LESSON 1 Introduction to Economics As an MBA student you need to study Managerial Economics which is concerned with decision making

by managers. As you all are aware that the main job of managers is decision making only. Before making a decision one has to take into accounts so many things. And here comes the importance of managerial economics. Meaning of Economics: Economics can be called as social science dealing with economics problem and man’s economic behavior. It deals with economic behavior of man in society in respect of consumption, production; distribution etc. economics can be called as an unending science. There are almost as many definitions of economy as there are economists. We know that definition of subject is to be expected but at this stage it is more useful to set out few examples of the sort of issues which concerns professional economists. Example: For e.g. most of us want to lead an exciting life i.e. life full of excitements, adventures etc. but unluckily we do not always have the resources necessary to do everything we want to do. Therefore choices have to be made or in the words of economists “individuals have to decide-----“how to allocate scarce resources in the most effective ways”. For this a body of economic principles and concepts has been developed to explain how people and also business react in this situation. Economics provide optimum utilization of scarce resources to achieve the desired result. It provides the basis for decision making. Economics can be studied under two heads: 1) Micro Economics 2) Macro Economics Micro Economics: It has been defined as that branch where the unit of study is an individual, firm or household. It studies how individual make their choices about what to produce, how to produce, and for whom to produce, and what price to charge. It is also known as the price theory is the main source of concepts and analytical tools for managerial decision making. Various micro-economic concepts such as demand, supply, elasticity of demand and supply, marginal cost, various market forms, etc. are of great significance to managerial economics.

It is viewed as a special branch of economics bridging the gap between pure economic theory and managerial practices. For e. investments. Management Decision Problems Economic Concepts Decision Science . According to Spencer and Seigelman—“it is defined as the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by the management”. It is defined as application of economic theory and methodology to decision making process by the management of the business firms. In it economic theories and concepts are used to solve practical business problem. It lies on the borderline of economic and management.” Managerial Economics consists of use of economic modes of thought to analyze business situation”. ME’s purpose is to show how economic analysis can be used formulating business planning. employment etc. Governments face many such problems. Definitions of managerial economics: In the words of Mc Nair and Merriam.g. This is the same type of problem facing all of us in our daily lives but in different scales. The basic purpose of managerial economic is to show how economic analysis can be used in formulating business plans. It has been described as an economics applied to decision making. Sometimes it is interchangeably used with business economics. It includes National Income. Managerial economic is concerned with decision making at the level of firm.Macro Economics: It’s not only individuals and forms who are faced with having to make choices. Meaning of managerial economics: It is another branch in the science of economics. Macro economics helps in the area of forecasting. Economic provides optimum utilization of scarce resource to achieve the desired result. It studies the economics as a whole. How much to spend on health How much to spend on services How much should go in to providing social security benefits. aggregate consumption. It helps in decision making under uncertainty and improves effectiveness of the organization. It is aggregative in character and takes the entire economic as a unit of study.

How does managerial economics differ from regular economics? • • • There is no difference in the theory.Managerial Economics Optimal Solution to Managerial Decision Problems Managerial Economics bridges the gap between purely analytical problems dealt within economic theory and decision problems faced in real business and thus helps out in making rational choices to yield maximum return out of minimum efforts and resources by making the best selection among alternative course of action. unemployment etc). The one main root cause of all economic problems is SCARCITY and managerial economics is the use of economic analysis to make business decisions involving the best use of organization’s scarce resources. standard economic theory provides the basis for managerial economics. It deals with . Unlimited Wants Scarcity What to produce? Limited resources or means How to produce? For whom to produce? Human wants are virtually unlimited and insatiable and economic resources to satisfy them are limited which give rise to choices between what to produce. MANAGERIAL ECONOMICS = Economics + Decision Science + Business Management Managerial economics has evolved by establishing link on integration between economic theory and decision sciences along with business management in the theory and practice for the optimal solution to business decision problems. Economics in its broadest sense means what economists do. They provide solutions to various economic problems (inflation. how to produce and for whom to produce. The difference is in the way the economic theory is applied.

Demand . Production function. As far as Managerial Economic is concerned it is very wide in scope. ME deals with Demand analysis. • • • Scope of Managerial Economics: Scope is something which tells us how far a particular subject will go. Resource allocation etc. ‘what should be’. Advertising. It takes into account almost all the problems and areas of manager and the firm.the application of economic principles and methodologies to the decision making process within the firm. Pricing System. Forecasting. Managerial Economics is pragmatic: It avoids difficult abstract issues of economic theory but involves complications ignored in economic theory to face the overall situations in which the decisions are made. Following aspects are to be taken into account while knowing the scope of ME: 1 2 1. Inventory Management. In other words it is prescriptive rather then descriptive. Therefore demand analysis is something which is necessary for the production function to happen. Demand analysis and forecasting: Unless and until knowing the demand for a product how can we think of producing that product. Managerial Economics belongs to normative rather than positive economics: Positive economics derives useful theories with testable propositions about ‘what is’ and normative economics provides the basis for value judgment on economic outcomes. Macro Economics is also useful to managerial economics: Macro economics provides an intelligent understanding of the environment in which the business unit must operate. It is known as the ‘normative micro economics of the firm. Chief Characteristics Managerial Economics is micro economic in character: This is because the unit of study is a firm. it is the problem of a business firm which is studied and it does not deal with the entire economy as a unit of study. • • Managerial Economics largely uses economic concepts and principles: Managerial Economics largely uses economic concepts and principles. Cost analysis. under the given situation. This understanding enables a business executive to adjust in the best possible manner with external forces over which he has no control but which play a crucial role in the well being of his concern.

the problem of cost.. Advertising: Advertising is a promotional activity. Under cost analysis we will take into account determinants of costs. simple simulation exercises. When the price of input rises the firm is forced to work out a combination of inputs to ensure the least cost combination. It also helps in inventory controlling. Factor of production called as inputs is combined in a particular way to get the maximum output. the measuring of the economic effects of advertising ---. Both the high inventory and low inventory is not good for the firm. the methods of determining the total advertisement costs and budget. Pricing system: . It takes into account all the costs incurred while producing a particular product. 1 1 4. the forecast of the cost. Managers not only assess the current demand but he has to take into account the future demand also. Inventory Management: What do you mean by the term inventory? Well the actual meaning of the term inventory is stock. Production function: Conversion of inputs into outputs is known as production function. It refers to stock of raw materials which a firm keeps.are the problems of the manager. Now here the question arises how much of the inventory is ideal stock. etc. 5. It is through advertising only that the message about the product should reach the consumer before he thinks to buy it. 1 2 3 4 3. In advertising while the copy. illustrations. With limited resources we have to make the alternative uses of this limited resource. and some mathematical models. these terms are very vital to any firm or business. Managerial economics will use such methods as ABC Analysis. to minimize inventory cost. There’s a vast difference between producing a product and marketing it. method of estimating costs. 1 1 6. 2. the relationship between cost and output. profit. are the responsibility of those who get it ready for the press.analysis helps in analyzing the various types of demand which enables the manager to arrive at reasonable estimates of demand for product of his company. Advertising forms the integral part of decision making and forward planning. Cost analysis: Cost analysis is helpful in understanding the cost of a particular product.

As you all know that pricing system as a concept was developed by economics and it is widely used in managerial economics. intuition and experience alone are not sufficient to make appropriate business decisions. Pricing is also one of the central functions of an enterprise. 7. The steps below put managers analytical ability to test and determine the appropriateness and validity of decisions in the modern business world. While pricing commodity the cost of production has to be taken into account. Resource allocation: Resources are allocated according to the needs only to achieve the level of optimization. For the allocation of the resources various advanced tools such as linear programming are used to arrive at the best course of action. It is in this area of decision making that economic theories and tools of economic analysis contribute a great deal. *************** Tools and Technique of Decision Making: Business decision making is essentially a process of selecting the best out of alternative opportunities open to the firm.Here pricing refers to the pricing of a product. It is also important to understand how product has to be priced under different kinds of competition. As we all know that we have scarce resources. Following are the various steps in decision making: • Establish objectives • Specify the decision problem • Identify the alternatives • Evaluate alternatives • Select the best alternatives • Implement the decision • Monitor the performance Modern business conditions are changing so fast and becoming so competitive and complex that personal business sense. . but a complete knowledge of the price system is quite essential to determine the price. and unlimited needs. for different markets. We have to make the alternate use of the available resources.

1 2) Incremental principle: It is related to the marginal cost and marginal revenues. procedures. Incremental concept involves estimating the impact of decision alternatives on costs and revenue. for economic theory. products. These tools are helpful for managers in solving their business related problems. For e. investments or whatever may be at stake in the decisions. emphasizing the changes in total cost and total revenue resulting from changes in prices. its opportunity cost is nil.g. b) The opportunity cost of using a machine to produce one product is the earnings forgone which would have been possible from other products. The two basic components of incremental reasoning are 1) Incremental cost . If a decision involves no sacrifices. Following are the basic economic tools for decision making: 1) Opportunity cost 2) Incremental principle 3) Principle of the time perspective 4) Discounting principle 5) Equi-marginal principle 1) Opportunity cost principle: By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision. These tools are taken as guide in making decision. c) The opportunity cost of holding Rs.Basic economic tools in managerial economics for decision making: Economic theory offers a variety of concepts and analytical tools which can be of considerable assistance to the managers in his decision making practice. For decision making opportunity costs are the only relevant costs. a) The opportunity cost of the funds employed in one’s own business is the interest that could be earned on those funds if they have been employed in other ventures. 1000as cash in hand for one year is the 10% rate of interest. Its clear now that opportunity cost requires ascertainment of sacrifices. which would have been earned had the money been kept as fixed deposit in bank.

Such customers may complain of being treated unfairly and feel discriminated against. The very important problem in decision making is to maintain the right balance between the long run and short run considerations.5000/for the lot) Analysis: From the above example the following long run repercussion of the order is to be taken into account: 1) If the management commits itself with too much of business at lower price or with a small contribution it will not have sufficient capacity to take up business with higher contribution.3/-. There fore the contribution to overhead and profit is Rs. For example.20000/. The short run incremental cost(ignoring the fixed cost) is only Rs.1/. .for the whole lot but not more. An order for 5000 units comes to management’s attention. Suppose there is a firm with a temporary idle capacity. they may demand a similar low price. 2) If the other customers come to know about this low price. The customer is willing to pay Rs 4/.unit or Rs.per unit (Rs.2) Incremental Revenue The incremental principle may be stated as under: “A decision is obviously a profitable one if – a) it increases revenue more than costs b) it decreases some costs to a greater extent than it increases others c) it increases some revenues more than it decreases others and d) it reduces cost more than revenues” 1 3) Principle of Time Perspective Managerial economists are also concerned with the short run and the long run effects of decisions on revenues as well as costs.

Relationship between managerial economic. an input should be so allocated that the value added by the last unit is the same in all cases. economics contributes to the managerial profession. This is true for two reasonsi) The future is uncertain and there may be uncertainty in getting Rs. What is the basic function of the managers of the business? As you all know that the basic function of the manager of the firm is to achieve the organizational objectives to the maximum possible extent with the limited resources placed at their disposal. a firm has 100 units of labor at its disposal.B. it can enhance any one of these activities by adding more labor but only at the cost of other activities.today or Rs.100/. The firm is engaged in four activities which need labors services. Economics contributes a lot to the managerial economics. today’s Rs. Suppose.C and D.will become 108 5) Equi . 4) Discounting Principle: One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a rupee today. This generalization is called the equi-marginal principle.In the above example it is therefore important to give due consideration to the time perspectives. Just as the biology contributes to the medical profession and physics to engineering. Naturally he will chose Rs.100/. 100/. Suppose a person is offered a choice to make between a gift of Rs. All other qualifications being same. According to this principle. managers with working knowledge of economics can perform their function more efficiently than those without it.100/.today. “a decision should take into account both the short run and long run effects on revenues and costs and maintain the right balance between long run and short run perspective”. Mathematics and managerial economics: .100/. viz.can be invested so as to earn interest say as 8% so that one year after Rs.marginal Principle: This principle deals with the allocation of an available resource among the alternative activities. A.next year.if the present opportunity is not availed of ii) Even if he is sure to receive the gift in future.100/. and other subjects: Economic and managerial economics: Economics contributes a great deal towards the performance of managerial duties and responsibilities. economic.

Statistical techniques are used in collecting processing and analyzing business data. and changing view of enterprises goals. The significant relationship between ME and OR can be highlighted with reference to certain important problems of ME which are solved with the help of OR techniques. forecasting techniques. waiting line problem. concepts. Management theory helps a lot in making decisions. competitive problem. like allocation problem. at the right time. mathematics. Businessmen deal primarily with concepts that are essentially quantitative in nature e. It has influenced ME through its new concepts and model for dealing with risks. wages etc. price. Operations Research and Managerial Economics: It’s an inter-disciplinary solution finding techniques.g. ME has also been influenced by the developments in the management theory. . ME calls for marshalling of quantitative data and reaching useful measures of appropriate relationship involves in decision making. and statistics to build models for solving specific business problems. and inventory problem. Linear programming and goal programming are two widely used OR in business decision making. a firm should have statistically derived or calculated demand and cost function. The statistical tools for e. with the help of right people so that organizational goals can be achieved. cost. and regression analysis help the decision makers in predicting the future course of economic events and probable outcome of their business decision. It combines economics. testing and validity of economics laws with the real economic phenomenon before they are applied to business analysis.Mathematics in ME has an important role to play. The central concept in the theory of firm in micro economic is the maximization of profits. Statistics is important to managerial economics in several ways. the frame work for taking them into account in the context of actual problem has been operationalised. In order to base its price decision on demand and cost consideration. ME should take note of changes concepts of managerial principles. Though economic theory has always recognized these factors to decision making in the real world. demand.g. theory of probability. Management theory and Managerial economics: As the definition of management says that it’s an art of getting things done through others. Statistics and managerial economics: Statistical tools are a great aid in business decision making. The use of mathematical logic I the analysis of economic variable provides not only clarity of concepts but also a logical and systematical framework. Bet now a day we can define management as doing right things.

The focus of accounting within the enterprise is fast changing from the concept of bookkeeping to that of managerial decision making. vectors.Accounting and Managerial economics: There exits a very close link between ME and the concepts and practices of accounting. ******************** . Accounting data and statement constitute the language of business. Gone are the days when accounting was treated as just bookkeeping. Now its far more behind bookkeeping. Cost and revenue information and their classification are influenced considerably by the accounting profession. As a student of MBA you should be familiar with generation. and use of accounting data. determinants and matrix algebra and calculus etc. Mathematics is closely related to ME. interpretation. Certain mathematical tools such as logarithm and exponential.

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