UNIT I (6 Hours)

Basic Concepts and principles: Definition, Nature and Scope of Economics-Micro Economics
and Macro Economics, Managerial Economics and its relevance in business decisions.
Fundamental Principles of Managerial Economics - Incremental Principle, Marginal
Principle, Opportunity Cost Principle, Discounting Principle, Concept of Time Perspective,
Equi-Marginal Principle, Utility Analysis, Cardinal Utility and Ordinal Utility. Case Studies

Meaning: Economics is that branch of social science which is concerned with the study of
how individuals, households, firms, industries and government take decision relating to the
allocation of limited resources to productive uses, so as to derive maximum gain or
satisfaction.
Nature of Economics:

1. Economics is a science: Science is an organised branch of knowledge, that analyses cause and
effect relationship between economic agents. Further, economics helps in integrating various
sciences such as mathematics, statistics, etc. to identify the relationship between price,
demand, supply and other economic factors.

2. Economics is an art: Art is a discipline that expresses the way things are to be done, so as to
achieve the desired end. Economics has various branches like production, distribution,
consumption. Economics, that provide general rules and laws that are capable of solving
different problems of society.
Scope of Economics

1. Microeconomics: The part of economics whose subject matter of study is individual units,
i.e. a consumer, a household, a firm, an industry, etc. It analyses the way in which the
decisions are taken by the economic agents, concerning the allocation of the resources that
are limited in nature. It studies consumer behaviour, product pricing, firm’s behaviour. Factor
pricing, etc.
2. Macro Economics: It is that branch of economics which studies the entire economy, instead
of individual units, i.e. level of output, total investment, total savings, total consumption, etc.
Basically, it is the study of aggregates and averages. It analyses the economic environment,
wherein the firms, consumers, households, and governments make decisions.

1. Microeconomics: Microeconomics is the social science that studies the implications of

incentives and decisions, specifically how those affect the utilization and distribution of
resources.

Features:
a) It is concerned with the study of individual units in the economy.

b) Micro economic analysis involves product pricing, factor pricing and theory of welfare.

c) Assumption of "Ceteris Paribus" is always made in every micro economic theory. It means
the theory is applicable only when 'other things remain unchanged'.

d) Micro economics divides the economy into various small units and every unit is analysed
in detail, i.e. uses slicing method.

Scope:

a) Product Pricing: The main principle in microeconomics is product pricing or price

mechanism. Prices of individual commodities are determined by market forces of demand
and supply.
b) Factor Pricing: Microeconomics deals with the pricing of factors of production like land,
labour, capital, and entrepreneur. All factors contribute to the production process. These
factors get rewards in the form of rent, wages, interest, and profit respectively.
c) Welfare Theory: Microeconomics also deals with the optimum allocation of resources and
maximization of social welfare.

2.Macroeconomics: Macroeconomics studies economic problems at the level of an economy

as a whole. It is concerned with the determination of aggregate output and general price level
in which are not concerned with an individual rather the economy as a whole.

Features:

(1) Study of Aggregates: Macro Economics deals with the study of entire economy. It studies
the overall conditions in the economy, such as National Income, National Output, Total
Employment, General Price Level etc.

(3) A General Equilibrium Analysis: Macro Economics analysis is based on general

equilibrium. This is because it deal with the economic system as a whole and studies the inter
relationships and interdependence between the various macro variables in an economy.

(4) Income Analysis: Macro Economics is also known as income theory. It studies the factors
determining National Income and employment and the causes of fluctuations in income and
employment.

(5) Policy Oriented: The study of Macro Economics is useful in formulating economic
policies to promote economic growth, to control inflation, to generate employment, to pull
the economy out of depression etc. Macro Economics is a policy oriented science.
 Scope:

a) Aggregate consumption: It is the consumption of goods and services by all individuals in

the economy during the period of an accounting year.
b) Aggregate investment: It refers to the total capital formation in the economy during an
accounting year.
c) Aggregate Demand (AD): It is the total demand of an economy including all the sectors at
a given level of income during a given period of time.
d) Aggregate Supply (AS): It is the total supply of goods and services by all the sectors of an
economy at a given period of time.
e) Domestic income: It is the income generated within the domestic boundary of the country
during an accounting year.
f) General price level: It is the index of prices of all goods and services at the end of a
specific time period.

MANAGERIAL ECONOMICS

Managerial economics is a stream of management studies that focus on decision-making and

problem-solving. Both microeconomics and macroeconomics theories are applied. It focuses
on the efficient utilization of scarce resources.

Importance:

a) The companies use managerial economics for forecasting demand. Based on demand
projections, long-term business policies are formulated.
b) The external environment poses various challenges and uncertainties. This discipline creates
an estimate of those threats; as a result, firms can prepare themselves for damage limitation
strategies.
c) Inventory management is crucial for business. By employing demand analysis, firms can
plan inventory beforehand.
d) It facilitates the determination of the future cost of the business. Scarce resources can be
utilized efficiently; this way total cost of production and sales can be mitigated.

Relevance in Business Decision Making:

a) Demand Analysis and Forecasting: A firm is an economic organisation which

transforms inputs into output that is to be sold in a market. Accurate estimation of demand,
by analysing the forces acting on demand of the product produced by the firm, forms the vital
issue in taking effective decision at the firm level.

b) Cost and Production Analysis: An element of cost uncertainty exists: All the factors
determining costs are not always known or controllable. Managerial economics touches these
aspects of cost analysis as an effective knowledge and the application of which is corner
stone for the success of a firm

c) Inventory Management: managerial economics will use such methods as Economic

Order Quantity (EOQ) approach, ABC analysis with a view to minimising the inventory cost.
It also goes deeper into such aspects as motives of holding inventory, cost of holding
inventory, inventory control, and main methods of inventory control and management.

d) Advertising: Expenditure on advertising and related types of promotional activities is

called selling costs by economists.
 e) Pricing Decision, Policies and Practices: Pricing is very important area of managerial
economics. The control functions of an enterprise are not only productions but pricing as
well. When pricing a commodity, the cost of production has to be taken into account.

Fundamental Principles of Managerial Economics

1.Incremental Concept: The incremental concept is closely allied with the marginal cost and
marginal revenue and the economists majorly used both the concepts- incremental cost and
incremental revenue. The incremental cost denotes the alteration in total cost, while the
alteration in total revenue is signified by incremental revenue occurring from a firm’s
production decision.

The firm’s decision will be profitable if:

a. Revenues will rise more than costs
b. The increment in some costs is less than the reduction in other costs
c. The increase in some revenues is more as compare to others
d. The reduction in costs is more than the revenues.

Despite being used widely, this concept has certain limitations:

a. Generalization of this concept is not possible due to the variable behaviour of the firms
b. The concept can only be applicable in short run.
c. The applicability on the concept is depend on the additional Production capacity of the
business firm

2.The Time Perspective Concept: The time element in economic theory was introduced by
Marshall. The short run is the time period in which a firm can only alter its factors of
production like labour and raw materials. The firm has to change its output without changing
its size. The firm can easily increase its output in the long run because the firm has enough
time to alter its size as well as can use both fixed and variable factors in the production
process. In managerial economics, the consequences of the decisions during short run and
long run are taken into consideration and maintain a right balance among these time
perspectives.

3. Opportunity Cost Concept: It refers to the benefit of revenue foregone by availing one
course of action rather than another. The opportunity cost here means the sacrificed
alternative. That alternative quantify the worth of best alternative choice forego by selecting
from a set of alternative options

The concept has economic significance as it helps in:

a. Deciding relative prices of commodities
b. Determining factor (inputs) remuneration
c. Optimal allocation of available resources

4.The Equi- Marginal Concept: The producer should allocate its productive resources in such
a manner that value addition or profit or marginal utilities yielding from each unit are equal. A
producer cannot increase the benefits or decrease costs without moving any unit of input from
one application to other. The system will operate below its optimum level if the condition of
equi-marginality is violated. Let’s take an example to simplify the concept, a firm is engaging in
five different production activities i.e. A, B, C, D, and E with 100 number/ unit of labour. Now,
if a firm wants to increase output of activity B by employing more labour, it can only be possible
by reducing number of labour employed on other activities. Moreover, the optimal allocation
can only be attained if marginal utility from activity B is greater than the marginal productivity
from another activities. In this way, the total productivity/utility from all activities will be
maximum.

5.The Discounting Concept: This principle is basically an extension of time perspective

concept and gave the due importance to the future uncertainties in receiving the future rupee. It
is also necessary to discount future rupee even in the absence of uncertainty to make them
equivalent to present day rupees.

6.Marginal Principle: It states that businesses should make decisions by considering each
option’s marginal benefits and marginal costs. In other words, businesses should compare the
additional benefits of an option to its additional costs and choose the option that provides the
most benefit for the least cost.

UTILITY ANALYSIS
According to Jevos, who first introduced the concept of utility, “Utility is the basis on which the
demand of an individual for a commodity depends upon”. In the words of Prof. Waugh, “Utility
is the power of commodity to satisfy human wants.”

Types of Utility:

a)Total Utility: It is the amount of utility (satisfaction); a consumer gets by consuming all the
units of a commodity. If there are n units of the commodity then the total utility is the sum of the
utilities of all n units
of the commodity

b)Marginal Utility: Marginal utility is defined as the change in the total utility due to a unit
change in the consumption of a commodity per unit of time. It can also be defined as the
addition made to the total utility by consuming an additional unit of a commodity.

Measurement of Utility: Measurement of a utility helps in analyzing the demand behaviour of

a customer. It is measured in two ways

a) Cardinal Utility: This approach consider utility as a measurable and quantifiable entity. An
individual express that he derives 10 or 20 utils from a consumption of a cup of tea.

Limitation of Cardinal Approach

  In the real world, one cannot always measure utility.
 One cannot add different types of satisfaction from different goods.
 For measuring it, it is assumed that utility of consumption of one good is independent
of that of another.
 It does not analyze the effect of a change in the price.

b) Ordinal Utility: Ordinal utility analysis does not quantify utility in numerical expressions.
One can express his or her satisfaction in ranking. One can compare commodities and give
them certain ranks like first, second, tenth, etc. It shows the order of preference. An ordinal
approach is a qualitative approach to measuring a utility.

Limitation of Ordinal Approach

 It assumes that there are only two goods or two baskets of goods. It is not always true.
 Assigning a numerical value to a concept of utility is not easy.
 The consumer’s choice is expected to be either transitive or consistent. It is always
not possible.