THE FUNDAMENTAL

PRINCIPLES OF
MANAGERIAL
ECONOMICS.
PRESENTED BY:
ALAN SANDEEP CASTELINO
 The most significant contribution of
economics lies in certain principles such
as,
 Opportunity cost principle.
 Incremental cost principle.
 Time perspective principle.
 Discounting principle.
 Equimarginal principle.
 Opportunity cost principle.
 This concept attributes to the alternative
uses of scarce resources.
 Both manmade and natural resources are
scarce in nature in relation to their demand
to satisfy the ever growing human needs
and the resources have alternative uses.
 EXAMPLE:

 Suppose a firm has $100 millions to

invest, and there may be three
alternatives:
1. Expansion of size of the firm.
2. Setting up of new production.
3. New unit in another locality.
 By these alternatives the firm may get annual
incomes of $20 million, $18 million, and $16
millions for first, second and third alternatives
respectively.
 Rationally thinking, the best alternative would be
the first one.
 But the $18 million has to be sacrificed expected
from second alterative to get the 20$ millions
from first alternative. This $18 million is called
annual opportunity cost of annual income of $20
million.
 Incremental cost principle.
 This principle is applied to business
decisions which involve a large increase
in total cost and revenue.
 Such increase in total cost and revenue is
called incremental cost and incremental
revenue respectively.
 Thus incremental cost can be defined as
the cost that arise due to the business
decisions taken.
 EXAMPLE:

 Suppose a firm decides to increase

production by adding a new plant to the
existing capacity or by setting up a new
production unit.
 This decision increases the firms total cost
of production from 100 million Rs to 115
million Rs. So the extra 15 million Rs due
to the business decision as called
incremental cost.
 Time perspective principle.
 Al business decisions are taken with a certain time
perspective.
 The time perspective refers to the duration of time period
extending from the relevant past and future taking in
view while taking a business decision.
 The time perspective may be short run or long run.
 For ex: decision to buy explosive material for
manufacturing crackers may be a short run time
perspective.
 The decisions for investment in plant, machinery,
building, land are long run time perspective.
 Discounting principle.

 This principle tells that the value of a rupee tomorrow

is worth less than a rupee today.
 Ex: suppose a person is offered to make a choice
between a 100 rupee today or 100 rupee next year,
naturally he will choose 100 rupees today only. This
may be because of two reasons.
1. The future is uncertain also there may be uncertainty
in getting those 100 rupees.
2. The value of 100 Rs will surely be not of the same
value as of today. Today’s 100 Rs can be invested so
as to earn interest say at 8%. So by 1 year its value
would be 108 Rs rather than getting only 100Rs.
 So naturally the first offer ill be accepted as it
gives 8 rupee extra by a year.
 The formula which gives the value of 100 rupees
after a year is

Where ,
V=present value,
i=rate of interest for a year.
 By applying the above formula the value of
100 Rs after a year at rate of 8% interest
would be 92.59%.
 Hence the discounting principle can be
stated as “if a decision affects costs and
revenues at future dates it is necessary to
discount the costs and revenues to
present values before a valid comparison
of alternative is possible”.
 Equimarginal principle.

 This concept was originally associated with the

consumption theory and the law is called the
“law of marginal utility”.
 This law was applied to the allocation a
resources between their alternative uses view to
maximizing profit in case of firm carrying out
more than one business activity.
 This principle suggests that the available
resources should be so allocated between the
alternative options that the marginal productivity
gains from the various activities are equalised.
 Say if the marginal productivity of three different
projects A, B and C are MPa, MPb and MPc
then according to this principle MPa=MPb=MPc.
 This principle suggests that a profit maximizing
firm , allocate its resources in a proportion such
that;
MPa=MPb=MPc……..MPn.
 If costs of projects (COP) varies from projects to
projects then resources are allocated in such a
way that as shown below:
MPa/COPa=MPb/COPb=MPc/COPc....MPn/COPn