104: MANAGERIAL ECONOMICS

Course objectives:

The course is designed to impart knowledge of the concepts and principles of Economics, which
govern the functioning of a firm/organization under different market conditions. The course aims at
enhancing the understanding capabilities of students about macro-economic principles and decision
making by business and government. This course will enlighten the students to apply various
techniques of economics in embracing business challenges
Learning outcomes: Relation of Managerial Economics with other disciplines and its relationship
with management; Understand the demand for and supply of the firm’s products; Managerial decision
under different market conditions; Importance of Production function; Causes and consequences of
Inflation

Course Layout:

Unit I

Introduction: Nature, scope, uses, relation with traditional economics, operations research,
Mathematics, Statistics, Accounting; responsibilities of a managerial economist, objectives of a firm,
Basic tools in Managerial Economics: Opportunity cost principle, Incremental principle, principle of
time perspective, discounting principle, Equi marginal principle.

Unit 1
Unit I

Introduction: Nature, scope, uses, relation with traditional economics, operations research,
Mathematics, Statistics, Accounting; responsibilities of a managerial economist, objectives of
a firm, Basic tools in Managerial Economics: Opportunity cost principle, Incremental
principle, principle of time perspective, discounting principle, Equi marginal principle

Definition of Managerial Economics

Managerial economics is defined as the branch of economics which deals with the application
of various concepts, theories, methodologies of economics to solve practical problems in
business management.

Spencer and Siegelman have defined the subject as “the integration of economic theory with
business practice to facilitate decision making and planning by management.”

Nature of managerial economics

1
  Art and Science: Managerial Economics requires a lot of creativity and logical
thinking to come up with a solution. A managerial economist should possess the art of
utilizing his capabilities, knowledge, and skills to achieve the organizational
objective. Managerial Economics is also considered as a stream of science as it
involves the application of different economic principles, techniques, and methods, to
solve business problems.
 Micro Economics: In managerial economics, problems of a particular organization
are looked upon rather than focusing on the whole economy. Therefore, it is termed as
a part of microeconomics.

 Uses Macro Economics: Any organization operates in a market that is a part of the
whole economy, so external environments affect the decisions within the
organization. Managerial Economics uses the concepts of macroeconomics to solve
problems. Managers analyse the macroeconomic factors like market conditions,
economic reforms, government policies to understand their impact on the
organization.
 Multidisciplinary: Managerial Economics uses different tools and principles from
different disciplines like accounting, finance, statistics, mathematics, production,
operation research, human resource, marketing, etc. This helps in coming up with a
perfect solution.
 Prescriptive/Normative Discipline: By introducing corrective steps it aims at
achieving the objective and solves specific issues or problems.
 Management Oriented: This serves as an instrument in managers’ hands to deal
effectively with business-related problems and uncertainties. This also allows for
setting priorities, formulating policies, and taking successful decision-making.
 Pragmatic: The solution to day-to-day business challenges is realistic and rational.

Scope of Managerial Economics

Demand analysis:
A business firm is an economic organization which is engaged in transforming productive
resources into goods that are to be sold in the market. The demand theory emphasises on the

2
consumer’s behaviour towards a product or service. It takes into consideration the needs,
wants, preferences and requirement of the consumers to enhance the production process.

Theory of Production and Production Decisions: This theory is majorly concerned with the
volume of production, process, capital and labour required, cost involved, etc. It aims at
maximising the output to meet the customer’s demand.

Pricing Theory and Analysis of Market structure: It focuses on the price determination of a
product keeping in mind the competitors, market conditions, cost of production, maximising
sales volume, etc.

Profit Analysis and Management: The organisations work for a profit. Therefore, they always
aim at profit maximisation. It depends upon the market demand, cost of input, competition
level, etc.

Theory of Capital and Investment Decisions: Capital is the most critical factor of business.
This theory prevails the proper allocation of the organisation’s capital and making
investments in profitable projects or venture to improve organisational efficiency.

Economic Environment: The economic conditions of a country, GDP, economic policies, etc.
indirectly impacts the business and its operations.

Social Environment: The society in which the organisation functions also affect it like
employment conditions, trade unions, consumer cooperatives, etc.

Political Environment: The political structure of a country, whether authoritarian or

democratic; political stability; and attitude towards the private sector, influence
organizational growth and development.

Uses of Managerial Economics

1. Managerial economics presents those aspects of traditional economics, which are

relevant for business decision-making in real life. It culls from economic theory the concepts,
principles and techniques of analysis, which have a bearing on the decision-making process.
These are, if necessary, adopted or modified with a view to enable the manager take better
decisions. Thus, managerial economics accomplished the objective of building a suitable took
kit from traditional economics.

3
2. Managerial economics also incorporates useful ideas from other disciplines such as
psychology, sociology, etc; if they are found relevant for decision-making. In fact,
managerial economics takes the aid of other academic disciplines having a bearing upon the
business decisions of a manager in view of the various explicit and implicit constraints
subject to which resource allocation is to be optimized.
3. Managerial economics helps in reaching a variety of business decisions in a
complicated environment such as what products and services should be produced? What
inputs and production techniques should be used? How much output should be produced and
at what prices it should be sold? What are the best sizes and locations of new plants? When
should equipment be replaced? And how should the available capital be allocated?
4. Managerial economics makes a manager a more competent model builder. Thus, he
can capture the essential relationship, which characterizes a situation while leaving out the
cluttering details and peripheral relationships.
5. At the level of the firm, where for various functional areas, functional specialists or
functional departments exist, such as finance, marketing, personal, production, etc.
Managerial economics serves as an integrating agent by coordinating the different areas and
bringing to bear on the decisions of each department or specialist the implications pertaining
to other functional areas. It thus, enables business decision-making not in
watertight compartments but in an integrated perspective, the significance of which lies in the
fact that the functional departments or specialists often enjoy considerable autonomy and
achieve conflicting goals.
6. Managerial economics takes the interaction between the firm and society and
accomplishes the key role of business as an agent in the attainment of social and economic
welfare. It has come to be raised that business, apart from its obligations to shareholders, has
certain social obligations. Managerial economics focuses attention on those social obligations
as constraints subject to which business decisions are to be taken. It serves as an instrument
in furthering the economic welfare of the society through socially oriented business
decisions.
7. Managerial economics is helpful in making decisions such as the following: What
should be the product-mix? Which is the production technique and the input-mix that is least
costly? What should be the level of output and price for the product? How to take investment
decisions? How much should the firm advertise and how to allocate an advertisement fund

4
between different media? It has to concede that good decisions require ability to analyse
problems logically and clearly.

8. Deciding the price of a product and the quantity of the commodity to be produced
9. Deciding whether to manufacture a product or to buy from another manufacturer
10. Choosing the production technique to be employed in the production of a given product
11. Deciding on the level of inventory a firm will maintain of a product or raw material
12. Deciding on the advertising media and the intensity of the advertising campaign
13.Making employment and training decisions
14. Making decisions regarding further business investment and the mode of financing the
investment

Managerial Economics in Relation with other Disciplines

Managerial Economics and Economics:

Managerial Economics is economics applied to decision making. It is a special

branch of economics, bridging the gap between pure economic theory and managerial
practice. Economics has two main branches—micro-economics and macro-economics.

Micro-economics:

‘Micro’ means small. It studies the behaviour of the individual units and small
groups of units. It is a study of particular firms, particular households, individual prices,
wages, incomes, individual industries and particular commodities. Thus, micro-economics
gives a microscopic view of the economy.

The roots of managerial economics spring from micro-economic theory. In price

theory, demand concepts, elasticity of demand, marginal cost marginal revenue, the short and
long runs and theories of market structure are sources of the elements of micro-economics
which managerial economics draws upon. It makes use of well-known models in price theory

5
such as the model for monopoly price, the kinked demand theory and the model of price
discrimination.

Macro-economics:

‘Macro’ means large. It deals with the behaviour of the large aggregates in the
economy. The large aggregates are total saving, total consumption, total income, total
employment, general price level, wage level, cost structure, etc. Thus, macro-economics is
aggregative economics.

It examines the interrelations among the various aggregates, and causes of

fluctuations in them. Problems of determination of total income, total employment and
general price level are the central problems in macro-economics.

Macro-economies are also related to managerial economics. The environment, in

which a business operates, fluctuations in national income, changes in fiscal and monetary
measures and variations in the level of business activity have relevance to business decisions.
The understanding of the overall operation of the economic system is very useful to the
managerial economist in the formulation of his policies.

Macro-economics contributes to business forecasting. The most widely used model

in modern forecasting is the gross national product model.

Managerial Economics and Theory of Decision Making:

The theory of decision making is relatively a new subject that has a significance for
managerial economics. In the process of management such as planning, organising, leading
and controlling, decision making is always essential. Decision making is an integral part of
today’s business management. A manager faces a number of problems connected with his/her
business such as production, inventory, cost, marketing, pricing, investment and personnel.

Economist are interested in the efficient use of scarce resources hence they are
naturally interested in business decision problems and they apply economics in management
of business problems. Hence managerial economics is economics applied in decision making.

6
Managerial Economics and Operations Research:

Mathematicians, statisticians, engineers and others join together and developed

models and analytical tools which have grown into a specialised subject known as operation
research. The basic purpose of the approach is to develop a scientific model of the system
which may be utilised for policy making.

The development of techniques and concepts such as Linear Programming,

Dynamic Programming, Input-output Analysis, Inventory Theory, Information Theory,
Probability Theory, Queuing Theory, Game Theory, Decision Theory and Symbolic Logic.

Operational Research is closely related to managerial economics. Operational research is the

application of mathematical techniques to solving business problems. It provides all the data
required for business decisions and forward planning. Techniques such as linear
programming, game theory, etc. are due to the works of operational research, linear
programming is extensively used in decision-making. Managerial economics is concerned
with efficient use of scarce resources. Operational research is also concerned with efficient
use of scarce resources. There is close affinity between managerial economics and
operational research. Managerial economics gives special emphasis to the problems involving
maximisation of profits and minimisation of costs, while operational research focuses
attention on the concept of optimisation. Managerial economics has made much use of
optimisation concept but initially started with marginal analysis taken from economics.
Managerial economics uses the logic of Economics, Mathematics and Statistics for
undertaking effective decisions, while operational research techniques based on these ways of
thinking are being used to solve decision-making problems in business. Again, both
operational research and managerial economics are concerned with taking effective decisions.

Operational research is a tool in the hands of managerial economics to solve day-to-day

business problems. Managerial economics is an academic subject which aims at
understanding and analysing problems and decision-making by a firm. Thus, operational
research is a functional activity pursued by specialists within the firm. Though it is expensive
and a slow process, it helps managers make accurate solutions by means of providing
necessary data.

7
Managerial Economics and Statistics:

Statistics is important to managerial economics. It provides the basis for the

empirical testing of theory. It provides the individual firm with measures of appropriate func-
tional relationship involved in decision making. Statistics is a very useful science for business
executives because a business runs on estimates and probabilities.

Statistics supplies many tools to managerial economics. Suppose forecasting has to

be done. For this purpose, trend projections are used. Similarly, multiple regression technique
is used. In managerial economics, measures of central tendency like the mean, median, mode,
and measures of dispersion, correlation, regression, least square, estimators are widely used.

Statistical tools are widely used in the solution of managerial problems. For eg.
sampling is very useful in data collection. Managerial economics makes use of correlation
and multiple regression in business problems involving some kind of cause-and-effect
relationship.

Managerial Economics and Accounting:

Managerial economics is closely related to accounting. It is recording the finan-

cial operation of a business firm. A business is started with the main aim of earning profit.
Capital is invested / employed for purchasing properties such as building, furniture, etc and
for meeting the current expenses of the business.

Goods are bought and sold for cash as well as credit. Cash is paid to credit sellers.
It is received from credit buyers. Expenses are met and incomes derived. This goes on the
daily routine work of the business. The buying of goods, sale of goods, payment of cash,
receipt of cash and similar dealings are called business transactions.

The business transactions are varied and multifarious. This has given rise to the
necessity of recording business transaction in books. They are written in a set of books in a
systematic manner so as to facilitate proper study of their results.

There are three classes of accounts:

8
(i) Personal account,

(ii) Property accounts, and

(iii) Nominal accounts.

Management accounting provides the accounting data for taking business decisions.
The accounting techniques are very essential for the success of the firm because profit
maximisation is the major objective of the firm.

Managerial economics and accounting are closely interrelated. Accounting can be defined as
the recording of financial operations of a business firm. A business manager needs a lot of
accounting information data for logical analysis in decision-making and policy formulation at
the level of firm. The accounting data and information has to be presented in a
methodological manner worthy of analysis and interpretation for decision-making and future
planning. This is why a new branch of accounting known as 'management accounting' has
developed to help correct managerial decision-making. The main task of management
accounting is to provide the sort of data which managers need to solve some business
problems accurately.

Managerial Economics and Mathematics:

Mathematics is another important subject closely related to managerial economics.

For the derivation and exposition of economic analysis, we require a set of mathematical
tools. Mathematics has helped in the development of economic theories and now
mathematical economics has become a very important branch of economics.

Mathematical approach to economic theories makes them more precise and

logical. For the estimation and prediction of economic factors for decision making and
forward planning, mathematical method is very helpful. The important branches of math-
ematics generally used by a managerial economist are geometry, algebra and calculus.

9
 The mathematical concepts used by the managerial economists are the
logarithms and exponential, vectors and determinants, input-out tables. Operations research
which is closely related to managerial economics is mathematical in character.

Responsibilities of a Managerial Economist

1To make reasonable profits on capital employed:

He must have strong conviction that profits are essential and his main obligation is to assist
the management in earning reasonable profits on capital invested by the firm.

He should always help the management to enhance the capacity of the firm to earn profits. If
he fails to discharge this responsibility then his academic knowledge, experience, expertise
and business skill will be of no use to the firm.

2. Successful forecasts:
It is necessary for the managerial economist to make successful forecasts by making in-depth
study of internal and external factors that may have influence over the profitability or the
working of the firm.

He must aim at lessening if not fully eliminating the risk involved in uncertainties. It is his
major responsibility to alert management at the earliest possible time in case he discovers an
error in his forecast, so that the management can make necessary changes and adjustment in
the policies and programmes of the firm.

A managerial economist is supposed to forecast the trends in the activities of importance to

the firm such as sales, profit, demand, costs, competition, etc.

He must inform the management about the trend turning point of business activities of the
firm.

He must be willing to make considered and fairly positive statement about occurring
economic development.

10
3. Knowledge of sources of economic information’s:
A managerial economist should establish and maintain close contacts with specialists and
data sources in order to collect quickly the relevant and valuable information in the field.

For this purpose, he should develop personal relation with those having specialized
knowledge of the field.

He should also join professional associations and take active part in their activities. His
success depends on how quickly he gathers additional information’s to serve best the interest
of the firm.

4. His Status in the Firm:

A managerial economist must earn full status in the business team because only then he can
be really helpful to the management in formulating successful business policies.

He should be ready and even offer himself to take up special assignments. He is to win
continuing support for his professional ideas by performing his functions efficiently in an
atmosphere where his resources and advice are widely sought and used.

He should express his ideas and suggestions in simple and understandable language with
minimum use of technical words, while communicating with his management executives.

It is clear from the above discussion that managerial economists perform many and varied
functions.

However, of these, marketing function, i.e. sales forecasting and industrial market research
has been the most important.

For carrying out their functions, they may have to undertake detailed statistical analysis.
Thus, managerial economists help the management a lot in discharging its function of making
decisions and formulating forward plans.

Managerial economist must see that his responsibilities and functions are successfully
discharged.

He can give the firm a profitable growth and his presence should be an effective solution to
the complex problems of the management.

11
5. Studies Business Environment
The managerial economist is responsible for analysing the environment in which business
operates. Proper study of all external factors that affect the functioning of organization is
must for proper functioning. He studies various factors like growth of national income,
competition level, price trends, phase of the business cycle and economy and updates the
management regarding it from time to time.

6. Demand Forecasting and Estimation

Proper estimation and forecasting of future trends help the business in achieving desired
profitability and growth. Managerial economist through proper study of all internal and
external forces makes successful forecasting of future uncertainties or trends.

7. Production Planning
Managerial economist is responsible for scheduling all production activities of business. He
evaluates the capital budget of organizations and accordingly helps in deciding timing and
locating of various actions.
Objectives of a Business Firm

1.Profit Maximisation:
In the conventional theory of the firm, the principal objective of a business firm is profit
maximisation. Under the assumptions of given tastes and technology, price and output of a
given product under perfect competition are determined with the sole objective of
maximising profits. The firm is supposed to act as one of a large number of producers which
cannot influence the market price of the product.

It is the price-taker and quantity-adjuster. Thus, the demand and cost conditions for the
product of the firm are determined by factors external to the firm. In this theory, maximum
profits refer to pure profits which are a surplus above the average cost of production. It is the
amount left with the entrepreneur after he has made payments to all factors of production,
including his wages of management.

In other words, it is a residual income over and above his normal profits. It is a necessary
payment for an entrepreneur to stay in the business. The rules for profit maximisation are (1)
MC = MR and (2) MC should cut MR from below.

2.Simon’s Satisficing Objective:

12
According to him, the firm’s principal objective is not maximising profits but satisficing or
satisfactory profits.

The firm aspires to achieve a certain minimum or ‘target’ level of profits. Its aspiration level
is based on its different goals such as production, price, sales, profits, etc., and on its past
experience. This also takes into account uncertainties in the future. The aspiration level
defines the boundary between satisfactory and unsatisfactory outcomes.

In this context, the firm may face three alternative situations:

(a) The actual achievement is less than the aspiration level;

(b) The actual achievement is greater than the aspiration level; and

(c) The actual achievement equals the aspiration level.

3.Williamson’s Utility Maximisation:

Williamson has developed managerial utility-maximisation objective as against profit
maximisation. It is one of the managerial theories and is also known as the ‘managerial
discretion theory’. In large modem firms, shareholders and managers are two separate groups.
The former wants maximum return on their investment and hence the maximisation of
profits.

The managers, on the other hand, have consideration other than profit maximisation in their
utility functions. Thus, the managers are interested not only in their own
emoluments(salary/fee/profit) but also in the size of their staff and expenditure on them.

Thus, Williamson’s theory is related to the maximisation of the manager’s utility which is a
function of the expenditure on staff and emoluments and discretionary(optional/non-
compulsory) funds. “To the extent that pressure from the capital market and competition in
the product market is imperfect, the manager, therefore, has discretion to pursue goals other
than profits.”
The managers derive utility from a wide range of variables. For this Williamson introduces
the concept of expense preferences. It means “that managers get satisfaction from using some
of the firm’s potential profits for unnecessary spending on items from which they personally
benefit.”

13
4.Marris Growth Maximisation:
He concentrates on the proposition that modern big firms are managed by managers and the
shareholders are the owners who decide about the management of the firms.

The managers aim at the maximisation of the growth rate of the firm and the shareholders
aim at the maximisation of their dividends and share prices. To establish a link between such
a growth rate and the share prices of the firm, Marris develops a balanced growth model in
which the manager chooses a constant growth rate at which the firm’s sales, profits, assets,
etc., grow.

If he chooses a higher growth rate, he will have to spend more on advertisement and on R &
D in order to create more demand and new products.

He will, therefore, retain a higher proportion of total profits for the expansion of the firm.
Consequently, profits to be distributed to shareholders in the form of dividends will be
reduced and the share prices will fall. The threat of take-over of the firm will loom(lower)
large among the managers.

As the managers are concerned more about their job security and growth of the firm, they
will choose that growth rate which maximises the market value of shares, give satisfactory
dividends to shareholders, and avoid the take-over of the firm.

On the other hand, the owners (shareholders) also want balanced growth of the firm because
it ensures fair return on their capital. Thus, the goals of the managers may coincide with that
of owners of the firm and both try to achieve balanced growth of the firm.

5.Baumol’s Sales Maximisation:

According to Baumol, with the separation of ownership and control in modern corporations,
managers seek prestige and higher salaries by trying to expand company sales even at the
expense of profits.

Being a consultant to a number of firms, Baumol observes that when asked how their
business went last year, the business managers often respond, “Our sales were up to three

14
million dollars”. Thus, according to Baumol, revenue or sales maximisation rather than profit
maximisation is consistent with the actual behaviour of firms.

Baumol cites evidence to suggest that short-run revenue maximisation may be consistent with
long-run profit maximisation. But sales maximisation is regarded as the short-run and long-
run goal of the management. Sales maximisation is not only a means but an end in itself. He
gives a number of arguments is support of his theory. According to him, a firm attaches great
importance to the magnitude of sales and is much concerned about declining sales.

If the sales of a firm are declining, banks, creditors and the capital market are not prepared to
provide finance to it. Its own distributors and dealers might stop taking interest in it.
Consumers might not buy its products because of its unpopularity. But if sales are large, the
size of the firm expands which, in turn, means larger profits.

6.Output Maximisation:
Milton Kafolgis suggests output maximisation as the objective of a business firm. According
to him, “The performance of firms frequently is measured directly in terms of physical output
with revenue occupying a secondary position.” Thus, Kafolgis prefers output maximisation
both to profit maximisation and revenue maximisation as the objective of a firm.

Given some minimum level of profits, a firm wants to maximise its output. It will spend its
funds on increasing its production rather than on advertising. Thus, the firm will produce a
larger output and its revenue sales may be less than the sales-maximisation firm.

7.Security Profits:
Rothschild has put forward the view that the firm is motivated not by profit maximisation but
by the desire for security profits. In his words, “There is another motive which is probably of
a similar order of magnitude as the desire for maximum profits, the desire for security
profits.”
Rothschild argues that so far as the objective of profit maximisation is concerned, it is valid
only under perfect competition or monopolistic competition in which the number of firms is
very large, and the individual firm is not faced with the security problem, so is the case with
the monopoly firm.

15
But under oligopoly, a firm is not motivated by profit maximisation. It is engaged in a
constant struggle to achieve and maintain a secure position in the market like a military
strategist.

The desire to increase its security leads to the struggle for position and to the setting of a
price which will not be so low that it provokes retaliation from rivals, nor so high that it
encourages new entrants, and it must be within the range which will maintain a protection
against the aggressive policies of the rivals and brine about a reasonable profit above its cost
of production

8.Satisfaction Maximisation:
Scitovsky favours maximisation of satisfaction in preference to the profit-maximisation
objective of the firm. He is concerned with managerial effort and the distaste(dislike) that
managers have for work. According to him an entrepreneur would maximise profits only if
his choice between more income and more leisure is independent of his income. In other
words, the supply of entrepreneurship should have zero income elasticity.

But an entrepreneur does not aim at profit maximisation. He wants to maximise satisfaction
and keep his efforts and output below the level of maximum profits.

9. Gaining Customers

Customers are crucial for any business without whom the business cannot survive. They are
the ones who help you earn a profit. Gaining customers to your business is an important
exercise, and it can be achieved with a focus on the right form of marketing. The marketing
in itself has a few other objectives which would help you achieve your business goals with
ease.

10. Optimum Use of Resources

A business needs a host(store) of resources to work with. The minimum requirements for
business include raw material, machines, workforce, and other requirements. Your prime
objective as a business owner should be to make optimum use of all the resources available to
you. Any business has limited resources, and the best strategy should be to make use of these
resources to the maximum possible extent.

16
Make sure you indulge(allow) in as much innovation as possible to bring in an advanced
functionality in your business. Adapting better methods of production and taking in the
latest technology can be one of the best means of achieving this objective.

11. Contribution to Society

One of the major objectives of business should be the upliftment of society at large and
working towards the welfare of society. How about running or assisting schools and colleges
for a better level of education? Some business houses plan vocational training at schools and
colleges. This can also be helpful in getting your workforce requirements fulfilled from this
training.

Another option you can check out can be establishing the hospitals or aiding them in
providing better medical facilities. Business houses can also take part in setting up
recreational facilities like children’s parks and sporting championships.

12.Creation of Employment Opportunities

It should be one of the prime national objectives that a business needs to focus on. Setting up
new manufacturing plants, setting up a nationwide marketing network of retailers and
distributors, and expanding the business to multiple locations are some of the ways you will
be able to achieve this goal. Make sure your business creates direct or indirect
employment opportunities for the national youth.

13. Social Justice Objective

A business is expected to serve the people of the nation without any sort of prejudices and
social discrimination. The opportunities and welfare schemes provided to the employees
should remain the same irrespective of their cast, creed, religion, gender, and rank. Your
business is also expected to pay attention to the economically and socially backward sections
of the society as per the national regulations.

14. Contribution to the betterment of society

17
Another important objective you need to pay heed to is to pay your taxes and other dues
honestly. The aim should be to increase the revenue of the government so that the nation will
progress along with your business.

15. Focus on exports and reducing imports

Enhanced focus on the exports will ensure that the nation will grow self-reliant and achieve
the best results. As one of the reliable and capable businesses, your objective should focus on
the reduction in the imports and if possible, work towards enhancing the exports. Exports will
help you achieve the task of improving foreign exchange reserves.

16.Economic satisfaction of employees

Employment benefits provided by the business to the employees should be in tune with the
national guidelines. Along with the remunerations commensurate with the experience and the
government guidelines, you should also provide other benefits like provident fund and other
retirement benefits. Also, it is also expected of them to provide other efficient well-being
facilities like medical facilities, housing benefits, and similar other options.

17. Social satisfaction of employees

Another objective of a business is to focus on providing both social and psychological

satisfaction to your employees. A proper work-life balance is one of the essential elements
and goes a long way in making their work bot76h challenging and interesting. Make sure that
you have put the right candidates on the right kind of job. Make sure you provide enough
opportunities for promotion and career advancements.

Make sure you are also paying a good deal of support to the social and economically
backward sections of the society. It should also be important to note that government
guidelines expect you to pay enough attention to the people belonging to physically and
mentally challenged. Some of the initiatives that can help achieve better prospects to the
employees can range from providing training programs to the economically backward
classes.

Basic Economic Tools in Managerial Economics

18
opportunity cost

This principle is of immense use in decision-making. It can be stated as; the cost involved in
any decision consists of the sacrifices of alternatives required by that decision. If there are no
sacrifices there are no costs.

By the opportunity cost of a decision is meant the sacrifice of alternatives required by that
decision. For e.g.

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.

The opportunity cost of using a machine to produce one product is measured as the income
which could have been obtained by renting it out to somebody else. If a machine has only one
use, its opportunity cost is zero.

In the same way, the opportunity cost of the time which an entrepreneur devotes to his
business is the salary he could earn by working with some other firm of which he has
knowledge

opportunity cost requires ascertainment of sacrifices. If a decision involves no sacrifices, its

opportunity cost is nil.

Incremental Principle

The economists make a use of the incremental principle in the theories of consumption,
production pricing and distribution. In price-determination, this principle states that a firm
would maximise its profits if it equates its marginal costs to its marginal revenue. In this way,
this principle guides a business manager that he should expand his business in each direction
only so long as the incremental benefit to his firm is more than the incremental costs.

It is related to the marginal cost and marginal revenues, for economic theory. Incremental
concept involves estimating the impact of decision alternatives on costs and revenue,
emphasizing the changes in total cost and total revenue resulting from changes in prices,
products, procedures, investments or whatever may be at stake in the decisions.

The two basic components of incremental reasoning are

19
 1. Incremental cost
2. Incremental Revenue

The incremental principle may be stated as under:

“A decision is obviously a profitable one if —

 it increases revenue more than costs

 it decreases some costs to a greater extent than it increases others
 it increases some revenues more than it decreases others and
 it reduces cost more than revenues”

Principle of Time Perspective

Another principle that is the principle of time perspective is useful in decision-making in

output, prices, advertising and expansion of business. Economists distinguish between the
short run and the long run in discussing the determination of price in a given market because
in the long run a firm must cover its full cost.

On the contrary, in the short-run it can afford to ignore some of its (fixed) costs.

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”.

Discounting Principle

Generally, people consider a rupee tomorrow to be worth less than a rupee today. This is also
implied by the common saying that a bird in hand is worth two in the bush. Anybody will
prefer Rs. 100 today to Rs. 100 next year.

It can be explained as “If a decision affects costs and revenues at future dates, it is necessary
to discount those costs and revenues to obtain the present values of both before a valid
comparison of alternatives can be made”.

One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a
rupee today. Suppose a person is offered a choice to make between a gift of Rs.100/- today or
Rs.100/- next year. Naturally he will choose Rs.100/- today. This is true for two reasons-

20
 1. The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present
opportunity is not availed of
2. Even if he is sure to receive the gift in future, today’s Rs.100/- can be invested so as
to earn interest say as 8% so that one year after Rs.100/- will become 108

Equi – Marginal Principle

This principle states that an input should be allocated in such a way that the value added by
the last unit of the input is the same in all its uses. This generalized law is known as the equi-
marginal principle.

This principle deals with the allocation of an available resource among the alternative
activities. According to this principle, an input should be so allocated that the value added by
the last unit is the same in all cases. This generalization is called the equi marginal principle.

Let us suppose that a firm has got two workers to employ in three activities, say production of
bottled milk, butter, and cheese. The firm must allocate these workers in such a way that the
marginal productivity of the last worker employed in each of these activities is the same.

To put it in more clear way, if the marginal worker given the duty of producing bottled milk,
adds output worth Rs. 20. Then the marginal worker employed on butter and cheese
production must also earn neither more nor less than Rs. 20 for the milk plant.

21