MANAGERIAL ECONOMICS NOTES

MBA 1stSemester

Unit- 5 By- Ruba Nasim

What Is Profit?
Profit describes the financial benefit realized when revenue generated from a business
activity exceeds the expenses, costs, and taxes involved in sustaining the activity in question.
Any profits earned funnel back to business owners, who choose to either pocket the cash or
reinvest it back into the business. Profit is calculated as total revenue less total expenses.

Profit, also called net income, is the amount of earnings that exceed expenses for the period. In
other words, it’s the amount of income left over after all the necessary and matched expenses
are subtracted for the period. Notice I didn’t say all the expenses that were paid during the
period.

A profit management strategy determines a property's net revenue after taking into
consideration costs of acquisition by channel, opportunity costs, and target audiences. These
factors should absolutely be considered as a part of any revenue management plan.

What is Profit Maximization and How to Achieve it?

Profit maximization is the capability of a business or company to earn the maximum profit
with low cost which is considered as the chief target of any business and also one of the
objectives of financial management. According to financial management, profit maximization
is the approach or process which increases the profit or Earnings per Share (EPS) of the
business. More specifically, profit maximization to optimum levels is the focal point of
investment or financing decisions.

“Profit maximization may be the ‘end’ but the means to achieve this end, is what matters, and
that distinguishes a company in the corporate world and the market.”

– Henrietta Newton Martin

 Benefits of Profit Maximization:

Profit maximization has the following benefits:

 Economic Existence:

The foundation of the profit maximization theory is profit and profit is a must for the
economic existence of any company or business.
 Performance Standard:

Profit determines the standard of performance of any business or company. When a business
is unable to make profits it fails to fulfill its chief target and causes a risk to its existence.
 Economic and Social Well-being:

Profit maximization theory indirectly plays a role in economic and social well-being. When a
business makes a profit, it utilizes and allocates resources properly which in turn results in
the payments for capital, fixed assets, labor and organization. In this way, economic and social
welfare is performed.
What Is Inflation?
Inflation is the decline of purchasing power of a given currency over time. A quantitative
estimate of the rate at which the decline in purchasing power occurs can be reflected in the
increase of an average price level of a basket of selected goods and services in an economy
over some period of time. The rise in the general level of prices, often expressed a a
percentage means that a unit of currency effectively buys less than it did in prior periods.

Inflation can be contrasted with deflation, which occurs when the purchasing power of money
increases and prices decline.

Types of Inflation

There are different types inflation which are explained below:

Creeping Inflation: This is also known as mild inflation or moderate inflation. This type of
inflation occurs when the price level persistently rises over a period of time at a mild rate.
When the rate of inflation is less than 10 per cent annually, or it is a single digit inflation
rate, it is considered to be a moderate inflation.

Galloping Inflation: If mild inflation is not checked and if it is uncontrollable, it may

assume the character of galloping inflation. Inflation in the double or triple digit range of
20, 100 or 200 percent a year is called galloping inflation . Many Latin American countries
such as Argentina, Brazil had inflation rates of 50 to 700 percent per year in the 1970s and
1980s.

Hyperinflation: It is a stage of very high rate of inflation. While economies seem to survive
under galloping inflation, a third and deadly strain takes hold when the cancer of
hyperinflation strikes. Nothing good can be said about a market economy in which prices
are rising a million or even a trillion percent per year . Hyperinflation occurs when the
prices go out of control and the monetary authorities are unable to impose any check on it.
Germany had witnessed hyperinflation in 1920’s.

Stagflation: It is an economic situation in which inflation and economic stagnation or

recession occur simultaneously and remain unchecked for a period of time. Stagflation was
witnessed by developed countries in 1970s, when world oil prices rose dramatically.

Deflation: Deflation is the reverse of inflation. It refers to a sustained decline in the price
level of goods and services. It occurs when the annual inflation rate falls below zero percent
(a negative inflation rate), resulting in an increase in the real value of money. Japan suffered
from deflation for almost a decade in 1990s.

What are the main causes of inflation?

Inflation is a sustained rise in the general price level. Inflation can come from both the
demand and the supply-side of an economy.

Demand-pull inflation

 Demand pull inflation occurs when Aggregate Demand (AD) is growing at an

uncontrollable rate leading to pressure on resources and labour.
 When there is excess demand, producers can raise their prices and achieve
bigger profit margins
 Demand-pull inflation happens when demand of a country is higher than supply.
 What are the main causes of Demand-Pull Inflation?

1. Increases in household incomes, including wages and other earnings

2. Lower government taxes.
3. An increase in public spending.
4. An increase in the money supply.
5. Lower bank interest rates.

DEMAND PULL INFLATION DIAGRAM

Cost-push inflation

Cost-push inflation occurs when firms respond to rising costs by increasing prices in order
to protect their profit margins.
There are many reasons why costs might rise:

1. An increase in the prices of raw materials and other components, will increase the cost.
2. Rising labour costs because skilled workers become scarce and this can drive pay
levels higher.
3. Increase in government taxes will increase cost.
4. Monopoly Market where seller is the King.

What is a Break-Even Analysis?

A break-even analysis is a financial tool which helps a company to determine the stage at
which the company, or a new service or a product, will be profitable. In other words, it is a
situation of no profit and no loss.
Break-even analysis is useful in studying the relation between the variable cost, fixed cost and
revenue.
Components of Break Even Analysis
Fixed costs
Fixed costs are also called overhead costs. These are the costs that have to be paid in all
situations as they are fixed. Fixed costs include interest, taxes, salaries, rent, depreciation
costs, labour costs, energy costs etc. These costs are fixed, no matter what is the level of
production. In case of no production also the costs must be incurred.

Variable costs
Variable costs are costs that will increase or decrease with change in the production ratio.
These costs include cost of raw material, packaging cost, fuel and other costs that are directly
related to the production.