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MANAGERIAL ECONOMICS

Introduction UNIT - 1

What is Managerial Economics?


Douglas - Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization. Pappas & Hirschey - Managerial economics applies economic theory and methods to business and administrative decision-making. Salvatore - Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.

What is Managerial Economics?


Howard Davies and Pun-Lee Lam It is the application of economic analysis to business problems; it has its origin in theoretical microeconomics.

Type of Economic Analysis:

Micro & Macro economics


Positive & Normative Economics Short run and Long run

Partial & General equilibrium. 4

Micro Economics:

Micro means small (looks at the smaller picture of the economy) It is the study of behaviour of small economic units, such as that of an individual consumer, a seller (or a producer, or a firm), or a product. It focuses on the basic theories of supply & demand in individual markets (cars, food items, mobile phones etc) Micro economics analyses the market behaviour of individual consumers & firms, in an attempt to understand their decision making 5 processes.

Macro Economics:

Macro means large, it is the branch of economic analysis, that deals with the study of aggregates. We study the industry as a unit and not the firm. We talk about aggregate demand & aggregate supply, national income, national capital formation, employment, inflation etc.,
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Short Run and Long Run:

Short run is a time period not enough for consumers and producers to adjust completely to any new situation. Long run is a planning horizon in which consumers and producers can adjust to any new situation

Partial and General Equilibrium:

Equilibrium is a state of balance that can occur in a model. The intersection of the supply and demand curves is the point that maximises both profit and utility.

What is the purpose of economic analysis?


Why do we want to apply economic analysis to business problems?
For the academic economist: to understand, to make predictions about firms behavior The positive approach to theory: What is? For the businessperson: to assist decision-making, to provide decision-rules which can be applied The normative approach to theory: What should be?

SCOPE OF MANAGERIAL ECONOMICS:

I. Managerial Economics Is it positive or normative?

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Positive Economics:

It establishes a relationship between cause and effect, It analyses problems on the basis of facts, For example this theory might describe the probable effect of an increase in price of petroleum on the price of cars, but it would not provide any instruction on what policy should be followed.
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Normative Economics

It is concerned with questions involving value judgements; It looks at the desirability of certain aspects of the economy, say inflation as better than deflation, redistribution of wealth in the economy, etc., It is what ought to be in economic matters, as opposed to what is in positive economics.
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II. Managerial economics deals with the following topics:

Demand analysis and forecasting Cost & production analysis Pricing decisions, policies and practices Profit management Capital management Linear programming & theory of Games
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Demand analysis & forecasting:

Accurate estimation of demand by analysing the forces acting on demand of the product produced by the firm. Demand analysis attempts at finding out the forces determining the sales. This has two main managerial purposes:
Forecasting sales, & manipulating demand

The demand analysis covers topics


Demand determinants, Demand distinctions and Demand forecasting
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Cost & Production analysis:

Production analysis deals with physical terms of the product, while cost analysis deals with monetary terms. Cost analysis is concerned with cost concepts, cost-output relations, economies of scale, production function and cost control.
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Pricing Decisions, policies & practices:

The success or failure of a firm mainly depends on accurate price decisions to effectively compete in the market. The important aspects under this are:
Price determination under market conditions, Pricing methods & policies, Product-line pricing And price forecasting

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Profit Management:

Profit management, profit policies and techniques, profit planning like breakeven analysis are studied under this category.

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Capital management:

Capital management deals with planning and control of capital expenditure, cost of capital, rate of return and selection of project, etc.

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Linear programming and Theory of Games:

Its a integration of managerial economics and Operations Research

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III Profits:

The maximisation of profits is the main objective of any firm and the survival of the firm depends on the profits it earns. Profit is the main indicator of firms success.

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IV. Optimisation:

Important concept used in Managerial Economics is Optimisation. This aims at optimising a given objective.

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V. Relationship or Managerial Economics with other Disciplines

ME is closely related to other subjects like


Micro economic theory, Macro economic theory, Mathematics, Statistics, Accounting, Decision making & operations
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Micro-economics applied to internal issues : Operational issues are of internal nature. Internal issues include all those problems which arise within the business organization and fall within purview and control of the management .Some of the basic internal issues are : What to produce

How much to produce


Choice of technology i.e. choosing of the factor combination Choice of price i.e. how to price the commodity How to promote sales
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How to face the price competition

How to decide on new investments How to manage capital and profit How to manage inventory i.e. stock of both finished goods and raw material Most of the micro economic problems deals with most of these questions.

The Law Demand


The Theory of Production

Analysis of Market Structure and Pricing


Theory
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Profit analysis and management


It guide firms in the measurement and management of profit , in making new allowances for the risk premium, in calculating the pure return on capital and pure profit and also for future planning.

Theory of Capital and Investment Decisions


Knowledge of capital theory can contribute a

great deal in investment-decision making, choice of


projects, maintaining the capital, capital budjeting etc.
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Macro-economics deals with external issues : The type of economic system in the country General trends in N.I., employment, prices, savings and investments Structural change in the working financial institutions viz., banks, insurance companies etc Magnitude of and trends in foreign trade

Trends in labour supply and strength of capital market


Governments economic policies i.e., industrial, monetary, fiscal, price and foreign etc.
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Social factors viz., value system of the society, property rights, customs and habits etc., Political environment i.e., democratic, authoritarian,

socialist political systems, or state attitude towards


private business man etc.

These Environmental factors have a far-reaching


bearing upon the functioning and performance of the firms. Therefore, decision makers have to take in to account the present and future economic, political and social
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Conditions in the country and give due consideration


to the environmental factors in the process of decision

making.
Eg : SEZ in the Nandigram, Tatas small car in Singur district in West Bengal

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Core topics of ME

Demand function & Estimation Demand Elasticity Demand Forecasting Production Function and Laws Cost Analysis Pricing & Output Determination Pricing policies & Practices Profit Planning & management Project Planning Capital Budgeting Break-Even Analysis Linear Programming Game theory
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Role of a managerial economist in the firm


Demand estimation and forecasting Preparation of business /sales forecasts Analysis of market survey to determine

the nature and extent of competition


Analyzing the issues and problems of

concerned industry

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Assisting the business planning process of


the firm

Discovering new possible fields of


business endeavor and its cost-benefit

analysis
Advising on prices, investment and capital budgeting policies Evaluation of capital budgeting etc.
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DECISION MAKING AREAS


Business decision making is influenced not only by

economic considerations, but also by human


behavioral, technological and environmental factors due to growing public awareness. Decision making and processing information are two important tasks of managers In order to make good decisions managers must be able to obtain, process and use information.
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Decision Making Areas

Demand forecasti ng

Producti on plannin g and cost revenue decision

Study of econo mic environ ment

Pricing and related decisio ns

Invest ment decisi ons

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DEMAND FORECASTING
QUALITATIVE
CONSUMER SURVEY JURY OF EXPERT OPINION
TIMESERIES METHODS

QUANTITATIVE

SALESFORCE COMPOSITE METHOD


DELPHI METHOD

CAUSAL METHODS

NOMINAL GROUP METHOD

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PRODUCTION PLANNING AND COST REVENUE DECISIONS Production Function : The production function is a technological relationship between output and various inputs used

in production viz., land, labour, capital and


technology.

The output depends on the increasing function of


all the factor inputs Q=f(S,L,K,T)
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The following types of cost are useful in the


decision areas

Average, Marginal and Total Costs


Fixed and Variable Cost

Direct and Indirect Cost


Replacement and Original Cost

Opportunity and Industrial Cost


Sunk Cost and Outlay Cost
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STUDY OF ECONOMIC ENVIORNMENT


Economic environment is the most significant component of the business environment. It affects the survival and success of a business organization.

Economic environment

General conditions

Industrial conditions

Stage of supply of resources of production


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PRICING AND RELATED DECISIONS


The Price-output decisions are taken under various market structures. The structure of the market refers to the degree of competition in the market for the firms goods and services.

Perfect competition Monopoly market

Market

Monopolistic market Oligopoly market


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INVESTMENT DECISION
Business firms invest large money in their

projects. Therefore, capital expenditure for


different project proposals compete within

themselves for their claim on scarce resources.


Generally , in business sector itself, individual

firms compete against access to financial


resources and scarce.
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STEPS IN DECISION MAKING


Managerial economics is concerned with decision making at the level of firm. These decisions have far reaching effects on the firm. Delay in taking

decisions or implementing decisions might turn in


to losses. Various steps in the decision making by a business firm are as fallows :
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Defining business problem Determining objective Exploring available alternatives Assessing consequences of various alternatives

Choosing best alternative

Performing sensitive analysis

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