Key Concepts Managerial Economics - Application of Micro-Economic principles and the tools/techniques of decision science to examine how an organisation/

a firm can achieve its objective most effectively. Decision-Making - The primary decision-making role of managerial economics is in determining the optimal course of action where there are constraints imposed on the decision. Managerial decisions are subject to legal, moral, contractual, financial, and technological constraints. Economic Decisions for the Firm - What goods and services should be produced? Is the product decision - how should these goods and services be produced? Is the hiring, staffing and capital-budgeting decision. For whom should these goods and services be produced? Is the market segmentation decision. How price output should be determined is known as pricing decision. Scarcity - A condition that exists when resources are limited relative to their demand. In the market process, the extent of this is normally reflected by the price of the resources, goods or services. Resources - Also referred as inputs or factors of production - viz. Land, Labour, Capital, Entrepreneurship usually used in economic analysis. Opportunity Cost - The amount or the subjective value foregone in choosing one activity over the next best alternative. Circular Flow - The interaction of individuals and firms, in a market economy, can be described as a circular flow of money, goods and services, and also of resources through product and factor markets. Economic Profit - Revenue less all relevant costs, both explicit and implicit. Role of Profit - Profit plays two roles in market economy. 1. A reward to entrepreneurs for taking risks, being innovative in developing new products, and reducing production costs etc. 2. Changes in profit give signal to the producers to change the rate of production. Functional Relationship - Total, Average and Marginal A functional relationship of the form Y= f (X1, X2, Xn) means that there is a systematic relationship between the dependent variable Y and the independent variables X1, X2, , Xn. And that there is a unique value of Y for any set of values of the independent variables. For any total function ( e.g. total product, total revenue etc.) there is an associated marginal function and average function. The key relationships among the total, average and marginal functions are: 1. The value of the average function at any point is the slope of a ray drawn from the origin to the total function. 2. The value of the marginal function at any point is the slope of a line drawn tangent to the total function at that point. 3. The marginal function will intersect the average function either at a minimum or at a maximum point of the average function. 4. If the marginal function is positive, the total function will be increasing. If the marginal function is negative, the total function will be decreasing.

5. The total function reaches maximum or the minimum when the marginal function equals zero. Economic Model - Economic model consists of several functional relationships, conditions, or constraints on one or more equilibrium conditions. Generally, economic models are used to demonstrate an economic principle, to explain an economic phenomenon, or to predict the economic implications of some change affecting one or more of the functional relationships. The slope of a function Y= f (X) is the change in Y (i.e. Y) decided by the corresponding change in X (i.e. X) For a function Y= f (X), the derivative, written as dy/dx is the slope of the function at a particular point on the function.

Key Concepts Demand - The quantity of goods or services that people are ready to purchase at a given point of time, at a given price, other factors besides the price held constant. It can be expressed as a numerical schedule, as a curve or as an equation. Change in Quantity Demanded - refers to a movement along the same demand curve, caused by a change in the price of the good or service. Change in Demand - is represented by a shift of the demand curve resulting from a change in the factors (other than the price) viz. income tastes and preferences of the consumer, or price of other related goods.

 If two goods are substitutes, increase in the price of one good increases the demand for the other good. If two goods are complements, a higher price for one will cause a decrease in the demand for the other. Equilibrium Price - The price that equates the quantity demanded with the quantity supplied, the price that clears the market of any shortage or surplus. Market Equilibrium - A condition that prevails in the market when the quantity of a commodity demanded is equal to the quantity supplied. Consumer Surplus - Consumers who were willing to pay more than the market price, receive a consumer surplus when they buy the product. In other words it is the difference between what the consumer is willing to pay and what he actually pays. Relationship among the demand curve, total revenue and marginal revenue For a linear demand curve, the absolute value of the slope of the marginal revenue curve is twice that of the demand curve. Marginal revenue is zero at the quantity that generates maximum total revenue and negative beyond that point. Marginal revenue is the change in total revenue associated with one-unit change in output. Elasticity - Sensitivity of one variable to another or, the

percentage change in one variable due to a percentage change in the other variable. Price Elasticity - The percentage change in the quantity demanded of a commodity that results due to a one percent change in the price of that commodity.
Point elasticity is measured at a given point on the demand

curve. It is used where the price change is very small.

Are elasticity is appropriate for a larger change in price. It is

measured over a discrete interval on the demand curve.

Demand is elastic if ep < -1, inelastic if -1< ep < 0 and unitary

elastic if ep = -1.
Demand is elastic where marginal revenue is positive, unitary

elastic when marginal revenue is zero, and inelastic if marginal revenue is negative.
A price increase will have one of the following effects,

depending on the price elasticity of demand: Total revenue will increase if demand is inelastic (-1 < ep < 0) -1) Total revenue will decrease if demand is elastic (ep <

Total revenue will remain unchanged if demand is unitary elastic (ep = -1)

Income Elasticity - Percentage change in quantity demanded caused by one percent change in income. Negative income elasticities denote inferior goods. Normal goods are those with positive income elasticities.

if o < em < 1, the product is a necessity. if em > 1, the product is a luxury

Cross Elasticity - Percentage change in the quantity demanded of a commodity, due to a one percent change in the price of a related commodity. cross-elasticities are positive for substitutes and negative for complements. Forecasting - A forecast is a prediction or estimation of a future situation. It is an approach to reduce the uncertainty associated with decision making. It involves predicting future economic conditions and assessing their effect on the operation of the firm.

Key Concepts Production Function - Maximum quantity of a commodity that can be produced by a set of inputs viz. Capital and Labour.

Cobb-Douglas Production Function - A power function in which total quantity produced is the result of product of inputs raised to some power e.g. Q = aLb Kc

Short-run is that period of time for which the rate of input use of at least one factor of production is fixed. In the long-run the input rates of all the factors are variable. The firm operates in the short-run but plans in the long-run Marginal product is the change in output associated with one-unit change in the variable input (i.e. MPL = Q/ L )

Average product is the rate of output produced per unit of the variable input employed (i.e., APL = Q/L)

The law of diminishing marginal returns states that when increasing rates of a variable input are combined with a fixed rate of another input, a point will be reached where marginal product will decline.

Returns to scale - Increase in output that results from an increase in all the inputs by some proportion (greater, smaller or same)

Isoquant - A curve representing different combinations of two inputs that produce the same level of output.

The slope of an isoquant is the marginal rate of technical substitution or the rate of which one input can be substituted for another so that a given rate of output is maintained.

Isocost - A line representing different combinations of two inputs that a firm can purchase with the same amount of money. Also known as budget line. Key Concepts: Total Fixed cost - Cost that remains constant as the level of output varies. In a short-run analysis, fixed cost is incurred even if the firm produces nothing. Total variable cost - The total cost associated with the level of output. This can also be considered as the total cost to a firm for using its variable inputs. Marginal Cost - The cost of producing an additional unit of output. Economies of Scale - Reduction in the unit cost of production as the firm increases its capacity i.e. increases all of its inputs. It is considered to be a long-run phenomenon.

Diseconomies of scale - Increase in the unit cost of production as the firm increases its capacity. It is also a long-run phenomenon. Economies of Scope - Reduction in the total cost resulting from the joint production of two or more goods or services Break - Even Analysis - Also known as cost-volume-profit Analysis. It is a simplification of the economic analysis of the firm that measures the effect of a change in the quantity of a product on the profits of the firm. Break -Even Point - The level of output at which the firm realises no profit and incurs no loss. Key Concepts: Total Fixed cost - Cost that remains constant as the level of output varies. In a short-run analysis, fixed cost is incurred even if the firm produces nothing. Total variable cost - The total cost associated with the level of output. This can also be considered as the total cost to a firm for using its variable inputs. Marginal Cost - The cost of producing an additional unit of output.

Economies of Scale - Reduction in the unit cost of production as the firm increases its capacity i.e. increases all of its inputs. It is considered to be a long-run phenomenon. Diseconomies of scale - Increase in the unit cost of production as the firm increases its capacity. It is also a long-run phenomenon. Economies of Scope - Reduction in the total cost resulting from the joint production of two or more goods or services Break - Even Analysis - Also known as cost-volume-profit Analysis. It is a simplification of the economic analysis of the firm that measures the effect of a change in the quantity of a product on the profits of the firm. Break -Even Point - The level of output at which the firm realises no profit and incurs no loss.

Session 5 Key concepts Economic Profit - Total revenue minus total economic cost. Market Analysis: Long Run - Firms are expected to enter a market in which sellers are earning economic profit. They are expected to leave a market in which sellers are incurring economic losses. Market Structure - The number and the relative size of buyers and sellers in a particular market. Marginal Revenue (MR) = Marginal cost (MC) Rule - The rule states that if a firm desires to maximise its total economic profit, it must produce an amount of output whereby the marginal revenue received at this particular level is equal to its marginal cost. Perfect competition - A market with four main characteristics (a) a very large number of relatively small buyers and sellers, (b) a standardised product, (C ) easy entry and exit, and (d) complete information to all the market participants about the market price. Firms in this type of market have absolutely no control over the price and must compete on the basis of the market price established by the forces of demand and supply. Monopolistic Competition - A market distinguished from perfect competition in that each seller attempts to differentiate its product from those of its competitions (e.g. in terms of location, efficiency of service, advertising etc.) Monopoly - A market in which there is only one seller for particular good or service. Oligopoly - A market in which there is a small number of relatively large sellers. Pricing in this type of market is characterised by mutual interdependence among the sellers. Products may either be standardised or differentiated.

 In markets where there are a large number of small buyers and sellers, individual firm have little control over price. By differentiating its product, a firm can gain some control over price. The firm, in perfect competition, maximise profit by producing at the output where price equals marginal cost. In the short-run, managers of a firm should shut down the operation if price is below average variable cost. If price is greater than average variable cost but less than average total cost, the firm should continue to produce in the short-run because a contribution can be made to fixed cost. Forms market structure of Number of firms Nature of product Price elasticity of demand for an individua l firm 4 Infinite Degree of control over price 5 None Some

1 a) Perfect competition b) Imperfect competition

2 A large no. of firms A large no. of firms

3 Homogeneous Product

I. Monopolistic A large competition no. of firms II. Pure Few firms oligopoly III. Differentia Few firms

Differentiated Large Products but close substitutes to each other Product Large differentiation by each firm Homogeneous Small Product Differentiated Small

Some Some Some

te oligopoly c) Monopoly

One

Products Unique without substitute

Product Very close small

Conside rable

SESSION 6
Key Concepts Capital Budgeting - Refers to the process of planning capital projects, raising funds, and efficiently allocating those funds to capital projects. It is an area of business decision-making of those undertakings whose receipts and expenses continue over a significant period of time. Capital Projects - The projects that are expected to generate returns for more than one year. Discount Rate - The rate at which cash flows are discounted. It is the required rate of return or cost of capital. Net Present value (NPV) - Using the NPV technique of project evaluation, if the present value of all future cash flows (discounted by the firms cost of capital taken as rate of discount), exceeds the initial cost of the project, the investment should be made . Internal Rate of Return (IRR) - The discount rate that equates the present value of all future net cash flows to the cost of an

investment. If the internal rate of return on an investment exceeds the cost of capital, the investment will increase profits. Payback - A method of evaluating capital projects in which the original investment is divided by the annual cash flow. It tells the management how many years it will take for a projects cash inflows to repay the original investment.

CASE STUDY
Case study
The managing Director of XY Motors Ltd., Bombay, called a conference of his top aides to discuss the situation arising out of the fall in demand for cars of the company as a result of a recession in automobile industry. At the conference Sales Manager, the cost Accountant and Business Economist of the company were also present. The sales Manager quoted certain demand analysis for new automobiles and pointed out that priceelasticities of demand for new automobiles have been estimated to range over 1.5 to 1.7. According to him, if we have the elasticity coefficient as 1.5, this would mean that the increased demand will be one and one-half times as great as the decreased price, or in other words a 1.0 per cent decrease in price would produce a 1.5 per cent increase in demand. At the existing price of Rs. 25,000 per car, he estimated the sales volume at 1,000 cars. He therefore, calculated that if price is reduced from Rs. 25,000 to Rs. 24,000 the volume and revenue will be affected as follows; A price reduction from Rs. 25,000 to 24,000 is 4 per cent. With a demand elasticity of 1.5 this would indicate a resulting increase in sales of 6 per cent (i.e. 1.5 x 4/0). So, volume would be increased from 1,000 to 1,060. The sales revenue will go up as follows; 1,000cars x 25,000 = Rs. 2,50,00,000 1060 cars x 24,000 = Rs. 2,54,40,000

At a price of Rs. 25,000 At a price of Rs. 24,000

Thus revenue will be increased by Rs. 4,40,000 He also pointed out that as price reduction by one producer will be met by others, he is keeping in view the effect of a general price change by all sellers and not considering any relative advantage.

The business economist was, however, hesitant in accepting the sales managers argument. He consulted the cost accountant who gave the following data; Average total cost Total variable cost = Rs. 23,000 per car = Rs. 1,84,00,000

On the basis of these data, he made certain calculations on the basis of which it was found that profits would decline from Rs. 20,00,000 to Rs. 13,36,000. Questions: (i) (ii) (iii) What is the change in total revenue resulting from a price reduction of Rs. 1,000? The price reduction of Rs. 1,000 has reduced revenue per car by Rs 1,000. How would it change the cost per car? What will be the average total cost at the new sales volume? What were the calculations mode by the Business Economist? Give your comments on the conclusions made by the Business Economist about the decline in profit from Rs. 20,00,000 to Rs. 13,36,000.

THE CASE STUDY METHOD The case method has come to occupy a significant place in the tool-kit of management education. Under this method, management training is imparted though the medium of what, are known as cases or case studies. A case may be defined as narration of facts and other evidence relating to problem-loaded business situation. The cases are usually drawn from life but they can be fictitious as well: such cases are, nevertheless, realistic and life-like. The case method is also sometimes called as the Harvard Approach after the Harvard Business School, a pioneer in case methodology. CasesSome features The cases are not all alike and a trainee unfamiliar with the case method may be at a loss while encountering the diverse features of the cases, as regards their presentation, explicitness of the problem involved, adequacy of material included of cases that may be presented for purposes of discussion. First, cases may be long as well as short. The length of the case varies with the amount of factual and descriptive material provided to familiarise the participant with the business situation, which has given rise to the problem or problems. The case may also include information, which would acquaint the case analyst with business operations and such other partinent factors, which have a bearing upon the problem under study. Secondly, besides providing material relevant for decision-making, a case may also include information pertaining to the entire economy or the industry to which the

particular business under study belongs. Being remotely related, This information may appear somewhat irrelevant. It is, however, included with a view to enhance the general understanding of the environment on the part of the participants. Thirdly, one may find certain cases lacking in logical sequence of the events of proper editing of the material sought to be presented. This is done deliberately so as to make the case conform to business reality. Fourthly, cases may also lack adequate data to enable a thorough analysis of the problems involved. Inadequacy of data, however, does not render such cases unfit or useless; on the other hand, such cases are more realistic, being representative of the actual business conditions. In practically every business situation, the businessman hardly knows all the facts. Some of these are unobtainable whereas others would entail prohibitive cost in terms time and money. Every business problem contains certain unknowns yet business decisions have got to be taken in the face of insufficient information and missing knowledge. This is precisely the reason why there cannot be one solution of the case problem. Different assumptions as to the missing information would justify different solutions. Fifthly, in some cases, the problem is clearly defined so that the participant has to concentrate on analysing and interpreting the factors relating to a decision. Sometimes a case study may describe the action taken to solve the problem(s) and the trainee may then by put questions such as: (1) (2) Do you think a satisfactory solution has been found? Could the problem be solved in some other way?

Generally speaking, in most cases, both problem - diagnosing and decision-making are required. Here, the cases may present simply symptoms and the participants may have to dive deep to search for the real problem. A few cases may just present a narration of facts without indicating any problem so that the case analyst would wonder if any problem existed at all. The task of identifying the problem in such cases is rather difficult. ANALYSING THE CASE We may now briefly outline the procedure for analysing the case. There need not be a single stereotype procedure suitable for every case. However, the following steps would be found useful in going for case discussion and analysis: (1) (2) (3) (4) (5) Clearly define the central problem or problems in the case. Divide the central problem into its significant related aspects. Marshal the facts, data and other evidence around these aspects. Determine and evaluate the alternatives. Decide the best alternative.

1.

Central Problem

A central problem of case is defined as a basic issue. It is impossible to analyse a case unless there is a clear understanding of its central problem. Sometimes, the central problem is obvious but often the cases may be quite complex so that discovering the central problem may be quite a difficult task. Case may contain a miscellany of issues some of which may significant and others not so significant or even trivial. The case analyst should identify key problem or problems, in the process separating the superficial issues, which may be mere symptoms of the central problem. Once the central problem has been determined, it gives a setting to further analysis. 2. Related Issue

The next step would be dividing the central into significant related issues and aspects. For example. Whether to Add a Product problem may contain aspects of financing, sales management, advertising, production, pricing, and so on. For a proper analysis, all these aspects of the central problem will have to be examined thoroughly. 3. Marshalling of Evidence

Having determined the central problem and related issues, the case analyst can proceed to marshal the fact, data and other available evidence around these issues. Sometimes, the evidence may be useful in its original form, but quite often, it may not be available in the most useful form and its implications may be required to be understood fully and clearly. In that case, facts may have to be rearranged in a new form, evidence may have to be correlated, further calculations may be required, and even charts and tables may have to be constructed to clarify the situation. In arranging and evaluating case evidence, the case analyst will often find it helpful to examine the source of data. The evidence may be a fact, an opinion or an assumption. Regarding facts, one would be quite justified in accepting them, be examined and assessed. Where an assumption is made, it should be clearly designated and the reason for making it should be specifically stated because unreasonable assumptions can prejudice business decisions. 4. Alternatives

The case analyst further requires determining the feasible course of action and evaluating them. In some cases, the alternatives are clearly stated but in other case, it falls on the case analyst to imagine alternatives appropriate to the situation. The analyst need not remain content with predetermined alternatives: he should also think of new and better courses of action. Besides, it is also necessary to evaluate each alternative. A convenient and useful method would be pro and con analysis, whereby for each alternative, the evidence may be listed under for and against categories. Some facts others suggest the probable consequences of

choosing one alternative over another. The next question arises: Which group of arguments, pro and con, is stronger in total. Thus by weighing the relative strengths and weakness of each alternative, it will be possible to arrive at a logical decision. 5. Decision

The last phase in case analysis is that of deciding the best alternative towards solving the central problem. The case analyst must not be evasive in making a final choice of what appears to him the best alternative: instead, he should be fully aware of the limitations and strengths of his choice and should avoid overstating his case. But he should be able to support his decision. Normally, there is no single correct solution to a case. Two managers of equal ability may select different alternatives. In some cases, it is possible to say that certain recommendations are superior to others. But quite often it analyst must analyst must nevertheless decide. In deciding an alternative, it is to be seen whether it is based on the particular facts of the situation and is really workable under the circumstances. SIGNIFICANCE OF CASE METHOD The significance of case method as a teaching technique as against the methods of classroom lecture and textbook reading is proved beyond doubt both for gaining sound foundation in management principles and practices and for developing the requisite practice and experience in decision-making in actual business situations. Of course, the case method is not to be regarded as a substitute of other methods of teaching. In order that the participants are able to obtain the maximum value from the use of case method, they should first understand the basic principles of the particular subject and then be asked to analyse the case. The case method provides opportunities to business students to develop their analytical abilities and decision-making skills and to utilise their imagination in devising feasible programmes of action. Certain valuable skills that case analysis enables one to learn are given below: (1) (2) (3) (4) (5) (6) (7) Thinking logically and meaningfully in a given business situation: Identifying the basic problem(s) amidst the complexities of business situation: Analysing, interpreting and weighing the available evidence bearing upon business situation: Recognising the limits on efficient decision-making where complete data are not obtainable: Recognising what additional information can possibly be acquired: Distinguishing relevant material from irrelevant material; and Reaching a decision with the co-operation of others.

To conclude, the case method has large educational value as the class-room discussion of case studies helps the management trainees in developing necessary skills for successful decision-making in actual business situations.

Case study method has also been found useful in training programmes for working executives. The realism of the case material makes many managers relate what they are learning to their own situations. They use their own experienced in analysing the case and derive management principles from the discussion of their analysis. The study method is, however, time consuming. The task of gathering all the pertinent facts, arranging them and then putting them into effective writing is a long and often tedious process. Time is also required of the knowledgeable managers who supply the facts. LIMITATIONS The case study method takes getting used to. Trainees who have not had experience with this method can become quite frustrated when they find that there is no right answer to the case problem and that there even may be a question as to just what the problem is. How can I learn to manage, they ask. If no one is sure of what is wrong or what should be done about it? Most trainees pass through this stage successfully: they learn eventually that management situations often are ambiguous and that there frequently is no single best solution.

Session