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BASIC TRAINING

DIAGRAMMATICAL REPRESENTATION OF RELATIONSHIP BETWEEN ECONOMICS, MANAGEMENT & MANAGERIAL ECONOMICS

• Decision making problems faced by business firms:
– • To identify the alternative courses of action of achieving given objectives. – • To select the course of action that achieves the objectives in the economically most efficient way. – • To implement the selected course of action in a right way to achieve the business objectives.

SCARCITY- COUNTRY & FIRM PERSPECTIVE
• COUNTRY
– What to produce- products – How to produce- choice of technology – For whom to produce- distribution of goods & services

• FIRM
– What- product decision – How- hiring, staffing, procurement, capital budgeting decisions – For whom- market segmentation decisions

PRODUCTION POSSIBILITIES CURVE
GUNS

GUNS 0 20 40 60 80 100 120

BUTTER 210 207 198 186 168 144 119

O

BUTTER

140 160 175

82 42 0

BASIC PRINCIPLES
• • • • • • • • • Accounting cost/profit versus economic cost/profit Opportunity cost principle Principle of time perspective Discounting & Compounding principle Functional relationships- TP(TR/ TC), MP(MR/ MC), AP (AR/ AC) Economic models Economic optimisation Marginal & Incremental principle Equi-marginal principle

ACCOUNTING COST/PROFIT VERSUS ECONOMIC COST/PROFIT
• Video

• Accounting profit = total revenue – total cost (explicit cost)
• Economic Profit = total revenue – total economic costs • = total revenue – (explicit costs + implicit costs) • Explicit costs= monetary payment to resource owners • Implicit costs= returns foregone by not taking owner’s resource to market

• Excercises PLJ pg. 15, 21.

OPPORTUNITY COST PRINCIPLE
• Video • To get something it costs the opportunity to do something else. The foregone alternative is opportunity cost • Next alternative that could be produced instead by the same factors, costing the same amount of money • Amount or subjective value that must be sacrificed in choosing one activity over the next-best alternative

OPPORTUNITY COST: SELF EXERCISE
• • • • • • Opportunity cost of attending this lecture…….. OC of living in own house…….. OC of investing your money in business….. OC of producing a product……. OC of doing PGDM from here……… OC of lending money to your friend……..

PRINCIPLE OF TIME PERSPECTIVE
• Temporary run analysis: constraints are rigidly fixed & pegged
• Short run analysis: some constraints are variable & some are fixed • Long run analysis: all constraints are variable & adjustable

FACTORS TIME PRSPCTV TEMPORARY RUN

LEVEL OF O/P

NATURE OF I/P

Χ

Χ

SHORT RUN
LONG RUN


Χ

DISCOUNTING PRINCIPLE (1)
• A rupee now is worth more than a rupee a year after. Example: One may ask how much money today would be equivalent to Rs 100 a year from now if the rate of interest is 5%. The present value of Rs 100 to be received after one year is: PV = Rs 100/1+i = Rs 100/1.05 = Rs 95.24

DISCOUNTING PRINCIPLE (1)
Money has time value: earning power (earn at least an interest rate), changing prices (demanded due to its purchasing power which is inversely related to price) & uncertainty (certainty of today’s money)

TIME VALUE OF MONEY
Present value (PV) of an amount (FV) to be received at the end of “n” periods when the per-period interest rate is “i”:

FV PV  n 1  i 

PRESENT VALUE OF A SERIES
Present value of a stream of future amounts (FVt) received at the end of each period for “n” periods:

FV1 FV2 FVn PV  1  2  ... n  1  i  1  i  1  i 

NET PRESENT VALUE
• Suppose a manager can purchase a stream of future receipts (FVt ) by spending “C0” rupees today. The NPV of such a decision is:

FV1 FV2 FVn NPV   C0  1  2  ... n 1  i  1  i  1  i 
NPV < 0: Reject NPV > 0: Accept

EXAMPLE An investment costs Rs 100 lakhs this year and is expected to yield net returns of Rs 30 lakhs, 40 lakhs & 60 lakhs in the next three years respectively. Assuming that the interest cost of money is 10%, calculate the Net Present Value.

30
(1 + .1)

+

40

+

60 –
(1 + .1)3

100

(1 + .1)2

= Rs 6.51 lakhs Investment is desirable

COMPOUNDING PRINCIPLE Future/ compound values of cash flows are calculated at a given rate of return at the end of a given period of time

 PV (1 + i)n FV

EXAMPLE
What will be the FV of Rs 7500 deposited today at 10% interest for 20 years FV = 7500 (1.10)20 = 50456

FUNCTIONAL RELATIONSHIPS: TOTAL, AVERAGE AND MARGINAL
• Handout • Exercise pg. 45, 46. • Total Product - total number of goods produced during a specified period of time using a particular input • Average product - the average output per unit of input used AP = TP / L • Marginal product - is the change in the TP corresponding to one unit change in the input.

MP = D TP / D L

Number of Total Average Marginal Workers Product Product Product (L) (Q) (AP) (MP) 0 0 0 0 1 2 2.0 2 2 5 2.5 3 3 9 3.0 4 4 14 3.5 5 5 22 4.4 8 6 40 6.7 18 7 57 8.1 17 8 63 7.9 6 9 64 7.1 1 10 63 6.3 -1

Number of Total Average Marginal Workers Product Product Product (L) (Q) (AP) (MP) 0 0 0 0 1 2 2.0 2 2 5 2.5 3 3 9 3.0 4 4 14 3.5 5 5 22 4.4 8 6 40 6.7 18 7 57 8.1 17 8 63 7.9 6 9 64 7.1 1 10 63 6.3 -1

Number of Total Average Marginal Workers Product Product Product (L) (Q) (AP) (MP) 0 0 0 0 1 2 2.0 2 2 5 2.5 3 3 9 3.0 4 4 14 3.5 5 5 22 4.4 8 6 40 6.7 18 7 57 8.1 17 8 63 7.9 6 9 64 7.1 1 10 63 6.3 -1

ECONOMIC MODELS
• Handout • Exercise PLJ pg. 38, 45

ECONOMIC OPTIMISATION
• Handout • Excercises PLJ pg. 47, 48, 62, 63 RULES: MAXIMISATION: • I Differentiation: 0 • II Differentiation: negative MINIMISATION: • I Differentiation: 0 • II Differentiation: Positive

EXCERCISE
Given TR function: TR = 50 Q – 0.5 Q2 & TC function: TC = 2000 + 200Q – 0.2 Q2 + 0.001 Q3 Find MR & MC functions

EXCERCISE
Given the following demand and cost functions for Apollo Cycles: Q = 20 – P C = Q2 + 8Q + 2 Find out: Revenue maximizing level of output and prices Profit maximizing level of output and prices Maximum Revenue Maximum Profit

• • • •

(IV) MARGINAL PRINCIPLE
• Marginal refers to change (increase/ decrease) in total of any quantity due to a one unit change in its determinant • Example: marginal output of labour, marginal output of machine, marginal cost of production

INCREMENTAL PRINCIPLE (1)
• In actual business conditions, concept of marginalism replaced by incrementalism • Concerned with “chunk changes” & not “unit change” Example: in a construction project, the labour which a contractor may change is not by one • Incremental cost (IC): change in cost with change in output • Incremental revenue (IR): change in revenue with change in output

INCREMENTAL PRINCIPLE (2)
Decision would be profitable if:  It increases revenue more than cost  Decreases cost to a greater extent than the decline in revenue

(V) EQUI-MARGINAL PRINCIPLE (1)
• Deals with allocation of available resources among alternative activities • An I/P should be so allocated that the value added by last unit is same in all cases

(V) EQUI-MARGINAL PRINCIPLE (2)
It states that a rational decision maker would allocate or hire his resources in such a way that the ratio of marginal returns and marginal costs of various uses of a given resource or of various resources in a given use is the same, e.g., a consumer seeking maximum utility (satisfaction) from his consumption basket will allow his consumption budget on goods and services such that MU1/MC1=MU2/MC2=......=MUn/MCn; Where, MU1 = marginal utility from product 1 MC1 = marginal cost of product 1, and so on.

(V) EQUI-MARGINAL PRINCIPLE (3)
• To maximize net benefits, managerial control variable should be increased up to the point where MB = MC • MB > MC means the last unit of the control variable increased benefits more than it increased costs • MB < MC means the last unit of the control variable increased costs more than it increased benefits

EXERCISE: FIND THE OPTIMUM COMBINATION OF GOODS WHEN 6 UNITS HAVE TO BE PURCHASED
UNITS ITEM A 1 10 MARGINAL UTILITY ITEM B 9 ITEM C 8

2
3 4

9
8 7

8
7 6

7
6 5

5
6

6
5

5
4

4
3

EXERCISE: FIND THE OPTIMUM COMBINATION OF GOODS WHEN INCOME = Rs. 19, Px= Rs 2, Py = Rs 3
Units 1 MUx 20 MUy 24

2
3 4 5 6

18
16 14 12 10

21
18 15 9 3