Managerial Economics

Introduction

Economics
The economics derived from the Greek word

(Oikos: “a house” & nomos: manager) means a prudent management of once house hold affairs . But, it has now come to mean the study of business affairs in general. So can say economics is study of managing maximum gains out of scarce resources

Management + Economics

Definition
“Managerial economics is concerned with the application of economic principles and methodologies to the decision process with in the organization .it seeks to establish rules and principles to facilitate the attainment of the desired economic goals of management.”
- douglas

Key points of definition
• Decision making • Economic methodology • Economic goals of firm

Decision making

It is the process of selecting best out of alternative opportunities open to the firm.

Economic methodology

It is a relation between ideas , thoughts , intuitions & experience with economic tools& techniques .

Economic goals of firm
In the nutshell it is making maximum gains out of available resources

Scopes of managerial economics

• Micro – when something is concerned with individual (person firm or household) • Macro – something related to the environment as a whole

Micro economic theories
• Operational issues
. Theory of production . Theory of price determination . Theory of profit & capital budgeting . Theory of demand

Macro economic theories
• Environment or external issues
• Theories of national income • Theories of economic growth & fluctuations • Theories of national trade &monitory mechanism • Theories of government policies

Why do managers need to know managerial economics?
• • • • What to produce? How to produce? For whom to produce? How much to produce? so that can organization generate maximum gains. & economics has the ans to all these problems

But economic theories are too theoretical to applied directly to the business decision making but when knowledge logic & analytical tools are added to these theories it becomes managerial economics which helps the manager in rational business decision making.

Objectives of business firm

“Profit”
As a sole objective

Profit
Different things to different people Example- commission salary fees , ect

In economic terms profit means pure profit or economic profit
• Economic profit - It is difference between actual earning & opportunity cost • Opportunity cost – it is the expected income forgone form second best alternative

Profit theories

Theory of rent
by , prof. F.A. walker

“profit is the rent of ability” Rent – remuneration for the use of land to land lord Profit – reward for ability of entrepreneur

According to professor walker
As rent is the difference between least & the most fertile land similarly, profit is the difference between earnings of the least & the most efficient entrepreneurs

Criticism
- Rent & profit are not similar
. rent is always positive . profit is positive as well as negative

- Absence of marginal entrepreneur - profit is not the rent of ability

Dynamic theory
by , prof. J.B.clark

According to clark – profit arises in a dynamic economy not in static .

Criticism
• All economies are dynamic • Profit is not the result of each change • Theory ignores uncertainty & risk taking

Theory of risk
By , Prof. Hawley

“NO RISK NO GAIN”

Criticism
• All risk do not lead to profits • Profit is to avoid risk • There is no direct relationship between risk & profit

Theory of innovation
by, prof. schumpeter

Profit is reward for innovation

Theory of uncertainty bearing
by, prof. knight

“Profit is the reward for uncertainties bearing”

Criticism
• uncertainty is not measurable • Profit is not the reward for uncertainty bearing only

Other business objectives
• • • • • Sales revenue maximization Maximization of firms growth rate Consumer satisfaction Long run survival Entry prevention

Consumer behavior :Utility

Meaning
“ utility is want satisfying power of commodity’’

Characteristics: • Utility is subjective/not measurable • Utility is variable • Utility is different from usefulness • No legal or moral connotations

Total utility
It is sum of the utility derived by the consumer from the number of units of goods & services he consumed.
Tun = Ux + Uy + Uz

No. of units consumed

Total utility

total utility 70 60 50 40 30 20 10 0 1 2 3 4 total utility 5 6

1 2 3 4 5 6

30 50 60 65 60 45

MARGINAL UTILITY
It is the change in total utility obtained from the consumption of additional unit of commodity .

MU = change in TU
change in Q

no.of units
consumed

Total utility Marginal utility

70 60 50 40 30 20 10 0 -10 -20 1 2 3 4 5 6 total utility marginal utility

1 2 3 4 5 6

30 50 60 65 60 45

30 20 10 5 -5 -15

Law of diminishing marginal utility As the quantity consumed of a commodity increases , the utility derived from each successive unit decreases , consumption of all other commodities remaining the same.

No. of units consumed

Marginal utility

marginal utility 35 30 25 20 15 10 5 0 -5 -10 -15 -20

1 2 3 4 5 6

30 20 10 5 -5 -15

marginal utility 1 2 3 4 5 6

Assumption
• No small units are consumed • Taste & preference remain same • There must be continuity in consumption • Consumer should be of sound mental health

Consumer’s Equilibrium
• Consumer will attain its equilibrium (maximum satisfaction) at the point, where marginal utility of a product divided by the marginal utility of a rupee, is equal to the price.
• Consumer’s equilibrium = Marginal utility of a product Marginal utility of a rupee

= its price

Steps:
• Generation of alternatives • Evaluation of alternatives • Choice of the best alternative

Assumptions:
• Consumer behaviour is rational. • Consumer behaviour is consistent. • There are two commodities in consideration.

Law of Equi-Marginal Utility
• This law states that the consumer maximizing his total utility will allocate his income among various commodities in such a way that his marginal utility of the last rupee spent on each commodity is equal. • Or • The consumer will spend his money income on different goods in such a way that marginal utility of each good

Limitations of Law of EquiMarginal Utility
• #
It is difficult for the consumer to know the marginal utilities from different commodities because utility cannot be measured.

• # Consumer are ignorant and therefore are not in a position to arrive at an equilibrium. • # It does not apply to indivisible and inexpensive

commodity.

The Budget Constraint, or Budget Line

Part of an Indifference Map

An Indifference Curve

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