to find thepresent value of longer
periods.A present value of Rs.100due two yearslater would be,
Rs.100 Rs.100 Rs.100
V2 


 82.64
2
2
1.21
1  i  (1.10)
We can thuswrite thepresent worth of a streamof incomespreadover n
years(i.e R 1 , R 2 ...Rn )as
R3
Rn
R1
R2
,
,
............,
3
2
(1 i) (1  i) 1  i 
1  i n
The sum of present values for n years would thus be
n
R3
Rn
Rk
R1
R2
V


 ............,

3
n
2
(1 i) (1  i) 1  i 
1  i  k 1 1  i k
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6.The Equi-Marginal
Principle
•The law of equi-marginal utility states that a utility
maximizing consumer distributes his consumption expenditure
between various goods and services he/she consumes in such
a way that the marginal utility derived from each unit of
expenditure on various goods and service is the same.
•This principle suggests that available resources (inputs)
should be so allocated between the alternative options that
the marginal productivity (MP) from the various activities are
equalized.
For eg. Suppose a firm has a total capital of Rs. 100 million
which it has the option of spending on three projects, A,B, and
C. Each of these projects requires a unit expenditure of Rs.
10 million.
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The Equi-Marginal
Principle
Marginal Productivity (MP) Schedule of Projects A, B, and C
Units of
Expenditure
(Rs.10 million)
1st
2nd
3rd
4th
5th
Marginal Productivity (MP)
Project A Project B
Project C
50
45
35
20
10
35
30
20
15
12
40
30
20
10
0
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The Equi-Marginal
Principle
T heequi marginalprinciplesuggests thata profit(gain) maximizing
firmsallocatesits resourcesin a proportionsuch that
MPA  MPB  MPC  ...  MP N
T heequi - marginalprinciplecan be appliedonly where
(i) firmshavelimitedinvestibleresources
(ii) resourceshavealternative uses and
(iii) theinvestmentin variousalternative uses is subject todiminishing
marginalproductivity or return.
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