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16-08-2010

Managerial Economics-
Definitions
Managerial Economics
• Is the application of economic theory and
methodology to business administration practice.

• Integration of economics theory with business


practice for the purpose of facilitating decision
M.Ramani making and forward planning by management.
M.A., M.A., M.Sc., MBA., M.Phil, Ph.D
PGDPR, PGDHM
Resource Person – Social Science • Is the discipline which helps a business manager
in decision making for achieving desired results.

Managerial Economics
Nature and
Business Decision Making Problems Characteristics.
• Micro in nature.
Decision Science
Traditional Economics Tools and Techniques of analysis • Business theory of markets & private
Theory and Methodology LP Technique, Statistical estimate,
Macro, Micro Game Theory etc enterprises.
• Pragmatic in approach.
Managerial Economics • Normative in nature.
Application of Economic theory and methodology to solving problems
• It uses analytical tools, concepts and notions
from other disciplines.
Optimal solutions to business problems
• Macro analysis

Scope of Managerial
Basic Economic Tools
Economics
• Opp.cost principles.
• Demand analysis& forecasting
• Incremental principles.
• Cost & production Analysis.
• Principles of time perspectives.
• Pricing decisions, policies & practices.
• Discounting principles.
• Profit Management.
• Equi-Mariginal principles.
• Capital Management.

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Role of Managerial Internal- Business


Economists. operations
• Sales budget.
Role of Managerial Economics • Profit budget.
• Wage policy.
• Price policy.
• Cash flows.
Internal External
• Fund flows.

External-Environmental
Specific functions.
studies.
• STEEPG. • Sales forecasting.
• Industrial Market Research.
• Prices. • Economic analysis of competitors.
• National income & output. • Pricing problems.
• Capital projects.
• Volume of trade. • Production programmes.
• Investment security analysis.
• Environmental forecasting.
• Economics intelligences.
• Participating in public debate.

Demand Forecasting
Demand Schedule Table & Graph
Price in Quantity Demand
(Rs) (units)
D
Symethod Statistical Method 5 5 10
4
4 20
3
Price

3 30
2

1
2 40
Consumer 0
D 1 50
Opinion poll methods Trend Projection Eco. method 10 20 30 40 50
Survey

Qty. demanded

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Demand curve Elastic Demand curve


Y D

Ed < 1
p

Price
P1

0 x
Q Q1
Qty. demanded

Inelastic demand Unitary elastic demand


D

Ed = 1
P
D

p
P1
Ed<1
price

P1
Price

D D

0 Q Q1 0 Q Q1
Qty. demanded
Qty. demanded

Perfectively inelastic Perfectively elastic


demand demand
Ed = 0 Ed =

p D
P2
Price

Price

P1

0 Q 0 Q1 Q2 Q3 Q4
Qty. demanded Qty. demanded

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Elasticity – Linear Demand Schedule of Total outlay method


Price in Quantity Total outlay Type of Elasticity
Rs/Kg demanded in Rs. demand
9 20 180 Ed>1
8 30 240 Elastic
7 40 280 demand
6 50 300 Ed=1
5 60 300 Unit Elastic
4 75 300 demand
3 80 240 Ed<1
2 90 180 Inelastic demand
1 100 100

Fixed Costs :
Various Concepts of Costs Costs which remain constant irrespective of
increase or decrease in production up to
Cost: particular level of activity.
It is defined as the value of all inputs used in the
production process. i.e. Example:
•Rent,
•Land •Interest on capital
•Labour •Salary to permanent staff
•Raw materials •Certain taxes
•Energy •Interest to loan
•Input •Dividend to share holders
•Depreciation
•Transport •Maintenance

Fixed Costs Various concepts of costs


Total Fixed Costs

Fixed Costs

Output

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Total fixed Cost Curve Average Fixed Cost

Average variable Cost


Total variable Cost curve
Curve

Short Run Cost Cost – TC, TVC, TFC

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Production function Production function


• A numerical example of production function is given in
table 3.1. The left column shows the amount of factor1 and
the top row shows the amount of factor2.
• As we move to the right along any row, factor 2 increases
and as we move down along any column, factor 1
increases.
• For different values of the two factors, the table shows the
corresponding output levels. For example with 1 unit of
factor1 and 1 unit of factor2, the firm can produce at most
1 unit of output; with2 units of factors 1 and 2 units of
factor2., it can produce at most 10 units of output; with 3
units of factor 1 and 2 units of factors2, it can produce at
most 18 units of output and so on.

LONG RUN COSTS

MC1 Plant ATC* is the LRMC


$ ATC! optimal size!
MC2
ATC2 ATC6 Short Run
ATC3 ATC5
ATC*
ATC*
LRAC
Cmin
There is a long run • The short run is a period in which at least one
marginal cost function.
At Q* the cost per unit are of the inputs has become a constant and at least
minimized [the least inputs one of the inputs is a variable.
used].
Q* Q
• If kapital [K] and land [R] are fixed or constant
For Plant size 1, the costs are ATC1 and MC1 : in the short run, labour [L] is the variable
For a bigger Plant 2, the unit costs move out and down. It is more cost
effective. As bigger plants are built the ATC moves out and down.
input. Output is changed by altering the
Eventually, the plant size is “too large,” the ATC moves out but also up! labour input. QX = f(L) Technology, K and R
An “Envelope curve” is constructed to represent the long run AC [LRAC]. are fixed or constant.

The Long Run Long Run cost


• The long run is a period of time where:
– technology is constant
– All inputs are variable
• The long run period is a series of short run
periods. [For each short run period there is a set of TP, AP,
MP, MC, AFC, AVC, ATC, TC, TVC & TFC for each possible
scale of plant]

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Production in the Short Run Production in the Short Run


Consider a production process where K, R and technology are TPL output Production of Good X
fixed: As L is changed, the output APL =
L = = Efficiency of
changes, QX= f(L) Production of Good X input labour L TPL APL MPL
L = labour input L TPL APL MPL Notice that the APL increases as the first 0 0 0 --
TPL = QX = output of good X three units of labour are added to the
APL = average product [TP/L]
0 0 0 -- fixed inputs of K and R. The maximum 1 4 4 4
∆L = 1 ∆TPL=4
MPL = Marginal product [∆TP/ ∆L] 1 4 4 4 efficiency of Labour or maximum APL , given 2 10 5 6
2 10 5 6 our technology, plant and natural
TPLL 3 20 6.67 10
APLLL===
AP resources is with the third worker.
L 3 20 6.67 10 4 25 6.25 5
∆TPL 4 25 6.25 5 As additional units of labour are added 5 29 5.8 4
MPL =
∆L 5 29 5.8 4 beyond the third worker the 6 32 5.3 3
TPL output 3 output per worker [APL ] declines.
APL = = = Efficiency 6 32 5.3 7 34 4.87 2
L input
7 34 4.87 2 8 35 4.37 1
Maximum of APL is at the 3 input of
8 35 4.37 1 0
labour. 9 35 3.89
9 35 3.89 0

Break Even analysis


Types of Market

Market
Cost / Revenue

BEP Variable cost

Perfect Imperfect
(Large Number of Sellers)

TFC

Fixed cost

Monopoly Duopoly Oligopoly Monopolistic


(Seller- 1) (Seller- 2) Sellers a few
Production/Sales Volume

Features Perfect Monopoly Monopolis Oligopoly


Features of different Market forms tic
Degree of zero absolute Limited Considerable
Features Perfect Monopoly Monopol Oligopoly Monopoly
power
istic
Advertisement Not Not essential Very Necessary to
Number of Firm Large One Many but A Few
necessary but they help essential, some extent
not to large
to maintain incurring
Nature of Homogenous Unique with Product Homogenous & the business selling cost
Product no substitute Differentiat Heterogeneous
ion Profit Normal abnormal short run- abnormal
Abnormal or
Price Policy Taking Making Making Making loss
Long run-
Normal
Entry Free No Easy Restricted
Example Agricultural Copy right of Soap or Cement or
Output Larger Smaller Larger Smaller products the book toothpaste petrol

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Circular Flow of Two Three sector model


Sectors Taxes & Loans Taxes and loans

Govt Sector

Govt. Purchase Exp. On Factor Services

Y= C+I Y = C+I+G
Household sector
Business Sector

Consumption Expenditure

Factor Payments

Four Sector Model


Trade cycle
Taxes & Loans Taxes & loans

Govt Sector

Prosperity
Prosperity
Business Condition

Govt. Purchases Exp. On Factor Services

Business Sector
Y=C+I+G+(X-M) Household Sector

Consumption Expenditure

Depression Depression Depression


Factors Payments

Payments for imports Payments for imports


Foreign Sector
Years
Exports & Transfer Payments Transfer Payments