WELL COME TO MANAGERIAL ECONOMICS

Contents
1.1 INTRODUCTION MANAGERIAL ECONOMICS ,Definition of managerial
economics

1.2 Scope of Managerial Economics

1.3 Nature of Managerial Economics
1.4 Principles of Managerial Economics
1.5 Decision making units and the circular flow model
1.6 The concept of profits
 CHAPTER ONE
1.1 INTRODUCTION TO MANAGERIAL ECONOMICS

 Economics is a study of human activity both at individual and

national level.
 Any activity involved in efforts aimed at earning money and
spending this money to satisfy our wants such as food,
Clothing, shelter, and others are called “Economic activities”
 It was only during the eighteenth century that Adam Smith, the
Father of Economics, defined economics as the study of nature
and uses of national wealth‟.
 Dr. Alfred Marshall, one of the greatest economists of the
nineteenth century, writes “Economics is a study of man‟s
actions in the ordinary business of life: it enquires how he gets
his income and how he uses it”.
Microeconomics

• The study of an individual consumer or a firm is

called microeconomics.
• Microeconomics deals with behavior and problems
of single individual and of micro organization.
• It is concerned with the application of the concepts
such as price theory, Law of Demand and theories
of market structure and so on.
Macroeconomics:
• The study of „aggregate‟ or total level of economic activity in
a country is called macroeconomics.
 It studies the flow of economics resources or factors of
production (such as land, labor, capital, organization and
technology) from the resource owner to the business firms
and then from the business firms to the households.
• It is concerned with the level of employment in the
economy.
• It discusses aggregate consumption, aggregate investment,
price level, and payment, theories of employment, and so on.
MANAGERIAL ECONOMICS
 Managerial Economics refers to the firm‟s decision making
process. It could be also interpreted as “Economics of
Management” or “ Industrial economics “ or “Business
economics”.
 Managerial Economics can be defined as
amalgamation of economic theory with business
practices so as to ease decision-making and future
planning by management.
 It makes use of economic theory and concepts.
 It helps in formulating logical managerial decisions.
 The key of Managerial Economics is the micro-
economic theory of the firm.
• Managerial Economics is a science dealing with
effective use of scarce resources.
• It guides the managers in taking decisions relating
to the firm’s customers, competitors, suppliers as
well as relating to the internal functioning of a
firm.
• It makes use of statistical and analytical Study of
Managerial Economics helps in enhancement of
analytical skills, assists in rational configuration as
well as solution of problems.
 Managerial Economics applies micro-economic tools to
make business decisions. It deals with a firm tools to assess
economic theories in solving practical business problems.
 The use of Managerial Economics is not limited to profit-
making firms and organizations. But it can also be used to
help in decision-making process of non-profit organizations
(hospitals, educational institutions, etc).
 It enables optimum utilization of scarce resources in such
organizations as well as helps in achieving the goals in most
efficient manner.
 Managerial Economics is of great help in price analysis,
production analysis, capital budgeting, risk analysis and
determination of demand.
 Managerial economics uses both Economic
theory as well as Econometrics for rational
managerial decision making.
 Econometrics is defined as use of statistical tools
for assessing economic theories by empirically
measuring relationship between economic
variables.
 It uses factual data for solution of economic
problems.
 Managerial Economics is associated with the
economic theory which constitutes “Theory of
Firm”. Theory of firm states that the primary aim of
the firm is to maximize wealth.
 The following figure tells the primary ways in which
Managerial Economics correlates to managerial decision-
making.
 1.2 Scope of Managerial Economics

 Managerial economics refers to its area of study.

 Managerial economics, Provides management with a strategic
planning tool that can be used to get a clear perspective of the
way the business world works and what can be done to
maintain profitability in an ever-changing environment.
 Managerial Economics is different from microeconomics and
macro-economics.
 Managerial Economics has a more narrow scope - it is
actually solving managerial issues using micro-economics.
 Wherever there are scarce resources, managerial economics
ensures that managers make effective and efficient decisions
concerning customers, suppliers, competitors as well as within
an organization.
Basic Economic Questions
 Basic economic problems is economic
problems faced by an economic system
due to scarcity of resources.
The basic economic problems are :
 What to produce?
 How to produce?
 For whom to produce?
What to Produce?
 The problem of allocation of resources
 It relates to what goods and services should be produced and in what
amount/quantities.
• It implies that every economy must decide which goods and in what
quantities are to be produced.
• The economy must make choices such as consumption goods versus capital
goods, civil goods versus military goods, and necessity goods versus luxury
goods.
 The managers use demand theory for deciding this. The demand theory
examines consumer behavior with respect to the kind of purchases they
would like to make currently and in future; the factors influencing
purchase and consumption of a specific good or service; the impact of
change in these factors on the demand of that specific good or service; and
the goods or services which consumers might not purchase and consume in
future.
 In order to decide the amount of goods and services to be
produced, the managers use methods of demand
forecasting.
How to Produce?
 The second question relates to how to produce goods
and services. The firm has now to choose among
different alternative techniques of production
 It has to make decision regarding purchase of raw
materials, capital equipments, manpower, etc. The
managers can use various managerial economics tools
such as production and cost analysis (for hiring and
acquiring of inputs), project appraisal methods ( for long
term investment decisions),etc for making these crucial
decisions.
For Whom to Produce?
• The problem of distribution of national product.
• It relates to how a product is distributed among the members of a
society.
• The third question is regarding who should consume and claim the
goods and services produced by the firm. The firm, for instance,
must decide which is its niche market-domestic or foreign? It must
segment the market.
 It must conduct a thorough analysis of market structure and thus take
price and output decisions depending upon the type of market.
 Managerial Economics take a wider picture of firm, i.e., it deals with
questions such as what is a firm, what are the firm‟s objectives, and
what forces push the firm towards profit and away from profit.
 1.3 Nature of Managerial Economics
 Managers study managerial economics because it gives them
insight to reign the functioning of the organization.
 If manager uses the principles applicable to economic
behavior in a reasonably, then it will result in smooth
functioning of the organization.
 Managerial Economics is a Science
 Science is a Systematic body of Knowledge. It is based on the
methodical observation.
 Managerial economics is also a science of making decisions
with regard to scarce resources with alternative applications.
It is a body of knowledge that determines or observes the
internal and external environment for decision making.
• In science any conclusion is arrived at after
continuous experimentation.
• In Managerial economics also policies are made after
persistent testing and trailing.
• Science principles are universally applicable.
Similarly policies of Managerial economics are
also universally applicable partially if not fully.
• The policies need to be changed from time to time
depending on the situation and attitude of individuals
to those particular situations. Policies are applicable
universally but modifications are required
periodically.
 Managerial Economics requires Art.
 Managerial economist is required to have an art of
utilizing his capability, knowledge and understanding to
achieve the organizational objective.
 Managerial economist should have an art to put in
practice his theoretical knowledge regarding elements of
economic environment.
 Managerial Economics for administration of
organization
 Managerial economics helps the management in
decision making. These decisions are based on the
economic rationale and are valid in the existing
economic environment.
 Managerial economics is helpful in optimum resource
allocation
 The resources are scarce with alternative uses.
Managers need to use these limited resources optimally.
Each resource has several uses. It is manager who
decides with his knowledge of economics that which
one is the preeminent use of the resource.
 Managerial Economics has components of micro
economics
 Managers study and manage the internal
environment of the organization and work for the
profitable and long-term functioning of the
organization. This aspect refers to the micro
economics study.
 The managerial economics deals with the problems
faced by the individual organization such as main
objective of the organization, demand for its
product, price and output determination of the
organization, available substitute and
complimentary goods, supply of inputs and raw
material, target or prospective consumers of its
products etc
 Managerial Economics has components of
macro economics
 None of the organization works in isolation.
 Managerial Economics is dynamic in nature
 Managerial Economics deals with human-beings (i.e. human
resource, consumers, producers etc.). The nature and attitude
differs from person to person.
 Thus to cope up with dynamism and vitality managerial
economics also changes itself over a period of time.
 Managerial economics Microeconomics
I. Micro Economics is a broader concept as
I. Almost all the concepts of Managerial Economics are compare to Managerial Economics.
the perceptions of Micro Economics concepts.
II. Managerial economics can be perceived as an applied II. Micro Economics forms the foundation of
Micro Economics managerial economics.
III. Managerial Economics applies the theories of Micro III.Micro Economic Analysis is important as it
Economics to resolve the issues of the organization is applied to day to day dilemma and
and for decision making. concerns.
IV. For fixing the price of the products managers applies
the pricing theories, cost and revenue theories of IV.Microeconomics is the study that deals with
micro economics. partial equilibrium analysis which is useful
V. Managerial economics utilizes statistical methods for the manager in deciding equilibrium for
such as game theory, linear programming etc for his organization.
application of Economic Theory in Decision making.
VI. Managerial Economics also uses tools of
Mathematical Economics and econometrics such as
regression analysis, correlation analysis etc.
1.4 Principles of Managerial Economics

Some important principles of managerial

economics are:
 Marginal and Incremental Principle
 Equi-marginal Principle
 Opportunity Cost Principle
 Time Perspective Principle
 Discounting Principle
A. Marginal and Incremental Principle

 This principle states that a decision is said to be

rational and sound if given the firm‟s objective of
profit maximization, it leads to increase in
profit, which is in either of two scenarios-
If total revenue increases more than total
cost.
If total revenue declines less than total
cost.
• Marginal analysis implies judging the impact of a
unit change in one variable on the other.
• Marginal revenue is change in total revenue per unit
change in output sold.
• Marginal cost refers to change in total costs per unit
change in output produced (While incremental cost
refers to change in total costs due to change in total
output).
• The decision of a firm to change the price would
depend upon the resulting impact/change in marginal
revenue and marginal cost. If the marginal revenue is
greater than the marginal cost, then the firm should
bring about the change in price.
 Incremental analysis differs from marginal analysis only in
that it analysis the change in the firm's performance for a
given managerial decision, whereas marginal analysis often is
generated by a change in outputs or inputs.
 Incremental analysis is generalization of marginal concept.
It refers to changes in cost and revenue due to a policy
change.
 For example - adding a new business, buying new inputs,
processing products, etc. Change in output due to change in
process, product or investment is considered as incremental
change. Incremental principle states that a decision is
profitable if revenue increases more than costs; if costs reduce
more than revenues; if increase in some revenues is more than
decrease in others; and if decrease in some costs is greater
than increase in others.
B. Equi-marginal Principle

 Marginal Utility is the utility derived from the

additional unit of a commodity consumed
 The laws of equi-marginal utility states that a
consumer will reach the stage of equilibrium when
the marginal utilities of various commodities he
consumes are equal.
 According to the modern economists, this law has
been formulated in form of law of proportional
marginal utility.
 MUx / Px = MUy / Py = MUz / Pz
• Where, MU represents marginal utility and P is the price of
good.
• Similarly, a producer who wants to maximize profit
(or reach equilibrium) will use the technique of
production which satisfies the following condition:
• MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3
• Where, MRP is marginal revenue product of inputs
and MC represents marginal cost.
• Thus, a manger can make rational decision by
allocating/hiring resources in a manner which
equalizes the ratio of marginal returns and marginal
costs of various use of resources in a specific use.
C. Opportunity Cost Principle
• By opportunity cost of a decision is meant the sacrifice
of alternatives required by that decision. If there are no
sacrifices, there is no cost.
• According to Opportunity cost principle, a firm can hire
a factor of production if and only if that factor earns a
reward in that occupation/job equal or greater than it‟s
opportunity cost.
• Opportunity cost is the minimum price that would be
necessary to retain a factor-service in it‟s given use.
• It is also defined as the cost of sacrificed alternatives.
 D. Time Perspective Principle
 According to this principle, a manger/decision maker
should give due emphasis, both to short-term and long-
term impact of his decisions, giving apt significance to
the different time periods before reaching any decision
 Short-run refers to a time period in which some/ at least
one / factors are fixed while others are variable.
 The production can be increased by increasing the
quantity of variable factors.
 While long-run is a time period in which all factors of
production can become variable.
 E. 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.
• Discounting can be defined as a process used to
transform future dollars into an equivalent number
of present dollars. For instance, $1 invested today
at 10% interest is equivalent to $1.10 next year.
• V = PV*(1+r)t
• Where, FV is the future value (time at some future
time), PV is the present value (value at t0, r is the
discount (interest) rate, and t is the time between
the future value and present value.
• 1.5 Decision making units and the circular flow
model
• The individuals own or control resources which are
necessary inputs for the firms in the production
process.
• These resources (factors of production) are
classified into four types.
 Labor:. is the work force of an economy. The
value of the worker is called as human capital.
 The reward for labor is called wage.
 Land: : It includes all natural resources on the
earth and below the earth. Nonrenewable resources
such as oil, coal etc once used will never be
replaced.
 Natural resources or all the free gifts of nature. The
reward for the services of land is known as rent.
 Capital: It is classified as working capital and fixed
capital (not transformed into final products)
The reward for the services of capital is called interest.

 Entrepreneurship: refers to a special type of human

talent that helps to organize and manage other factors
of production to produce goods and services and takes
risk of making loses.

The reward for entrepreneurship is called profit.

Entrepreneurs are individuals who:
 Organize factors of production to produce goods and
services.
 Make basic business policy decisions.
 Introduce new inventions and technologies into business
practice.
 Look for new business opportunities.
 Take risks of making losses.
• There are three decision making units in a closed
economy. These are households, firms and the
government.
I ) Household: A household can be one person or
more who live under one roof and make joint
financial decisions.
• Households make two decisions.
a) Selling of their resources, and
b) Buying of goods and services.
ii) Firm: A firm is a production unit that uses
economic resources to produce goods and
services. Firms also make two decisions:
a) Buying of economic resources
b) Selling of their products.
• iii) Government: A government is an
organization that has legal and political power to
control and services known as public goods and
services for the society.
 The three economic agents interact in two
markets

 Product market: it is a market where goods and

services are transacted/ exchanged.
 A market where households and governments buy
goods and services from business firms.
 Factor market (input market): it is a market
where economic units transact/exchange factors of
production (inputs).
• In this market, owners of resources (households)
sell their resources to business firms and
governments.
Four sectors model
 A modern monetary economy comprises a network
of four sector economy these are:
 Household sector
 Firms or Producing sector
 Government sector
 Rest of the world sector.
 Each of the above sectors receives some payments
from the other in lieu of goods and services which
makes a regular flow of goods and physical
services.
1.6 The concept of profits
Two important concept of profit in business decision are
Economic profit and accounting profit .
 It will be useful to understand the difference between the
two concepts .
Accounting Profit : In accounting sense , profit is surplus of
revenue over and above all paid out costs .
Accounting profit = TR-(W+R+I+M) ,
where w = wages and salaries
R = rent
I = interest and
M = cost of material
Obviously ,while calculating profit , only explicit book cost,
The cost recorded in the book accounts are considered .
Economic profit
The concept of economic profit differs from that of
accounting profit .
 Economic profit takes in to account also the
implicit and or imputed cost
 Implicit cost is opportunity cost.
 Opportunity cost is defined as the payment that
would be necessary to draw forth the factors of
production from their most remunerative
alternative employment .
 Accounting profit does not take in to account the
opportunity cost .
So, Profit has several meanings in business decision.
 Profit is the reward gained by risk taking
entrepreneurs when the revenue earned from
selling a given amount of output exceeds the
total costs of producing that output.
 Total profits(π) = total revenue (TR) – total costs
(TC) or profit = TR- ( explicit cost + implicit
cost).
However, the concept of profit needs clarification
because there is no standard definition of what counts
as a cost.
 The accounting definition of profits is rather
different because the calculation of profits is based
on a straightforward numerical calculation of past
monetary costs and revenues, and makes no
reference to the concept of opportunity cost.
 Accounting profit occurs when revenues are
greater than costs, and not equal, as in the case of
normal profit.
Profit can be :
1.Normal profit(π):. This exists when
total revenue(TR) equals total cost(TC).
 Normal profit is defined as the minimum reward
that is just sufficient to keep the entrepreneur
supplying their enterprise.
 In other words, the reward is just covering
opportunity cost – that is, just better than the next
best alternative.
2.Super-normal, Positive (economic)profit
• If a firm makes more than normal profit it is called
super-normal profit
• Supernormal profit is also called economic profit,
and abnormal profit.
• It is earned when total revenue is greater than the
total costs(TR>TC).
• Super-normal profit can be derived in three general
cases:
 By firms in perfectly competitive markets in the
short run, before new entrants have eroded their
profits down to a normal level.
 By firms in less than competitive markets,
 like firms operating under monopolistic competition
and competitive oligopolies,by innovating or
reducing costs, and earning head start profits.
 By firms in highly uncompetitive markets, like
collusive oligopolies and monopolies, who can erect
barriers to entry protect themselves from competition
in the long run and earn persistent above normal
profits.
3.Negative profit(Loss) : When total revenue less than
total cost ( TR< TC) , when the total revenue less than
total cost firm gets loss.
Profit Maximization condition
Profit maximization as the only objective of
business firm
 There are two conditions that must be fulfilled for
profit to be maximum.
1. Necessary Condition (FOC)
2.Supplementary Condition(SOC)
 1. Necessary Condition: The necessary condition
requires that marginal revenue(MR) must be equal
to marginal cost or MR = MC . This is called First
order condition (FOC).
2.Supplmentary condition (SOC)
The secondary Condition (SOC): This condition
requires that the necessary condition must be
satisfied under the condition of decreasing MR and
rising MC.
 In short The slope of MC is greater than
slope of MR, or MC is rising).
Mathematical Exercise
1.Assuming that a price function as
P = 100- 2Q and cost function as
TC = 10 +0.5𝑄 2 ,then
A. Find profit maximizing level of output and price .
B. Find amount of Total Revenue(TR),Total Cost and
maximum profit(π).
2.Assuming a price function
p = 90-2Q and a cost function as
TC = 10 +0.5𝑄 2
A. Find profit maximizing out put and price.
B. Find marginal revenue and marginal cost functions.
C. Find maximum amount of profit.