fev 1.1 MANAGERIAL ECONOMICS - DEFINITION, NATURE AND SCOPE 21. Define managerial economics and point out its chief characteristics. How is microeconomics useful to managerial economics? Answer ] Managerial Economics sJune.03, Set-2, 01 Managerial economics has been defined by different scholats as follows, a 1. “Managerial economics is the integration of economic theory with business practice for the purpose of facilitating decision- making and forward planning by management Spencer and Siegelman 2, “Managerial economics is the use of economic models of thought to analyze business situations”, = Me Nair and Meriam 3 “Managerial economics is the application of economic theory and methodology to business administration practice”. ~ Brigham and Pappas Nature/Characteristics of Managerial Economics Managerial economics by nature is a specialized discipline of management studies that deals with the'application’of economic theory, tools and methodologies to business management practice. Managerial economics has evolved as an integration of economic theory and decision sciences with business managemént. The following points specify the nature of managerial economics, 1 Managerial economics is confined only to a part of business management but it is not directly concerned with the managerial problems involving control, implementation, conflict resolution and other management strategies. 2 Managerial economics mainly relies on the sound framework of traditional economics and decision sciences in analyzing the problems in a business. It mainly relies on the application of economic principles and methodologies for business decision- ‘making. 3.» Managerial economics is mainly microeconomic in nature. Microeconomics is that branch of economics which deals with the individual units or sections (a person, a firm or a group of persons or firms) of an economy. As managerial economics is mainly concerned with analyzing and finding optimal solutions to the problems of decision-making in business firm, itis essentially micro economic in nature, 4. Managerial economics is pragmatic ice., it is a practical subject. It prevents the abstract issues of economic theory and incorporates complications that are not covered by the economic theory in order to analyze the situation in which managers, take decisions. | 5. Managerial economics falls into normative economics. Economics can be classified into two broad categories namely positive and normative. Positive economics describes ‘what is’ i.e,, observed economic pheriomenon. The statement “Poverty in India is very high” is an example of positive economics. Normative economics describes “what ought to be” ¢., it differentiates the ideal from the actual. An example of normative économics is the statement “People who earn high incomes ought to pay more incomes tax than people who earn low incomes” 6 Managerial economics utilizes some of the theories of macroeconomics, An organization affects and is affected by many different factors of the environment in which it works. Most factors related to this environment come under the subi matter of macroeconomics. In order to overcome these problems, an organization takes the help of some of the theories of ‘macro economics. sion sciences 7. Managerial economics is goal-oriented and problem solving i for solving business oriented problems. nature. It uses the economic theory and de S_ Itintegrates theory into practice ice, it converts the theoretical framework of economics into réal business practiceThe figuie below depicts the nature of managerial economics ‘Managerial Economics Solutions to Business Problems Figure: Nature of Managerial Economics Q22. What is managerial economics? (ov.-10, Set-1, Q1(a) | Now-10, Se-2, O1(a)) Answer : For answer refer Unit-I, Q21, Topic: Managerial Economics. Q23. Economics cannot be a science because economists disagree. Discuss. Answer: May-13, Set-3, Q1(a) For answer refer Unit-I, Q21, Topic: Nature/Charac- teristics of Managerial Economics, Q24, Define managerial economics and briefly explain its characteristics and scope of managerial economics? (May-12, Set, Q1 | Model Paper. 22) oR Define managerial economics. Explain the na- ture and scope of managerial economics. (Dee.12, Set-1, G1 | April-10, Set-4, 1) OR What is managerial economics? Explain the natyre and scope of managerial economics. oR Define managerial econ basting ander jomics. Explain its t (May/dune-09, Set 1 | Nov.-08, Set-3, a1 | Now-07, Set ‘Answer: cine ._ Definition’: Managerial Economics For answer refer Unit-1,Q2! fopic: Managerial Economics, For answer refer,Unit-l, Q21, Topic: Nature/Chay, teristics of Managerial Economics re Focus Areas/Scope of Managerial Economics ‘The scope of managerial economics includes 2) economic concepts, theories, ideas, principles, tools ° techniques that can be sed to analyze the business environs, and find solutions to practical business problems. The follow, business areas can be considered as the scope of manapen, economics. 1. - | Objectives ofa Business Firm or Organization | ‘Nature of Managerial Economics ~ ‘ q Managerial economics provides a sound framework, | facilitating a business firm to frame its objectives both in w. | short-run and long-run | 2, Resource Allocation | Managerial economics provide the methods of effec. | resource allocation, It mainly aims at achieving high out: through low and proper allocation of resources. | 3. Demand Analysis and Demand Forecasting | It suggests the methodologies for analyzing the demans of a product. The demand forecasting techniques it provides, | are proven to be quite efficient for meeting the competition, 4, Competitive Analysis | The techniques provided by managerial economics | facilitates a firm to withstand in a competitive situation, 5. Strategic Planning Managerial economics guides a business manager in making strategic decisions. 6. Production Management Managerial economics plays a vital role in production management. Its effective tools help to plan the business schedule, regulate the production process and effectively place the output in the market. 7. Cost Analysis Managerial economics provides various cost concep’ and cost curves that facilitate in determining cost-outpst relationship both in short-run and long-run. 8. Pricing Strategies Managerial economics provides certain pricing strategies that are used in analyzing the price of a product and in determining or setting the price of a product. 9. Market Structure Analysis ‘The techniques and concepts of managerial economic: analyze the market structure and guide in taking necess*9 decisions that are required for a firm to exist in the market. 10. Investment and Capital Budgeting Decisions ‘The concept of opportunity cost provided by managet! economics facilitates in making appropriate investme™ decisions and choose the best alternative that fits organizational requirements.1. “Marketing Strategies Managerial economics provides marketing strategies like, 0% % % Product policy % Sales promotion, - +: » Segmentation, targeting and positioning of markets. “e it ee 12. Economies of Scale Managerial economies in the long-run helps a firm to enjoy economies and diseconomies of scale. 13. Profit Management Managerial economics mainly ‘concentrates on the Primary goal of a firm i.e., profit maximization. It deals with the activities like profit estimation and profit planning. 14. “Input and Output Analysis The concept of production function managerial ‘conomics depicts the input and output relationship. 8, Inventory Control Effective inventory control techniques of managerial £conomics readily meet the organizational requirements,033. Explain the key decision areas covered in managerial economics also identify the important techniques. ; Answer ; ! May-12, Set-2, Q1 For answer refér Unit-I, Q30, Topic: Importance Managerial Economics in Decision Making and Q32. 1.3 CONCEPT oF DEMAND-TYPES AND _ DETERMINANTS OF DEMAND oe Q34, ‘Define ‘demand? and explain the factors that influence the demand of product. (Apr/May-07, Set-1, Q1 | Apr/May-07, Set-4, Q1) Answer : : : Demand-Concept and Definition The demand for a commodity is essentially con-sumer’s attitude and reaction towards that product/commodity. It isGefined as the amount of the commodity which an individual consumer will purchase or is willing to purchase ata given price {na period of time. From economics point of view, demand for a ‘consmodity refers to both the desire to purchase the commodity and the ability to pay for it. In other words, a mere desire forthe commodity does not constitute the demand for it, it should be backed up by the ability to pay. ‘Thus, the demand for a comimodity canbe viewed as, Consumer's desire to purchase the product 4 Consumer's willingness to purchase the product Sufficient purchasing power ic. the ability to pay. It can be concluded that every want supported by the willingness and the ability to buy constitutes the demand for a product or a service. Determinants or Factors Influencing Demand for a Product ‘There are several factors or determinants that affect the individval dernand and market demand for a product. 4. Determinants of Individual Demand ‘The following are the factors as determinants that affect «the individual's demand for a product. (@ _ Priceofthe Commodity itself ‘The price of the product or the commodity is the basie coasideration for determining the demand of a commodity with other things remaining the same. Usually, a consumer buys more ofa product when its price is low and buys a fewer of i uwhen ts price is high. Thus, the demand for a commodity varies inversely with its price, A decrease in price, increases the purchasing power of the consumer, he can therefore buy more ‘fit Substitute effect) and the demand for the product rises. ‘An increase in price reduces the purchasing power of the consumer and thereby the demand for the product reduces (income effect). When the price of the commodity increases, the demand for it decreases and as a result the demand curve slopes downwards, Therefore, an increase in price has the negative effect on demand. The inverse relation between the price and the demand for a commodity is symbolically represented a5, hot “P Where, D—Demand for the commodity P—Price of the commodity. Graphically, it can be represented as shown in figure ( < Pricé ofthe commodity (Rs.) a Qa ‘Quantity Demanded In figure (1) Qy. Q, ate the quantities demanded of the commodity atthe prices P, and P, respectively i.e. ifthe price is P, (low), the quantity demanded is Q. (high) and ifthe price is (high) the quantity demanded is @, (low). In atabular form, itis represented as, Demand | ze =F Increases Decreases a S Increases Decreases (&) Consumer's Income Individual consumer's income determines his/her purchasing ability. Therefore, consumer's income isan important determinant of demand. An increase in income makes an individual to buy many commodities in his purchase bundle. ‘The effect of income on demand can be analyzed for the following. @ Normal Goods ‘Usually, the demand fora normal good goes in the same direction with consumer's income ie., demand for normal ‘goods is directly related to consumer's income. ‘Symbolically, Del Where, D—Demand forthe commodity Consumer's income Graphically, ey ‘ é 3 Denand : Cine i ° @ a Quanity Demanded . ofthe commaity Figure (2) In figure (2), Q,, Q, are the quantities demanded of the commodity at the income levels /, and 1, respectively ofthe commodity Figure 1) i.e., income and demand increase/decrease in the same direction, ;uae 4p @ _ Perishable Goods meat; vegetables ctc., the quantity demanded raises with an inerense in income, hu, erp on es ae ae th danas Troe yn recast in figure @). i Demand * ‘ Zu Cine Bs b 1 z aike 1, 0k x o 2 9,29 Quon Demanded oe te cy Figure (3) In figure'(3), Q;; Q,, Q, and Q are the quantities demanded at the income levels /,, 5.4.4.1, and f,. Itis observed that th 40% © quantity demanded raises to Q, as income raises to 1,, But alter J, even if the income increases to /, 1, and f,, the quanti demanded remains same at Q,. This indicates that the demand for perishable goods increases with income, but aftr certaif point, it remains constant even though the income increases. (ii) | Inferior Goods ‘The goods for which the demand decreases even though the income level increases dire ‘inferior goods’. The demand curve fo inferior goods is shown in following figure (4). > y . 3 : i z ° @, 0.0.0, ~* uniy Demanded site ctmmaty Figure (4 From figure (4), Q,, Q,,Q,,Q, are the quantities demanded at the income levels 1, J, and J, It is observed that the qua demand raises from Q, 10 Q, and then to Q, as the income raises from I, 10, and /,, But after /, .¢., from /, as the income le __ increases, the demand starts decreasing. This indicates that for inferior goods, the demand decreases as the ince increases. The table below gives a clear understanding about the demand income relationship of different goods. | Type of Good Income Demand - Normal Goods | Increases | Increases/decreases in same direction | Perishable Goods | Increases | Increases to a certain point and then remains constant. | Interior Goods __| Increases _| Increases to a certain point and then decreases as the income increases. (©) Consumer’s Tastes, Habits and Preferences Demand for many goods depend upon consumer tastes, preferences and their habits. For example, the demand for £° like chocolates, beverages, ice-creams etc., depend upon individual tastes and preferences, whereas the demand for goods like betel, cigarettes etc., depend upon individual habits. In cases like, a strict vegetarian has no demand for meat at any price. we® anon-vegetarian will purchase meat at any price. Therefore, it can be said that irrespective of price and income levels, the d¢™ for a commodity depends upon consumer tastes, habits and preferences,By Price of the Related Goods {Ina given market if the price of one good influences gant demanded of ansher gan tenet gos ae sid {bite related goods. Two commodities in a given markel ae feisted 10 cach other either as substitutes of complementary goods a ‘Substitute Goods When @ want can be satisfied by alternative similar goods, they are said to be substitutes to each other. In ‘other words, when the price of one commodity and the quantity demanded of another commodity increase! decrease in the same direction, they are called as substitutes to each other. ‘Examples ‘Teaand Coffee, Apple and Pears, Rail and Road transport, Peas and Beans, Groundnut oil and sesame oil, Jowar and Bajraetc. The demand curve for substitute goods is shown in figure (5) ‘Consumer Expectations © ‘A-consumer usually makes two kinds of expectations. (About his future income (i) About prices of the given com related goods. (Future Income If the consumer expects a higher income in future, he spends more on 4 commodity in the present sind therefore, the demand for the commodity inereases. Ifhe expects a low income in future, he spends less on the commodity thereby decreasing the demand for the ‘commodity. (i) Future Prices ‘Similarly, ifthe consumer expects the future prices of the ‘commodity to increase, he buys more of the commodity at present, increasing the demand for it. fhe expects the future prices to fall, he buys less in the present thereby decreasing the demand for the commodity. The table gives a clear understanding about the changes in demand due to consumer expectations about his future income and future prices. x — —— — ~ city Demstied ‘Consumer Expectations | Changesin Demand of the mS about Future Commodity at Present | Figure (5) i From the above graph in figure (5), itis observed thatas | |) Inerease in Income Increases the price of coffee increases, the quantity demanded of Decrease in Income Decreases tea is increased. , Increase in Prices Increases Decrease in Prices _ Decreases Complementary Goods When a want can be satisfied by two or more goods in ‘combination, these goods are termed as complementary ‘goods. In other words, when the price of one commodity and the quantity demanded of another ‘commodity increase or decrease in the opposite direction, they are called as complementary goods. Examples Bread and Butter, Pen and Ink, Car and Petrol, Tea and Sugar, Shoes and Socks, Sarees and Blouses, Gun and Bulletsetc., Complementary goods are always in joint demand, The demand curve for complementary goods is shown in figure (6). Quantity Demanded of Tea (0) Advertisement In the present scenario, organizations are spending a lot of money on advertisements in order to attract consumer's tastes and preferences towards them. An effective advertisement strategy can help an organization to increase the demand for its product. Determinants of Market Demand The following are the factors or determinants that affect, the demand for a commodity in a given market. @) Price of the Commodity itself : With low market price, the market demand for the product increases and with high market price, the demand decreases. (b) Income and Wealth Level in a given Market Ifthe income and wealth levels ina given market are equally demand of a commodity. © distributed, the market demand for many products increase. ‘Unequally distributed income and wealth level reduces the market Common Habits and Preferences ofa given Market Figure: (6) ‘The market demand for a commodity depends upon the commion habits and preferences of a given market.ee @ Standard of Living of People in'a given Market ; If the standard of living of people in a given market is high, then the demand for luxurious goods increases. (©) Demographic Factors The market demand for a product depends upon the demographic factors like - age structure, male and female ratio of the population. For example, in vacating city of Italy, the number of men are very high when compared to women and therefore the demand for gents’ garments and accessories is high. (® — TaxStructure The products with high tax rate have less demand when compared to the products with low tax rate. (g) Fadsand Fashions The demand for a commodity increases/decreases with latest fads, fashions and trends in the market, For example, the demand for jeans, skirts etc., depend upon current fashion in the market. (h) Environmental Changes Market demand for products is also dependent on weather and climatic conditions. For example, there is a great demand for cool drinks, fans, cotton clothes etc., during summer season and for umbrellas, rain coats etc., during rainy season. i) Customs and Festivals Market demand for certain products depends upon customs and festivals. For example, during Deepawali, there is "a great demand for sweets and crackers and during Christmas and New year, there is a greater demand for cakes. In addition to these determinants of market demand, there exists other factors like - inventions and innovations, advertisement and sales propaganda, number of consumers in a given market etc.MucudleconomicsandDemand Analysis demand? What are the types of el 1.35 ticity of demand? 7 (Way-13, Set, 0210) Model Papers ‘On (2) [Model Papers, a6(a) Brielly explain types of éldstieity of demand. ee et (Wtay-13, Set2, c24a)) BlastcityofDemand Meaning a Elasticity of demand is the change in price of the commodit There are four important iy aio the depres of change in the amount demanded ofthe commodity ines oagven ity, price of some related goods or changes in consumers income. kinds of elasticity of demand. They are, @ Price elasticity of demand oo Gi) Income elasticity of demand Gi) Cross elasticity of demand’ ' (iv) Advertising or: Promotional elasticity of demand. @ Price Elasticity of Demand sven di LM ande,>1 IEP, = Lower then MN < LM and e,<1 For non-linear demand curve, Lower portion of tangent “4” Upper portion of tangent Fora non-linear demand curve, the: elasticity of demand is found by drawing a tangent to it at the point where the elsticity is to be found. Slope/Mathematical Method Mathematically, the price elasticity of demandis calculated by using the concept of differential calculus. By differential caleulus, the slope of a demand curve at any point is calculated ap by the formula —— formula 5 Where, P =Price of the commodity Q = Quantity demanded of the commodity. Ifthe slope (dP/dQ) is reversed i.e, the reciprocal of the Slope (dQ/aP)is taken and multiplied with the ratio (P/Q) then, / NeBet price elasticity of demand (€,). (a) ) © ae dQ ~ aP/dQ oGQie a “= PO ) ‘Total Outlay Method This method is aso ea also called as "Tota Revenue Method Marshall provided th st ne eee easiest method of asocaten of demand i.e., ‘whether the demand is aces elastic or a Acco cag bound ou tat demand scans ee “oral Revenve/Total Outlay = Price x Quantity purchased or sola ‘This can also be written as, Total Revenue = Price x Quantity sold and Total outlay = Price x Quantity purchased, Consider an example as follows. Price ofthe | Quinity | Tot | Bima] ‘commodity | Demanded | Revenue. | of nem (85) | aiey” | ot |e tit [3 8 28 = varies] 6 4 mw | eet 2 8 26 | wis) +— vasa] 6 3 18 wot 3 0 | caine) Lo varied] 6 3 ~ | ea soompi ne 18 | dneuste) }— co) Table According to this method, When a variation in price causes no change in the Total Revenue (TR), the elasticity of demand €,=1 i. unitary. ‘The total revenue here remains constant based on the fact that the demand varies in the same proportion as, the price varies (see table (a)) When the total revenue falls, as the price rises or if it rises as the price falls, the elasticity of demand tends to be greater than unity (e,> 1). This is because, the proportionate change in demand is greater than that of price. In other words, when the total revenue and price ‘move in the opposite direction, the demand is relatively elastic (see table (b)]. When the price and total reveny: move ini the same direction, ie., iftotal revenue rises as the price rises and falls as the price falls, then the elasticity of demand is less than unity (€, « 1). This is because the proportionate change in demand is less than the proportionate change in price. Thus, when the price and total revenue move in " the same direction, the demand is relatively inelastic. Graphically, the relationship between total outlay/total revenue and price elasticity is represented as shown it, figure (2).”) Elasticity of Demand. Answe! MANAGERIAL ECONOMICS AND. FINANCL D ANALYSIS [JNTU-KAKINAD a) 1.42 : Fortes <) Tolal revenue x oval Revenue (TR) Figure (2) y R Total evenve P. P, x x Total Revenue (TR) Figure (3) Y 2 Total revenue € cuive z T OO oop x ‘Total Revenue (TR) Figure (4) Pointand AreMethod For answer refer Unit-l, Q55, Topic: Measuring the lain the concept and significance of © elasticity. How do you measure it? Pric (&) Briefly explain indu: istry demand ani company demand, 4 May-12, Sot2, a2 ity of Demand __ Por answer tefer Unite 087 tant. 5» Understanding price elasticity of demand of a Producti, essential t6 determine the product price. While deciding the price of joint supply products, iy elasticity of demand of those products is considerey The price elasticity of demand helps the busines in taking production decisions such as d regarding optimum product mix, 88 men lecision Supper markets can determine their sales depending upon the price elasticity of demand to the products. Policy related Price elasticity of demand of the products helps the ‘monopolist in implementing price discrimination policy Higher prices are charged to those consumers whose demand is inclastic and lower prices are charged to those consumers whose demand is more elastic. Measurement of Price Elasticity of Demand ) For answer refer Unit-1, Q60, Topic: Measuring the Price Elasticity Industry Demand and Company Demand For answer refer Unit-l, Q36, Topic: Company/Fim Demand and Industry Deman Q62. Determine price elasticity of demand given that Solution : the quantity demanded of a product is 1000 units when the price is ¥ 100 and when the price declines to% 90, demand increases to 1500 units. Feb..08, Sett, 02 Q,=1000, P, =100 2,=1500, — P, =90 %AQ ~ GoAP AQ %AQ = —=x100 1D oO E, _ 1500-1000 1000 * 100 500 500 = Too9 * 100=5>av. f pieces ine. Production function with all inputs ” . (Mar-14, S¢ Q3 | Mode! Paper-1, Q2(0)) oR Define production function. wt }. What are the types: of production function? Explain them in brit. Unit Sap What do you mean by prdduction? ? Explain the concept of production function. answer = May-12, Sets, Q4(b) production Function A production function is a tool used to explain the in- j-output relationship. It describes the technological relation- ship between inputs and output in physical terms. In its general fom, ittells that the production of a commodity depends upon cerain specific inputs. In its specific form, it presents the quan- {itive relationship between inputs and output. Besides these, the production function represents the technology of a firm, of an industry or the economy as a whole. Stigler says that the “Production function is the name given to relationship between rales of inputs of productive services and the rate of output of oduct”. It is the economist’s summary of technical knowl- ‘edge. A production function can take the form of a schedule, a table, a graphed line or a curve, an algebraic equation or a math- ematical model showing the maximum level of output, that can fe produced from a given set of inputs under the existing tech- sclogy. Mathematically, a production function is represented %, Q =fil, CM. Where, Q = Quantity of the output produced f =Function L = Labour units C =Capital employed (M-=Machinery raw materials. In the above production function, the inputs consid- ed are labour, capital and raw materials. But an empirical pro- ition function is very complex with a wide range of inputs land, labour, capital, materials time and technology. With tse inputs, the production function is expressed:as, Q =fLylh CMT Where, Q = Quantity of the output produced ‘f= Function __L, = Land and buildings L = Labour units veins» © =Capital employed ig M. = Materials T = Technology st = Time period of production. In order to reduce the complexity, economists have considered the three main inputs ~ labour, capital and machinery for indicating a production function. Therefore, with these inputs the production function can be expressed as, Q =f\l.C.M) A hypothetical production function with the inputs Labour (L) and Capital (C) is represented as, Quantiy of Output s[™ 6. 8 @ 4 l 3 g 2 é1 Pee ea 8 Labour(L). ——> Figure ‘Types of Production Functions ‘The following are the various production factions, Depending on the Time Element ‘The various inputs used in the production process are categorized into two depending on the time element. Fixed in- puts and Variable inputs. The inputs which canriot be varied or converted in a given period of time are fixed inputs. Examples are land and buildings, machinery etc: The inputs which can be varied or altered in a given period of timne aré variable inputs. Examples are materials, power etc. ‘The nature of the inputs (i.e., fixed or variable) depends upon the time period of productioi. The time period of produc- tion can be of two categories. Short-run and Long-run. Short- run is the period in which all the inputs (only variable but not fixed) cannot be altered into output. Whereas, long-run is the period in which all the inputs (both fixed and variable) are con- verted into output. Depending on the time element, a production function is of two types, (@)Short-run production function (b) Long-run production function. @__ Short-run Production Function The functional relationship of the maximum quantity of 1a goods or services that can be produced by a set of inputs, assuming that the amount of at least one of the inputs used remains unchanged as the output varies is known as short-run production function. A short-run production function can be represented as, Q=fil,C,M) Where, Q = Quantity of the output produced f= Function L = Labour units C = Capital employed M = Materials.oe eee ee vie SARAKINA\, Here, the inputs Labour (L), Materials (M) and Capital (C)are onl aken because these re the Variable inputs an ge only be converted into output in the short-run, uN The key terms associated with short-run production function are, (@ Total Product (TP) (ii) | Marginal Product (MP) (iii) Average Product (AP). (@ | TotalProduct (TP) Total product is the amount of output that is produced by using different quantities of inputs. (ii) Marginal Product (MP) Marginal product is defined as the change in the Total Product input Labour (L) be considered, then marginal product. ! (7P) per unit change ina variable input Let the vig, ATP ' MPD t Where, MP, ATP = Change in total product wi rou = Marginal product of labour AL =-Unit change in the labour input,” (iii) Average Product (AP) Average product may be defined as the Total Product (7P) per unit of variable input, Ifthe variable input ‘L’ is consider average product is, 7 AP, =o Where, AP, = Average product of labour c a u TP = Total product L= Labour units, Letus consider an example of short-run production function with the variable input Labour (L), | ‘Total | "Marginal | Average Variable | Product | Product | Product ! ap) op) (ap) 0 0 a E 1 a. 4 4 i 2. roa n 750 ge 3 3 Dot Pies y 4 4 #8 u 275 5 45 3 9 The above table shows that the total product reaches a maximum of 48 when Jabour units are 4. But at the 5 units of the total product decreases, The marginal product increases initially and later with an increase in labour units, it decreas reaches a negative value at 5 labour units, The average-product fluctuates with increasing labour units The short-run production function can be divided:into threg distinct stages of production as shéwn in the fioure b!"}Stage Stage mn Average Product (ap) Marginal Product tp) Stage In stage 1, Total Product-Increases Average Product-Maximum Marginal Product-Maximum, StageIT In stage II, Total Product-Maximum Average Product-Maximum Marginal Product-Declining Stage I In Stage II, Total Product-Declining Average Product-Declining Marginal Product-Declining to Negative. Inthe above figure, the stage where the ‘marginal product Hats declining shows the law of diminishing returns or the law. *f variable proportion. It may be observed that when total Poductis maximum, MP, =O, Initially as the labour units in the Mluction process are increased the MP, > AP, (L-Labour). DAP, is maximum itequals MP, ie., AP, = MP, . Further, Sthe labour units increase both MP_and AP, decline and later Temains positive even when MP, becomes negative. ) Long-run Production Function The functional relationship of the maximum quantity of ‘0r a service that can be produced by varying the amount ‘nputs used in production is known as long-run produc- nction. A long-run production function can be repre- Med as, Q=f(L,L,CM,T,) Te, 2 = Quantity of output produced . f = Function en L, = Land and building , “ 4= Labour unis C = Capital employed ‘M = Raw materials = Technology S ‘ arvied out in order to achieve the specified organizational goals. Long-run produc luction function is. ba: anh on is, based on the @ Verted into output, Production technique remains constant "unction with Two Variable Inputs: ~~ Production function with two v: ‘general case where the firm increases of two inputs that are substitutes to ea able input case may be taken either as ariable inputs is a more S output by using more ch other, The two-vari- a short-run or a long-run Production function with two-variabe-inputssillutrated below, o—> pit Labour(L)- From the above table, if the firm wants to produce an Output of 80 units, the input combinations (labour, capital) it can use are (3, 4) and (1, 5). Similarly for, 13 units » 23units 21u G.D,(1,4) (1,2), (3,5) 2.0.4.5) Ifa graph is drawn by representing the different combi nations of inputs used to produce the same amount ek oan it is known as an ‘isoquant’. A production function with two vvaritible inputs can be represented by a family of isoquants or isoproduct curves or product indifference curves.a ——— aye MANAGERIAL ECONOMICS The ‘production function’with two variable inputs can be represented as, Q =f(L,©) Where, : Q = Quantity of output produced f = Function L = Labour units ’ C = Capital employed. Assumptions upon which the production function with two variable inputs is based are, @) Two factors can be substituted for each other. Gi) No change in the technology used for the produc- tion process.1 ANALE™: Cs pers, MANAGERIAL ECONOMICS AND FINANG! s 2.6 COST ANALYSIS cost CONC! i i inmanageriat dectsion® a, of | Mote! PEPE, Oy 30. Define and distinguish various cost concepts in manag seit unit.2 q2 a . ntay-07, S69, 02a Define ‘Cost’. How are costs classified? agen scan 07, Se. OM) Answer : a desired benefit. ‘Cost Concepts and Classifications ther to acquire dor ot rifice of some Kint swith expense, all costs invoke a8 «ds upon the business Cost used as synonymou! gee particular si “There ae various kinds of cost concepts and the use ofthese COnEEPLS parti decisions that are to be made. an st co “Therefore, it is very essential to unders i 7 - various kinds of she toloning are he ferent cost ingredients which re aproprns FOF" 2N : vice. It is generally recordedin “Those costs are also known as 1 of various €0 and the meaning of various anagement problems, 1 Actual Cost and Opportunity Cost ‘Actual costs mean the actual expenditu the books of account. For example, cost of raw solute costs” or “outlay costs” ng a good or Se uci rete. incurred for acquiring or prod aed : interest, rem materials purchased, wages Pai er to that particular alternative. It can be ook account. it fe ‘ificing sJternative in ords ‘Whereas, opportunity cost refers to sacrificing the next best altern defined asthe revenue forgone by not making the best alternative use. Tt s not recorded in the b ‘Example ‘The opportunity cot of using a machine to produce one product isthe earning forezone hich would have been possible from other products. ‘Similarly if a piece of land is used for raising ground nut crop, would have been raised on the same piece of land. ite often it becomes necessary to consider not the actual cost of its opportunity cost isthe value of paddy foregone which In managerial decision-making, qu ‘a good but its opportunity cost. xy cost is more important and useful for managerial decisions. For example, suppose @ company ‘The concept of opportu hras two alternatives regarding its expansion program. 1. Having a site in remote area which costs it. 2,00,000. 2 Having asite in the suburban area which is nearer othe town but cost® 800,000. While comparing the two alternatives, management will have to take into consideration the additional earnings that it can achieve by employing the additional Jimount of having a site in suburban area. Thus, the opportunity cost of having a site in the suburban afea is ®. 8,00,000 plus imerest foregone thereon. 2. Explicit (Out-of-pocket) and Implicit (Book) Costs COut-of pocket costs refer to costs that involve current ( 9 payments made by firm t ; i rent, uility expenses etc. They are also called explicit costs. EERE Sep ch a8 payment lari, Outof-pocket costs exhibit both fixed and variable nature, fo 0 ; for example, factory rent Ofte non-traceable, Example, the electric power bill. Whereas, Book costs are in some aes ihbeta S teieton er een ana some cases, they aré readily traceable and becomes a part of direct costs ae enlace cin cL Jn distinction, “Book Costs” refers to those costs which do not require currer expenditure, such as depreciation, , sto those costs which do not requi sme tine lire current cash expendi spreciati insect on owneée money and so on. These costs are generally recorded in the books of account: The oe : me ¢ S. These costs are also known a Book costs can be converted ino out-of : -oF-pocket costs, by sel i 7B er f-pa , by selling the assets and havi interest cost on owned capital can be avoided by converting book costs pepe a eenon hire, Depreciation charges pocket costs. an ot a emtOStS and rey carried on the balance shoe = Historical costs are y are those costs that are to be historical costs and replacen, Contradiction, replac an ‘ment costs : Foran ge anges ‘are same over a period of time. thes Ce Of equipme we ean say the historical ost ores PMN in 1996 was 10000and the same equi tleostof equi ill be OW OSL. 13,000 (ie, in 2005), then 4. Inerementat Conan Senet *¥ 10,000 and ihe replacement cost wile 13,000. Incremental costs ay Th StS BE those addition a “costs changes with change ie fice A Costs that are incurred due to the change in the level o nature of activity. These (Groping) an exi oe : 18 Product question of increment activity) in the e: wai eth 8 seding a new product to the existing remain same whatever the | level of acti the past. The question of ch; lange in these ci ol oF nature of business activity, they wil This means, sunk costs are thse costs that have already bees committed or spent in regu achange in the level of activity does not arise here. Activites may change but the sunk costs, Which re 10 Costs, which remain the sam Tespective of the level of activity (or) alternative selected Thus, they are not essential tothe management in evaluating the alternati 'ves as they are common to all of them, Preliminary expenses and depreciation, Controllable and Non-controllable Costs Controllable costs are those costs which can-be identified and regulated by the business, The controllability ofa cost cepends upon the levels of responsibilty under consider a n. Thus a cost which is uncontrollable at one level of. responsibility may be-controllable at some other, usually higher level. Tre controllability of particular cost may be shared by two or more executives. Example, materials cost, where paying ofthe production supervisor. Direct material and diret labour costs we usually controllable Non-controllable costs are those costs which cannot be controlled ‘and regulated by the business Example Taxes, excise duties, allocated costs. The distinction of costs based on controllability enables management to contol expenseé and efficiency. 6. Short-runand Long-run Cost ‘The short run is defined asa period in which the supply of at last one ofthe inputs cannot be changed by the firm, For example, plant and capital equipment, ic. they should remain same during the period. Long-run, onthe other hand, is defined asa period in which all factors of production (inputs) ean be varied as desta Iti that time-span in which all adjustments BE Gipes are possible 0 realize. On te basis of above time periods one can easily define that the short-run costs are those costs which vi ith ourput when fixed plant and capital equipment remains the same. Aid the long-run costs are those which Vary with einpatehen all input factors (or production) including plant and machinery vary. Sh sts become relevant when a firm has to decide whether or nét to produce more in the immediate future. In this ase, th Sie tion of setting up of a new plant, only the firm has to manage with the given plant. Long-run costs come into Euscnce when be firm decides about to setup a new plant. Thus long-run costsvcan be helpful both in the initiation of new wher Enterprises as well as the expansion of existing one, 7. Shutdown and Abandonment Costs If the production is stopped temporarily the expenses’ incurred on plant ikachinery ding the stoppage petiod is called producti shutdown cost. : ‘ i isa cost, The cost incurred due to discontinuity of activities:on plant and machinery permanently is called abandonment » cost incurr Urgent and Postponable Costs A e ae fe 5 those costs which should be incurred in order to run the activitjes of the business firm, Cost which can F tgent cost refers S Posiposed for future period are called postponable costs.9. Fixed Cost and Total Fixed Cost ae A We o ) Taal fred int me Cost Opa Figure: Total Fixed Cost Curve Fixed cost refers to that cost which docs not change With the level of output. That means fixed cost remains constant at any level of output. Even if the output 1s nl the fined cunt remains unchanged. E.g: Salary, Taxes, Rent, Insurance, adding all the components of fixed cost we get total fired cont 10. Variable Cost and Total Variable Cost Variable cost refers to the cost which fluctuate directly ‘ith the level of output. That means if the output increases the variable cost also increases. If the output is zero, variable const will be zero. E.g: Power, transport charge, price of raw materials If we add all the components of variable cost we get total variable cost. y A Tc » Cost Toul varabi: wvst > 0 ‘Oupa Figure: Total Veriable Cost Curve Fixed and Variable Costs Total cost of any production (product) could be divid: into two components, ie. into fixed costs and variable costs Fined costs are those costs that are fixed or constant in the short-run. Fixed costs remain constant in total regardless of changes in volume up to a cenain level of output. But beyond this limit, fixed costs per unit changes with the volume of Production thus total fixed costs do not change with a change in volume but vary per unit of volume. Greater the total production, less is the fixed cost per unit and vice versa. ‘Example Cost of plant and machinery. Variable costs refer to those costs that vary with the volume of production. Total variable costs are Proportional to the volume. ‘An increase in volume means a proportionate increave in the total variable costs and decrease in volume results in a Proportionate decrease in the total variable costs. Variable costs remain constant per unit and exhibit linear relationship between ts le costs. nL directly 12, oreenente porersne nore ses cerry pf ‘Sern Sind on Semi-variathe Corts. “The deciniene reyaating which ert i Yret d wies, varie tiny be: Oifcrent ii cath itor sitation. Baran” haa in fined at cre level ch pet tary become: ve neste evel cx. This ease phecemmenen, Ye anantiescategeny of cents sexiest vest ation, ined 0 Semi changes in volume. They they ate vat bills often consumption 13. Separate (Direct) Conte and Sohta edireet) Coats ified ont “Yost ae Cents are ab cha Separabte con directly with ap Fxaunples 1 Conteh raw cats be tear OF itetsten Cet 8 greg las pr be traced to Flectncity ch multip The vepa Past Costs and Futere Cents Past conts are thor costs th periods. Their a management i The ma control pr introduction uf new product expansion prog: pacing JS. Accounting Costs and Ecemeric Costs c to differees peor Accountant ple, tend wa view oe to suit their own particular interest and parpones. Accom costs are costs that are recorded as expenses in the banks $ acedunting records. The main function of accounting tas = that of recording, reporting. and control. 3 These costs are usually set up for legal. financial == and auditing purposes. ‘UNIT-2 Py, ‘duction and Cost Analysis Bec iivi Whi Je the €conomist looks beyond this, economists and managers always try to Tecognize those imputed costs which corded in the books. The economist tries to ascertain the costs much before they are incurred and tries to explain their significant impact on managerial decisions. Example G In accounting, the assets are valued at the book value (cost of acquisition less depreciation). Whereas an economist would like to treat the value of these assets in terms of replacement cost. 16. _ Escapable and Unavoidable Costs Escapable costs refer to costs which can be reduced by reducing the scale of operations to a lower level. Unavoidable Costs refer to costs which are essential for the sustenance of the business activity and hence they cannot be avoided. —— en ty and’ Hence they cannot be avoided.