You are on page 1of 9

Economic Principles

Economic theory provides a number of concepts and analytical tools which can be of considerable help to a manager in taking scientific decisions and business planning. So it is quiet help full in providing assistance to a business manager in his decision making and forward planning exercises. The basic concepts are Incremental reasoning Opportunity cost Scarcity marginalism Equi-Marginalism Time Perspective Discounting Principle Risk and Uncertainty

1. 2. 3. 4. 5. 6. 7.

Incremental concept • Incremental reasoning involves estimating the impact of decision alternatives. The two basic concepts in the incremental analysis are • Incremental cost and • Incremental Revenue .

investment etc.Incremental cost and • Incremental cost may be defined as the change in total cost as a result of change in the level of output. .

price etc.Incremental revenue • Incremental revenue is a change in total revenue resulting from a change in the level of out put. While taking a decision a manager always determines worth whileness of a decision on the basis of the criterion that the incremental revenue should exceed incremental cost. .

suppose that a firm is considering whether or not to install a new plant.18 million.15 million and incremental revenue of Rs.• Incremental reasoning is used in accepting or rejecting a business option. The firm will accept the proposition of installing a new plant.3 million which means a 20 per cent return on investment in the new plant. . The firm estimates an incremental cost of installing a new plant at Rs. • For instance. provided there is no better business proposition available to the firm. The incremental revenue exceeds the incremental cost by Rs.

• However. it may reject the proposition to install a new plant for in that case its rate of return would fall to 10 per cent. The firm may find it advisable to put its money in ICICI or IDBI bonds at 12.5 million on advertisement to sell the output from the new plant.5 percent annual return . is the firm finds that it will be required to spend an additional amount of Rs.1.

.

Marginal Principle • The term ‘Marginal’ refers to the change (increase or decrease) in the total of any quantity due to a one-unit change in its determinant. marginal cost (MC) can be defined as the total change in total cost as a result of producing one unit less of a commodity. the total cost of production of a commodity depends on the number of units produced. In this case. . For instance.

IN fact. profit is maximum where MR = MC. • The decision rule under the marginal principle is that a business activity must be carried out so long as its MR > MC. economists use the marginality principle to set a necessary condition for profit maximization. If a one unit increase in output results in an increase in cost from Rs 100 to 150 and an increase in revenue from Rs 200 to 215.• For example. the marginal cost is Rs 10 and the marginal revenue is Rs 15. that is. The necessary condition for profit maximization is that MC must be equal to MR. .