Managerial Economics

305 Pages·2009·2.62 MB·English

?
Managerial Economics
Subject: MANAGERIAL ECONOMICS Credits: 4
SYLLABUS

Basics of Managerial Economics
Introduction to Economics, Basics of Managerial Economics, Introduction to Economics, Nature and Scope of
Managerial Economics, Managerial Economics & Economics Related Disciplines Interrelationship with Other
Subjects, Economics Tools

Demand Theory
Demand Analysis, Elasticity Concepts, Demand Forecasting, and Importance of Demand forecasting

Cost of Production:
Cost Analysis, Economic of Scale, Cost Reduction and Cost control, Capital Budgeting

Production Theory
Introduction to Production Concept, Production Analysis, Stage of Production, Return to Scale, Supply
Analysis

Market Analysis
Introduction to market Structure, Perfect Competition, Monopoly, Oligopoly and Pricing

Suggested Readings:

1. Managerial Economics – Analysis, Problems and Cases, P.L. Mehta, Sultan Chand Sons, New Delhi
2. Managerial Economics – Varshney and Maheshwari, Sultan Chand and Sons, New Delhi
3. Managerial Economics – D. Salvatore, McGraw Hill, New Delhi
4. Managerial Economics – Pearson and Lewis, Prentice Hall, New Delhi
5. Managerial Economics – G.S. Gupta, T M H, New Delhi
------------------------------------------------------------------------------------------------------------
NATURE AND SCOPE OF ECONOMIC ANALYSIS
------------------------------------------------------------------------------------------------------------

Structure

1.1 Introduction to Economics
1.2 Concept of Economics in Decision Making
1.3 Scope of Managerial Economics

1.4 Relationship between Managerial Economics and Other Subjects

1.5Tools and Techniques of Decision Making
1.6 Review Questions
------------------------------------------------------------------------------------------------------------
1.1 INTRODUCTION TO ECONOMICS
------------------------------------------------------------------------------------------------------------
This unit introduces you to the basic concepts of Economics. After going through this
unit you will come to know how Economics is helpful for Managers in their Decision
making process.

Objectives:
• To analyze the concept of economics- scarcity and efficiency
• Micro Economics and macro economics
• Concept of managerial economics
• How managerial economics differ from economics and its relationship with
management

Good morning students, the basic purpose of our studying of economics are the efficient
utilization of scarce resources. We always have to make choices amongst various
alternatives available for efficient utilization of our scarce resources. The twin theme of
economics is scarcity and efficiency. We will discuss this twin theme in detail before
coming to managerial economics.

Scarcity and Efficiency: The first question which comes here is what is Economics?
Economics is the study of how society chooses to use productive resources that have
alternative uses, to produce commodities of various kinds, and to distribute them among
different groups.
Two key ideas in economics:
• Scarcity of goods
5
• Efficient use of resources

(cid:153) Scarcity of goods
The word scarce is closely associated with the word limited or economic as opposed to
unlimited or free. Scarcity is the central problem of every society.
• Concept lies at the problem of resource allocation and problem of a business
enterprise.
• The essence of any economic problem, micro or macro, is the scarcity of
resources.
• The managers who decide on behalf of the corporate unit or the national economy
always face the economic problem of Scarcity of good quality of materials or
skilled technicians

As a Marketing Manager: He may be encountering scarcity of sales force at his
command
As a Finance Manager: He may be facing the scarcity of funds necessary for expansion
or renovate a program
As a Finance Minister of the Country: His basic problem when he prepares the budget
every year is to find out enough revenue resources to finance the necessary expenditure
on plans and programs. Thus, we see that Scarcity is a universal phenomenon.

Let us attempt a technical definition of “Scarcity”
• In economic terms it can be termed as “ Excess of Demand”
• Any time for any thing if its demand exceeds its supply, that thing is said to be
scarce.
• Scarcity is a relative term: Demand in relation to its supply determines the
element of scarcity.

Problem:
Unemployment: Scarcity of jobs
Unsold stock of inventory: Scarcity of buyers
Under utilized capacity of plan: Scarcity of power or other support facilities.

Had there been no scarcities there would not have been any managerial problem. It is
only because of this scarcity a manager has to decide on optimum allocation of scarce
resources of:
• Man
• Materials
• Money
• Time
• Energy

Thus we see that every business unit or manager must aim at rational but optimum
allocation of scarce resources. Optimality lies in finding the best use of scarce resources,
given to the constraints.

6
(cid:153) Efficiency of Resources
Economy makes best use of its limited resources. That brings the critical notion of
efficiency. Efficiency denotes most effective use of a society’s resources in satisfying
people’s wants and needs.

Consider the Monopoly Situation: In economics we say that an economy is producing
efficiently when it cannot make anyone economically better off without making someone
else worse off. The essence of economics is to acknowledge the reality of scarcity and
then figure out how to organize society in such a way, which produces the most efficient
use of resources. Economics can be called as social science dealing with economics
problem and man’s economic behavior. It deals with economic behavior of man in
society in respect of consumption, production; distribution etc. Economics can be called
as an unending science. There are almost as many definitions of economy as there are
economists. We know that definition of subject is to be expected but at this stage it is
more useful to set out few examples of the sort of issues which concerns professional
economists.

Example: For e.g. most of us want to lead an exciting life i.e. life full of excitements,
adventures etc. but unluckily we do not always have the resources necessary to do
everything we want to do. Therefore choices have to be made or in the words of
economists “individuals have to decide “how to allocate scarce resources in the most
effective ways”. For this a body of economic principles and concepts has been developed
to explain how people and also business react in this situation. Economics provide
optimum utilization of scarce resources to achieve the desired result. It provides the basis
for decision making. Economics can be studied under two heads:
1. Micro Economics
2. Macro Economics

Micro Economics: It has been defined as that branch where the unit of study is an
individual, firm or household. It studies how individual make their choices about what to
produce, how to produce, and for whom to produce, and what price to charge. It is also
known as the price theory and is the main source of concepts and analytical tools for
managerial decision making. Various micro-economic concepts such as demand, supply,
elasticity of demand and supply, marginal cost, various market forms, etc. are of great
significance to managerial economics.

Macro Economics: It’s not only individuals and forms that are faced with having to
make choices. Governments face many such problems. For e.g. How much to spend on
health; How much to spend on services; How much should go in to providing social
security benefits. This is the same type of problem faced by all of us in our daily lives but
in different scales. It studies the economics as a whole. It is aggregative in character and
takes the entire economy as a unit of study. Macro economics helps in the area of
forecasting. It includes National Income, aggregate consumption, investments,
employment etc.

7
Following are the various economic concepts which are useful for managers for decision
making:
• Price elasticity of demand
• Income elasticity of demand
• Cost and output relationship
• Opportunity cost
• Multiplier
• Propensity to consume
• Marginal revenue product
• Production function
• Demand theory
• Theory of firm: price, output and investment decisions
• Money and banking
• Public finance and fiscal and monetary policy
• National income
• Theory of international trade

The Three Problems of Economic Organization: Because of scarcity, all economic
choices can be summarized in big questions about the goods and services a society should
produce. These questions are:
• What to produce?
• How to produce?
• For whom to produce?

What to Produce?
The first question every society faces is what to produce. Should a society build more
roads or schools? Because of scarcity, society can not build everything it wants. Choices
have to be made. Once a society determines what to produce it then needs to decide how
much should be produced. In a market economy the "what" question is answered in large
part by the demand of consumers?

How to Produce?
The next question a society needs to decide after what to produce is how to produce the
desired goods and services. Each society must combine available technology with scarce
resources to produce desired goods and services. The education and skill levels of the
citizens of a society will determine what methods can be used to produce goods and
services. For example, does a nation possess the technology and skills to pick grapes with
a mechanized harvester, or does it have to pick the grapes by hand?

For whom to produce?
The final question each society needs to ask is for whom to produce. Who is to receive
and consume the goods and services produced? Some workers have higher incomes than
others. This means more goods and services in a society will be consumed by these
wealthy individuals, and less by the poor. Different groups will benefit from the different
ways that we choose to spend our money.
8
Inputs and Outputs: Every economy must make choices about the economy’s inputs
and outputs.
Inputs: Commodities used to produce goods and services .A economy uses its existing
technology to combine inputs to produce outputs.
Output: The various useful goods and services that result from production process that is
directly consumed or employs in further production.

Another term for inputs is factors of production:

Factors of Production: It refers to the resources used to produce goods and services in a
society. Economists divide these resources into the four categories described below.
• Land refers to all natural resources. Such things as the physical land itself, water,
soil, timber are all examples of land. The economic return on land is called rent.
For example, a person could own land and rent it to a farmer who could use it to
grow crops. A second resource is labor.
• Labor refers to the human effort to produce goods and services. The economic
return on labor is called wages. Anyone who has worked for a business and
collected a paycheck for the work done understands wages. A third factor of
production is capital.
• Capital is anything that is produced in order to increase productivity in the future.
Tools, machines and factories can be used to produce other goods. The field of
economics differs from the field of finance and does not consider money to be
capital. The economic return on capital is called interest.
• Finally, the fourth factor of production is called entrepreneurship.
Entrepreneurship refers to the management skills, or the personal initiative used
to combine resources in productive ways. Entrepreneurship involves the taking of
risks. The economic return on entrepreneurship is profits

Meaning of Managerial Economics: It is another branch in the science of economics.
Sometimes it is interchangeably used with business economics. Managerial economics is
concerned with decision making at the level of firm. It has been described as an
economics applied to decision making. It is viewed as a special branch of economics
bridging the gap between pure economic theory and managerial practices. It is defined as
application of economic theory and methodology to decision making process by the
management of the business firms. In it, economic theories and concepts are used to solve
practical business problem. It lies on the borderline of economic and management. It
helps in decision making under uncertainty and improves effectiveness of the
organization. The basic purpose of managerial economic is to show how economic
analysis can be used in formulating business plans.

Definitions of Managerial Economics: In the words of Mc Nair and Merriam,” ME
consist of use of economic modes of thought to analyze business situation”. According to
Spencer and Seigelman it is defined as the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by the
management”. Economic provides optimum utilization of scarce resource to achieve the
9
desired result. ME’s purpose is to show how economic analysis can be used formulating
business planning.

Managerial Economics = Management + Economics

Management deals with principles which helps in decision making under uncertainty and
improves effectiveness of the organization. On the other hand economics provide a set of
preposition for optimum allocation of scarce resources to achieve a desired result.
Managerial Economics deals with the integration of economic theory with business
practices for the purpose of facilitating decision making and forward planning by
management. In other words it is concerned with using of logic of economics,
mathematics, and statistics to provide effective ways of thinking about business decision
------------------------------------------------------------------------------------------------------------
1.2 CONCEPT OF ECONOMICS IN DECISION MAKING
------------------------------------------------------------------------------------------------------------
Students, earlier we had discussed various aspects of economics- scarcity and efficiency
and meaning and role of managerial economics. Now we will be discussing the various
aspects of decision making.

What do you mean by Decision Making?
Well decision making is not something which is related to managers only or which is
related to corporate world, but it is something which is related to everybody’s life.
Whether a person is working or non working, irrespective of his/her field, decision
making is important to everyone. You need to make decision irrespective of the work you
are doing. As a student also you have to take so many decisions. Suppose at a particular
point of time you want to go for a movie, and at the same point of you want to go for
shopping then what you will do. You can’t do two things at the same point of time. You
have to decide what to do first and what to do next. Therefore decision making can be
called as choosing the right option from the given one. To decide is to choose. Whether to
do this or to do that is what is decision making.

Decision making is the most important function of business managers. Decision making
is the central objective of Managerial Economics. Decision making may be defined as the
process of selecting the suitable action from among several alternative courses of action.
The problem of decision making arises whenever a number of alternatives are available.
Such as:
• What should be the price of the product?
• What should be the size of the plant to be installed?
• How many workers should be employed?
• What kind of training should be imparted to them?
• What is the optimal level of inventories of finished products, raw material, spare
parts, etc.?

Therefore we can say that the problem of decision making arises due to the scarcity of
resources. We have unlimited wants and the means to satisfy those wants are limited,
with the satisfaction of one want, another arises, and here arises the problem of decision
10
making. While performing his function manager has to take a lot of decisions in
conformity with the goal of the firm. Most of the decisions are taken under the condition
of uncertainty, and involves risks. The main reasons behind uncertainty and risks are
uncertain behavior of the market forces which are as follows:
• The demand and supply
• Changing business environment
• Government policies
• External influence on the domestic market
• Social and political changes
• The maximum use of limited resources.

Now we will discuss various aspects relating to the management decision making or
Managerial Decision Making.

• What Is Management?
(cid:57) Management is the process of coordinating people and other resources to
achieve the goals of the organization
(cid:57) .Most organizations use various kinds of resources.

• Basic Management Functions
A number of management functions must be performed if any organization is to
succeed.
(cid:57) Establishing Goals and Objectives.
(cid:57) Establishing Plans to Accomplish Goals and Objectives.
(cid:57) Organizing the Enterprise. Leading and Motivating
(cid:57) Controlling Ongoing Activities.

• Kinds of Managers
They can be classified along two dimensions:
(cid:57) Level within the organization which include: Top managers; Middle
Managers; First Line Managers.
(cid:57) Area of management which include: Financial Managers; Operations
Managers; Marketing Managers; Human Resources Managers;
Administrative Managers.

• What Makes Effective Managers?
Key Management Skills. The skills that typify effective managers tend to fall into
three categories.
(cid:57) Technical Skills
(cid:57) Conceptual Skills.
(cid:57) Interpersonal Skills.
(cid:57) Managerial Roles.
(cid:57) Decisional Roles
(cid:57) Interpersonal Roles
(cid:57) Informational Roles.

11
• Managerial Decision Making
Decision-making is the act of choosing one alternative from among a set of
alternatives. Managerial decision making involves four steps.
(cid:57) Identifying the Problem or Opportunity
(cid:57) Generating Alternatives.
(cid:57) Selecting an Alternative
(cid:57) Implementing and Evaluating the Solution

Now we will discuss the various factors affecting decision making.

• Conditions Affecting Decision Making: An Ideal Business situation would be
the one where
(cid:57) Full Information with managers to make decisions with certainty
(cid:57) An Actual business situation with managers:
(cid:57) Most business are characterized by incomplete or ambiguous information

• Conditions that affect decision making: (certainty, risk and uncertainty)
(cid:57) Certainty: Situation when decision makers are fully informed about A
problem; Alternative solutions; their respective outcomes; Individuals can
anticipate, and even exercise some control over events and their outcomes.

(cid:57) Risk: Condition when decision makers rely on incomplete, yet reliable
information. Manager does not know the certainty the future outcomes
associated with alternative courses of action, although he knows the
probability associated with each alternative

(cid:57) Uncertainty: It is the condition that exists when little or no factual
information is available about a problem, its alternative and their respective
outcomes. He does not have enough information to determine the probabilities
associated with each alternative possible that he may be unable even to define
the problem

Hope you all must be clear with the concepts certainty, risk and uncertainty. Now, we
will discuss various models of decision making.

(cid:153) Decision Making Models

• The Classical Model:
(cid:57) Also called rational model
(cid:57) A prescriptive approach that outlines how managers should make decisions.
(cid:57) Assumptions: Manager has complete information about decision situation and
operations under condition of certainty; Problem is clearly defined, and the
decision – maker has knowledge of all possible alternatives and their
outcomes; Through the use of quantitative techniques , rationality and logic ,
12