ECONOMICS FOR BUSINESS

DECISIONS
Introduction to Managerial Economics
Module -1
 Reasons For Studying Economics
 It is a study of society and as such is extremely important.

 It trains the mind and enables one to think systematically about the problems of

business and wealth.

•From a study of the subject it is possible to

predict economic trends with some
precision.

•It helps one to choose from various

economic alternatives.
 Few Definitions
Economics is a social science that deals with the society as a whole
and human behaviour in particular , and studies the production,
distribution and consumption of goods and services..

Resources are simply anything used to produce a good or service to

achieve a goal.

A Manager is a person who directs resources

to achieve a stated goal
He/she has the responsibility for his/her own
actions as well as for the actions of individuals,
machines and other inputs under the manager’s
control.
 Broad categories of Economics
Micro economics

Focuses on the behaviour of the

individuals, firms and their interaction
in markets.

Macro economics
It is related to issues such as determination
of national income, savings, investment,

Employment at aggregate levels, tax

collection, government expenditure,
foreign trade, money Supply etc.
 Managerial Economics

“Managerial economics is concerned with the

application of economic concepts and
economic analysis to the problems of
formulating rational managerial decisions.

Managerial economics is the study of how scarce resources are directed

most efficiently to achieve managerial goals. It is a valuable tool for
analyzing business situations to take better decisions.
 Managerial Economics

Prof. Evan J Douglas defines Managerial Economics as “Managerial

Economics is concerned with the application of economic principles and
methodologies to the decision making process within the firm or
organization under the conditions of uncertainty”

According to Milton H Spencer and Louis Siegelman “Managerial

Economics is the integration of economic theory with business
practices for the purpose of facilitating decision making and
forward planning by management”
 Nature of Managerial Economics
 Managerial economics is concerned with the analysis of finding optimal

solutions to decision making problems of businesses/ firms (micro economic in

nature).
 Managerial economics is a practical subject therefore it is pragmatic.

 Managerial economics describes, what is the observed economic phenomenon

(positive economics) and prescribes what ought to be (normative economics)

 Managerial economics is based on strong economic concepts. (conceptual in

nature)
 Managerial economics analyses the problems of the firms in the perspective of

the economy as a whole ( macro in nature)

 It helps to find optimal solution to the business problems (problem solving)
 Types of economic analysis
1. Micro and Macro
Microeconomics (“micro” meaning small) looks at the smaller picture of
the economy and is the study of the behaviour of small economic units.

Macroeconomics (“macro” meaning large) is that branch of

economic analysis that deals with the study of aggregates.
 Types of economic analysis
2. Positive and normative

Positive statements are factual by nature; Positive economics establishes a

relationship between cause and effect. It is “what is” in economic matters.

Normative statements involve some

degree of value judgment, and cannot be
verified by empirical study or logic.
Normative economics is concerned with
questions involving value judgments. It is
“what ought to be” in economic matters.

e.g.
•The distribution of income in India is unequal.
• The distribution of income in India should be
equal
 Types of economic analysis
3. Short Run and long Run
 Short run is a time period not enough for consumers and producers to adjust
completely to any new situation.
 the analysis is focused on a planning period in which some input is fixed and others
are variable. Thus, the manager has to select different levels of the variable input to
combine with the fixed input, in order to optimise the level of production e.g.
Capital – fixed and Labour - variable

•A long run is a “planning horizon” in which consumers and producers

can adjust to any new situation.
•all inputs can be varied. Thus, in the long run, the managerial economist
deals with decisions of whether to adjust capacity; whether to introduce
a larger plant or continue with the existing one; whether to change
product lines, and so on.
 Types of economic analysis
3. Partial and General Equilibrium

 Partial equilibrium analysis studies

the internal outcome of any policy
action in a single market only

•General equilibrium analysis

explains economic phenomena
in an economy as a whole.
 Fundamental Economic Problems
1. What to produce?

 Which goods and in what quantities

 Capital Goods or Consumer Goods
 Resource allocation between consumer
goods and capital goods
 Specific quantity of each type of capital good and
each type of consumer goods
 Fundamental Economic Problems
2. How to produce?
 What combination of resources a society
decides to produce goods i.e. technique
of production.
 Problem of Efficiency

3. For Whom to produce?

 How the national product is to be
distributed among the members of the
society.
 In market economy -on Basis of “Ability
to Pay”
 In command economy- according to need
 Fundamental Economic Problems
4. Are the Recourses Utilised
Economically
 Resources needs to be economically
employed
 Deals with welfare economics
 Explains how socially efficient
allocation of resources can be
identified and achieved

5. Are the resources fully employed?

 Society must endeavour to achieve the
fullest possible use of its available
resources.
 Fundamental Economic Problems
6. Is the Economy Growing
 Economy seeks to grow to improve standard of living

 Growing economy can have more of everything than less of anything

 Major sources of growth are

 Growth of Labour Force

 Capital formation

 Technological progress
 Economic Principles relevant to managerial decisions
I. Concept of Scarcity

 Human wants are unlimited, but human

capacity to satisfy such wants is limited

 Resources available to the firm are limited,

and the managers of the firm need to
optimally utilise them

 In view of the scarcity of resources and

multiplicity of needs, the economic
problem lies in making the best possible
use of resources so as to get maximum
satisfaction or maximum output.
Economic Principles relevant to managerial decisions
II. Concept of Opportunity Cost
 The managerial economist has to make
rational choices in all aspects of business
by sacrificing some of the alternatives,
since resources are scarce and wants are
unlimited.
 Opportunity cost is the benefit forgone
from the next best alternative that is not
selected.
 A firm may even have to make a choice between quantity and quality. It
may commit itself to quality (and hence, remain restricted to a small
customer base) by selling its product at high price (such a pricing is often
regarded as market skimming pricing), or it may compromise on quality
and lower the price in order to capture a larger market (such a pricing is
often regarded as market penetration pricing).
Economic Principles relevant to managerial decisions
III. Production Possibility Curve
 Production Possibilities Curve is a graph that shows the different
combinations of the quantities of two goods that can be produced (or
consumed) in an economy, subject to limited availability of resources

IV. Concept of Margin and Increment

• The concept of marginality deals with a unit increase in cost or
revenue or utility.
• According to this concept, Marginal Cost (or Revenue or Utility) is the
change in Total Cost (or Total Revenue or Total Utility) due to a unit
change in output. In other words, Marginal Cost (or Marginal Revenue
or Marginal Utility) is the Total Cost (or Total Revenue or Total
Utility) of the last (or nth.) unit (of output). Thus, we may express
Marginal Cost (MC) as:
MCn = TCn – TCn–1 or change in TC/Change in TO
Economic Principles relevant to managerial decisions
V.Discounting Principle
 Discounting principle refers to time value
for money and  explains about the
comparison of money value in present and
future time.
 Businesses need to bother about
discounting because most business
decisions relate to outflow and inflow of
money and resources that take place at
different points of time.

Example:
If person is given option to take 100/- as a gift for today.
or
If person is given option to take 100/- as a gift after one month.
Normally a person chooses first offer only. Why because “today rupee is having
more worth than tomorrows rupee”
Economic Principles relevant to managerial decisions
Application of discounting principle in business:
Example 1:
 In the business, everybody prefers to do cash sale only rather than the
credit sale and even they are ready to give cash discount for cash sale.
The reason is we will get a rupee today and today’s rupee is more
valuable than the tomorrow’s rupee. But In credit sale we will get rupee
tomorrow or in the future time and nobody give the discount for credit
sale.
Example 2:
 We commonly see bank and postal departments adverting that they will
give 12% interest for every year on bank deposits what we have invested
with them. With this 12% interest for one year, if we want to get 1-lakh
rupees after one year, how much we should deposit at present? This
question is answered by discounting principle.
FV=PV*(1+r)t or PV=FV/(1+r)t
Relation of Managerial economics with decision
Sciences
 QUIZ - 1

 Positive statements are................. in nature.

 Economic resources are scarce and needs are ....................

 Capital as an input is fixed in the ................

 The subject of economics is:
a. A physical science b. A natural science
c. An exact science d. A social science

 A long run is a time period:

a. Long enough for consumers and producers to adjust to any new
situation.
b. In which industrial capacity is assumed to be given.
c. All factors are fixed.
d. Technology is given

 The study of unemployment is a part of

a. Normative economics b. Microeconomics
c. Macroeconomics d. Descriptive economics
 Circular Flow of Activity
The all pervasive economic problem is that of scarcity which is solved by
three institutions (or decision-making agents) of an economy. They are:

 Households (or individuals)

 Firms

 Government

These decision-makers act and react in such a manner that all economic
activities move in a circular flow.
 Circular Flow of Activity
Households:
 Households are consumers. They may be
single-individuals or group of consumers
taking a joint decision regarding consumption.
They may also be families. Their ultimate aim
is to satisfy the wants of their members with
their limited budgets.

Households are the owners of factors of production—land, labour,

capital and entrepreneurial ability. They sell the services of these
factors and receive income in return in the form of rent, wages, and
interest and profit respectively.
 Circular Flow of Activity
Firms:
 The term firm is used interchangeably with
the term producer in economics.

 The decision to manufacture goods and

services is taken by a firm.

 For this purpose, it employs factors of production and makes payments to

their owners. Just as household’s consumer goods and services to satisfy their
wants, similarly firms produce goods and services to make a profit.
 Circular Flow of Activity
 Government:
The government plays a key role in all types
of economic systems—capitalist, socialist
and mixed.
 In a capitalist economy, the government
does not interfere. It simply establishes
and protects property rights. It sets
standards for weights and measures, and
the monetary system.

 In a socialist economy, the role of the government is very extensive. It

owns and regulates the entire production and consumption processes of
the economy, and fixes prices of goods and services.
 In a mixed economy, the government strengthens the market system.
 Production, consumption and exchange are the three main activities of

the economy.
 Consumption and production are flows which operate simultaneously and

are interrelated and interdependent.

 Production leads to consumption and consumption necessitates

production.

 In other words, production is a means (beginning) and consumption is the

end of all economic activities.

 Both production and consumption, in turn, depend upon exchange.

 Thus these two flows are interrelated and interdependent through

exchange.
Circular Flow of Activity in two sector
economy
 Circular Flow of Activity in two sector
economy
 Consumers or households own all the factors of production, that is, land,
labour, capital and entrepreneurship, which are also called productive
resources. They sell them to firms for producing goods and services.

 In the diagram, the sale of goods and services by firms to consumers in

the product market is shown in the lower portion of the inner circle from
left to right; and the sale of their services to firms by households or
consumers in the factor market is shown in the upper portion of the inner
circle from right to left. These are the real flows of goods and services
from firms to consumers which are linked with productive resources from
consumers to firms through the medium of exchange or barter.
 Circular Flow of Activity in two sector economy
 In a modem economy, exchange takes place through financial flows
which move in the reverse direction to the “real” flows. The purchase of
goods and services in the product market by consumers is their
consumption expenditure which becomes the revenue of the firms and is
shown in the outer circle of the lower portion from right to left in the
diagram.
 The expenditure of firms in buying productive resources in the factor
market from the consumers becomes the incomes of households, which is
shown in the outer circle of the upper portion from left to right in the
diagram.
The Circular Flow in a Three-Sector Economy
The Circular Flow in a Four-Sector Economy
Leakages (withdrawals) from the circular flow
 Not all income will flow from households to businesses directly. The circular flow
shows that some part of household income will be:
 Put aside for future spending, i.e. savings (S) in banks accounts and other types of
deposit
 Paid to the government in taxation (T) e.g. income tax and national insurance
 Spent on foreign-made goods and services, i.e. imports (M) which flow into the
economy

Injections into the circular flow 

 Capital spending by firms, i.e. investment expenditure (I) e.g. on new technology
 The government, i.e. government expenditure (G) e.g. on the NHS or defence
 Overseas consumers buying UK goods and service, i.e. UK export expenditure (X)

An economy is in equilibrium when the rate of injections = the rate of

withdrawals from the circular flow.
 Theory of Firm
Firms: A firm is an entity that draws various types of factors of production
in different amounts from the economy, and converts them into desirable
output(s), through a process with the help of suitable technology.

There are five factors of production, namely:

 land,
 labour
 capital
 enterprise
 organisation
 Organization of the Firm

1. Level of vertical integration:

When a firm relies on itself rather than others (i.e. purchases from the
market) to produce an input.

Reasons for vertical integration

 To do things right
 Lower transactions costs
 Secure supply of an input
 Ensure quality
 Avoid government restrictions, regulations or taxes
 Exploit market power
 Organization of the Firm

2. Internal Organization:
 Organization of management – chain of control, who reports to whom
 Functional separation: separate divisions for each activity of production
such as (1) production, (2) transportation, (3)sales
 Divisional separation: divisions based on the outputs produced rather than
the activity. E.g. Time Warner books/magazines/television/music
 Compensation/incentive system: Straight salary based on hours, piece -
rate compensation, % of sales (commission) above a certain threshold,
equity stake (stock ownership).
The compensation system can
(1) increase output, (2) increase productivity, (3) decrease internal
monitoring costs.
 Organization of the Firm

3. Forms of ownership
Ownership is always measured from the point of view of investors (entrepreneurs). Based
on this concept, we may divide business organisations into three broad categories:

Forms of Ownership

Private Sector Joint Sector Public Sector

Individual Collective Company Corporation Department

Proprietorship
Partnership Company Cooperative
 Forms of ownership
I. Private Sector
When ownership is in the hands of individuals, whether independently, or
as a small group, or in a large number, without any investment from the
government, then the setup is referred to as private sector.

Few Arguments for private and Public sector

 Economic activities is profit making, and that governments cannot
run organisations with profit motive
 Private investors would invest only in those areas in which returns are
high and also gestation period is small; hence governments should step
into economic activities in order to ensure equal distribution of economic
resources and balanced growth of the economy.
 Forms of ownership
Business organisations under Private Sector

1. Sole Proprietorship: Sole

proprietorship firm is one in
which an individual invests own
(or borrowed) capital, uses own
skills in management, and is
solely responsible for the results
of operations.
 Forms of ownership
Business organisations under Private Sector

1. Partnership: Two or more

individuals decide to start a
common business. Or
relation between persons
who have agreed to share
the profits of a business
carried on by all or any of
them acting for all”

Persons who have entered into partnership are individually regarded as

‘partners’ and collectively as a ‘firm
 Characteristics of Partnership
 Association of two or more persons- max no was 20in company act
1956 and increased to 50 after the amendment in 2013

 Agreement to voluntarily form partnership: The agreement is to share

the profits emerging from the business, which also implies sharing the
losses; however, agreement to share losses is not essential. It may include:
 it may be for a certain specified period and a specific purpose,
 it may be for a certain specified period and any purpose,
 it may be for an uncertain period and a specific purpose,
 it may be for an uncertain period and any purpose.
An heir of a partner does not automatically become a partner, unless other
members agree to induct the heir(s) as partners.

 Business carried out by all or any one acting for all

 Characteristics of Partnership
 Partnership deed : Partnership is created as an agreement. It is not necessary to
prepare this agreement in writing, though it is strongly desired that the agreement is
prepared in writing, in order to avoid any dispute arising in future. A typical
partnership deed normally consists of following information:

 Name and location of firm, and nature of business

 Name of partners, their respective shares, powers, obligations and duties
 Date of commencement of partnership
 Duration of firm
 Capital employed by different partners
 Manner in which profits (losses) are to be shared among partners
 Salaries (if any) payable to partners
 Rules regarding operation of bank accounts
 Interest on partners’ capital, loans, drawings, etc.
 Provision for admission, retirement or expulsion of partners k. Settlements on
dissolution of the firm
Advantages of Partnership
 Forms of ownership

Joint Stock company /company: A joint

stock company gets this name from its
characteristic that it is a business entity in
which stocks can be bought and owned
by the shareholders.

 A joint stock company in India is

established under Companies Act 1956,
amended in 2013.
 Features of Joint Stock Company
Separate Legal Entity: A joint stock company is an individual legal entity, apart from the

persons involved. It can own assets and can because it is an entity it can sue or can be sued. 
Perpetual: Once a firm if born, it can only be dissolved by the functioning of law. So,

company life is not affected even if its member keeps changing.

Number of Members: For a public limited company, there can be an unlimited number of

members but minimum being seven.

Limited Liability: In this type of company, the liability of the company’s shareholders is

limited. However, no member can liquidate the personal assets to pay the debts of a firm.
Transferable share: A company’s shareholder without consulting can transfer his shares to

others.
Incorporation: For a firm to be accepted as an individual legal entity, it has to be

incorporated. So, it is compulsory to register a firm under a joint stock company.

A joint stock company has two basic forms, namely,

Private Limited Company

 Public Limited Company

1. Private Limited Company

 The maximum number of shareholders in such a company is limited to 50-

in company act 1956 and up to 200 after the amendment in the
company act in 2013 .

 The shares of the company are transferable only among the members.

 This type of company is free from the necessity of submitting certain

returns to the Registrar.

 But a private limited company has to operate under certain restrictions: it

can neither issue a prospectus, nor can it raise capital by selling its
shares to outside public other than the members.
2. Public Limited Company
 The joint stock company may take the form of a public limited
company, in which there is no limit on the maximum number of
members, though the minimum number of members is seven.

 Such a company has to submit certain statements and its balance sheet
to the Registrar of joint stock companies on an annual basis.

 It can invite the public to buy shares by issuing a prospectus.

 One feature of a public limited company is that, its business cannot be

started unless the minimum capital laid down as per law has been
subscribed.
 Advantages of Joint Stock Company:
 Larger Capital
 Limited Liability
 Stability of Existence
 Economies of Scale
 Scope for Expansion
 Public Confidence
 Transferability of Shares
 Professional Management
 Tax Benefits
 Risk Diffused
 Disadvantages of Joint Stock Company
 Difficulty in formation
 Lack of Secrecy
 Delay in Decision Making
 Concentration of Economic Power
 Lack of Personal Interest
  More Government Restrictions
 Undue Speculation in the Shares of the Company
 Cooperative
A cooperative is a non-profit, non-political, non-religious, voluntary
organisation, formed with an economic objective.

The main principles of cooperation are:

 It is based on mutual help and self reliance. This can be neatly summed
up as “each for all and all for each”.

 Dealings are confined to members only.

 Its objective is not earning profits but to encourage mutuality and

cooperation.
Producers’ Cooperative In this form of cooperation, workers are their own
masters i.e., the business is owned by them.

Surpluses (Profits), if any, are divided among all the members. Thus, profits go to
the actual workers instead of enriching a few individuals. For example, Indian
Fertilisers and Farmers Cooperative (IFFCO) has proved to be great success.

Consumers’ Cooperative Persons living in a particular place, or working in an

establishment, may combine together to open different types of cooperative
societies.

Typical examples are multi purpose stores, credit societies and housing societies
 Advantages of Cooperatives

Dual benefits
Promotes societal values

Limitations of Cooperatives

Fraudulent activities
Uncertain life
 Public Sector

Public sector is that segment of economy where government is the investor

and the owner of a business. The public sector came into existence as an
outcome of two major revolutions:
 Communism

 Great Depression.
 Public Sector

 Communism: Karl Marx propounded the

theory of public ownership of all resources

and gave the logic that the entire society is
a community and all resources, whether
natural or manmade, should be owned by
the community as a whole and not by any
individual.
 Public Sector
 Great Depression: John Maynard Keynes

recommended that in order to break the

impasse, the government should enter into
business activities, because only
government can invest in the areas where
profits are not certain. As a result,
governments of nations, the world over,
forayed into business activities, giving rise
to another sector in the economy, regarded
as the public sector. In many countries,
including India, the two sectors continue to
coexist even today
 Forms of organisations under public sector
1. Corporate (or Company): when government invests in production
activities and enters the market, such firms are called Public Sector Units
(PSUs) or Public Sector Enterprise (PSEs).
Features:
 These PSUs (or PSEs) have to operate on the same ground as any other
joint stock company, with the single exception that there are no
shareholders, as the government owns the entire or controlling amount of
invested capital.
 These units play very significant role in many respects like: employment
generation; development of products where private sector does not want to
enter;
 balanced economic development and equitable distribution of national
wealth.
Examples: SAIL, ONGC, NTPC, GAIL, BSNL are some of the examples of
PSUs.
 Forms of organisations under public sector
2. Corporation or Board: The corporation or the board normally controls
some of the economic activities, especially where the government feels
that government intervention is necessary for equal distribution of
economic resources.
Features:
 A corporation does not aim at revenue generation; it rather aims at
optimum utilisation of national resources
 Welfare maximisation of groups of small economic units like
household and cottage industries.

Examples: Khadi and Village Industries Corporation (KVIC), Coir Board,

Food Corporation of India and Railway Board.
 Forms of organisations under public sector
3. . Department : A Department is run for a specific purpose related to
social utility, such as education, health, civil administration, etc.

Features:
 These Departments normally function under the directives of relevant
ministries, either at the appropriate level.
Example: police, excise and education (up to secondary) are the
responsibility of State Governments, whereas telecommunication, post
and telegraph, customs, etc., are under the Central Government.
 These Departments help the government in smooth delivery of welfare
measures, maintenance of law and order and equality of opportunities
Advantages of Public Sector
 Balanced economic growth
 Employment generation
 Profits for public welfare

Limitations of Public Sector

 Evils of bureaucracy
 Absence of profit incentive
 Extravagance and inefficiency
 Economic objectives of firms
1. Profit maximisation Theory

2. Sales maximisation

3. Increased market share/market dominance

4. Social/environmental concerns

5. Profit satisficing

6. Co-operatives
 Economic objectives of firms
Profit maximisation Theory
According to profit maximisation theory, objective of business is generation of the
largest amount of profit.

However, certain pertinent questions arise in accepting profit maximisation as the

objective of the firm
 First of all, which measure of profit to consider among gross profit, net profit, net

profit after tax, and net profit before tax?

 Another question is which period of time to take into account among current year,

next year, next five years, and next 10 years?

 validity of profit maximisation may also be questioned in competitive markets,

because it may be simply impossible to maximise profits in modern times of high

customer awareness and highly competitive markets.
 Economic objectives of firms
Baumol’s Theory of Sales Revenue Maximisation
This theory stressed that in competitive markets, firms would rather aim at
maximising revenue, through maximisation of sales. The theory claims that:

 sales volumes, and not profit volumes, determine market leadership in

competition.
 It further stressed that in large organisations, management is separate from owners.

Hence, there would always be a dichotomy of managers’ goals and owners’ goals.
Manager’s salary and other benefits are largely linked with sales volumes, rather
than profits.
 Baumol hypothesised that managers often attach their personal prestige to the

company’s revenue or sales; therefore they would rather attempt to maximise the
firm’s total revenue, instead of profits.
 Economic objectives of firms
Marris’ Hypothesis of Maximisation of Growth Rate

 According to growth maximisation theory, owners (shareholders) aim at profits

and market share, whereas managers aim at better salary, job security and growth.

 These two sets of goals can be achieved by maximising balanced growth of the

firm (G), which is dependent on the growth rate of demand for the firm’s
products (GD) and growth rate of capital supply to the firm (GC).

Hence, growth rate of the firm is balanced when the demand for its product and the
capital supply to the firm grow at the same rate.
 Economic objectives of firms

Marris’ Hypothesis of Maximisation of Growth Rate

Marris further said that firms face two constraints in the objective of maximisation
of balanced growth, which are as follow

1. Managerial Constraint:
 Marris stressed on the importance of the role of human resource in achieving
organisational objectives.
 According to him, skills, expertise, efficiency and sincerity of team managers
are vital to the growth of the firm.
 Economic objectives of firms
Marris’ Hypothesis of Maximisation of Growth Rate
2. Financial Constraint :Marris suggested that a prudent financial policy will be based on at
least three financial ratios
 Debt equity ratio (r1): This is the ratio between borrowed capital and owners’ capital.
High value of debt equity ratio may cause insolvency; hence, a low value of this ratio is
usually preferred by managers to avoid insolvency.
 Liquidity ratio (r2) This is the ratio between current assets and current
liabilities and is an indicator of coverage provided by current assets to current
liabilities. According to Marris, a manager would try to operate in a region
where there is suffi cient liquidity and safety and hence would prefer a high
liquidity ratio. But a high r2 would imply low yielding assets, since liquid assets
either do not earn at all (like cash and inventory), or earn low returns (like
short-term securities).
 Retention ratio (r3) This is the ratio between retained profits and total profits.
In other words, it is the inverse of dividend payout ratio, i.e., the retained profits
are that portion of net profit which is not distributed among shareholders. A
high retention ratio is good for growth, as retained profits provide internal
source of funds.
 Economic objectives of firms
Behavioural Theories
 Behavioural theories propose that firms aim at satisficing behaviour, rather than
maximisation.
 According to satisficing model firm has to operate under “bounded rationality”
and can only aim at achieving a satisfactory level of profit, sales and growth
 According to the model by Cyert and March, firms need to have multi goal and
multi decision-making orientation.
 Economic objectives of firms
Williamson’s Model of Managerial Utility Function

As per Model of Managerial Utility Function, managers apply their discretionary

power to maximise their own utility function, with the constraint of maintaining
minimum profit to satisfy shareholders.

The utility function of managers, namely Um, is dependent upon managers’ salary
(measurable); job security, power, status, professional satisfaction (all non
measurable); and the power to influence firm’s objectives.
 PRINCIPAL AGENT PROBLEM
Conflict of interests between the owners and the managers of a
firm is a principal agent problem.
As per Williamson’s model, managers are more interested in
maximisation of their own benefits, instead of maximising
corporate profits.
Difference in information between two parties in any
transaction is termed as a state of asymmetric information.
Thank You