Chapter-1

Managerial Economics
Topic:
Ø     Managerial Economics
Ø      Introduction
Ø      Basic concepts and their
application to business decision-
making.
Introduction:
The emergence of managerial economics as
a separate course of management studies can be
attributed to at least three factors:
a) Growing complexity of business decision –
making process due to changing market
conditions and business environment.
b) Consequent upon, the increasing use of
economic logic, concepts, theories and tools of
economic analysis in the process of business
decision making.
c) Rapid increase in demand for professionally
trained managerial manpower.
 Meaning of Economics:
Economics is a social science that deals with production,
distribution and consumption of scarce resources in an economy.
Economics is classified as
   Pure Economics.
    Normative Economics.
P ure Economics:
Pure Economics is also called as Positive Economics. It deals with
facts. It also deals with how the problems solved.
Normative Economics:
Normative Economics is also called as Applied Economics. It deals
with how problems should be solved and it involves ethical values.
Economics can be classified into two types. They are
    Micro Economics.
    Macro Economics.
Differences between Micro and Macro Economics.
Micro Economics Macro Economics

Micro Economics deals Macro Economics studies

with the economic - the economy as a whole.
behavior of individual
entities such as
individuals, household,
industries, firms etc.
Micro Economics Macro Economics
explains the inter- explains about the GDP,
relationship between aggregate demand and
economic units like supply, general price
consumers, firms, level, total employment
industries, markets, etc.
commodities etc.
Micro Economic theory Macro Economic theory
describes product describes the theory of
raising, which explains income & employment
the theories of demand, to explain economy by
production & cost, factor consumption &
pricing which explains investment. The theory
concept of wages, of the general price level
interest, rent & profit & & inflation, theories of
the theory of economic economic growth & the
welfare. macro theory of
distribution.
Micro Economics analyses Macro Economics analyses
the conditions for the fluctuations and trends
efficiency in consumption in the overall economic
and production. activity in the country and
between various countries in
the world.
Definition of Managerial Economics

“Managerial Economics is the integration of economic

theory with business practice for the purpose of facilitating
decision making & forward planning by management”.
-               Spencer and Seigelman.
Meaning of Managerial Economics

Managerial Economics is the study of economic

theories, logic & tools of economic analysis & business
decision-making.
a)    Profit making
b)   Maximization of profit.
Manager has to take a number of decisions in
conformity the goals of the firm. Many business decisions are
taken under the condition of uncertainty & risk.
Uncertainty & risk arise mainly due to uncertain
behavior of the market forces, changing business environment,
emergence of competitors with highly competitive product,
government policy, external influence on the domestic market
& social & political changes in the country.
 Business Decisions and Economic Analysis
Business decision-making is essentially a process of
selecting the best out of alternative opportunities open to the firm. The process of
decision-making comprises 4 main phases.
a) Determining & defining the objective to be achieved.
    

b) Collection& analysis of information regarding economic, social, political &

   

technological environment.
c) “Inventing, developing & analyzing possible course of action”; and
    

d) ‘Selecting a particular course of action’, from the available alternative

   

E Economic Theories
Economic theories state the functional relationship between two or
more economic variables, under certain given conditions. Economic theories help a
business to take decision in 3 ways
a) It gives a clear understanding of various economic concepts.
(That is; cost, price, demand, etc.) Used in business analysis.
b) It helps in ascertaining the relevant variables and specifying the
relevant data.
c) Economic theories state the general relationship between two or
more economic variables and events.
Scope of Managerial Economics

1)     The scope of managerial economics

comprehends all those economic concepts, theories
and tools of analysis which can be used to analyse
the business environment and to find solutions to
practical business problems.
2)     Managerial economics is economics applied to
the analysis of business problems & Decision-
making.
 
Micro Economics applied to operational issues
Operational problems are of internal nature. They include all
those problems which arise within the business organization and fall within
the purview and control of the management.
Some of the basic internal issues are:
a) Choice of business and the nature of product, ie, what to
produce;
b) Choice of size of the firm, ie, how much to produce;
c) Choice of technology, ie, choosing the factor-combination;
d) Choice of price, ie, how to price the commodity;
e) How to promote sales;
f) How to face price competition;
g) How to decide on new investments;
h) How to manage profit & capital;
i) How to manage inventory, ie, stock of both finished goods & raw
Micro Economic Theories:-
Micro economic theories deals with some most of the questions like
Theory of Demand, Theory of Production &Production Decisions, Analysis of
Market - Structure & Pricing Theory, Profit Analysis & Profit Management,
Theory of Capital & Investment Decisions.
1) Theory of Demand->
Demand theory explains the consumers’ behavior. It
answers the questions:
a) How do the consumers decide whether or not to buy a commodity?
   

b) How do they decide on the quantity of a commodity to be purchased?

  

c) When do they stop consuming a commodity?

   

d) How do the consumers behave when price of the commodity, their income &
  

tastes & fashions, etc., change?

e) At what level of demand, does changing price become inconsequential in
   

terms of total revenue?

The knowledge of demand theory can, therefore, be helpful in the choice of
commodities for production.
2) Theory of Production & Production Decisions->

Production theory, also called “Theory of Firm”. It

explains the relationship between inputs & outputs.
It also explains under what conditions costs
increase or decrease; how total output increases
when units of one factor (input) are increased
keeping other factors constant, or when all factors
are simultaneously increased; how can output be
maximized from a given quantity of resources; &
how can optimum size of output be determined?
Production theory, thus, helps in determining the
size of the firm, size of the total output & the
amount of capital & labour to be employed.
 
3) Analysis of Market-Structure and Pricing Theory-

Price theory explains how prices are determined

under different market conditions; when price
discrimination is desirable, feasible and Profitable; to what
extent advertising can be helpful in expanding sales in a
Competitive market. Thus, price theory can be helpful in
determining the price Policy of the firm. Price &
Production theories together, infact, help in determining
the optimum size of the firm.
4) Profit Analysis & Profit Management->
Profit making is the most common objective of all business
undertakings. But, making a satisfactory profit is not always
guaranteed because a firm has to carry out its activities under
conditions of uncertainty with regard to
a) Demand for the product.
b) Input prices in the factor market.
c) Nature & degree of competition in the product market,
d) Price behavior under changing conditions in the
product market, etc.
5) Theory of Capital & Investment Decisions->
 

Capital like all other inputs is a scarce & expensive

factor. Capital is the foundation of business. Its efficient
allocation & management is one of the most important tasks
of the managers & a determinant of the success level of the
firm. The major issues related to capital are;
a) Choice of investment project.
b) Assessing the efficiency of capital.
c) Most efficient allocation of capital.
d) It helps in Investment decision with decision-
making process.
 
 Macro Economics [ Core objectives]:-
It is necessary to learn about the objectives of macro
economic policy, before studying macro economic theory & the alternative
policies available. The objectives of macro economic policy are to achieve high
level of output [GDP],
Price stability, full employment, sustainable balance of payment & rapid
economic growth.
Some key variables like gross domestic product, inflation &
unemployment rate help economists to measure the macro economic
performance of an economy.

      Core Objectives:-

1)   Gross Domestic Product [GDP]: -
The GDP is the most complete measure of the value of economic activity
in an economy. It measures the market value of all products produced using
factors of production during a specified period of time & within the boundaries
of a country.
It providing the desire & necessary goods & services to the population
& it is the measure of the market value of all goods & services.
2) Full Employment Level: -
One of the primary objectives of macro economic policies is to achieve full
employment level by minimization of unemployment.

3) Price Stability: -
The purchase power of money is determined by prices. If there is movement i
the price level of products, the purchasing power of money also changes. An
overall increase in prices is called an inflationary trend, while decreasing prices
characterize deflation.
 
4) Sustainable balance of payment: -
It is the systematic record of all transactions between the country & the rest

Of the world. These transactions consist of imports & exports of goods & service
lending & borrowing, etc. investing in foreign countries.
 
5) Economic Growth: -
It increases in production possibility & GDP growth. The rate of growth of real per
capita output depends on the population growth rate.
The objective of macro economic policies is to raise economic growth to a higher
Instruments of Macro Economic Policy: -
To achieve economic objectives, governments have to use various macro
economic policies. They are fiscal, & monetary policies, employment policy,
International trade policy, exchange rate policy, & prices & income policy.
1) Fiscal Policy: -
Fiscal policy refers to the governments program with regard to
a) Expenditure like purchases of products & spending on transfer payments, &
b) Mobilization of resources through the amount & type of taxes. It refers to the
policy of the government with respect to its spending &
Mobilization of resources.
2) Monetary Policy: -
Money acts as a medium of exchange in all modern societies. Money can
also be regarded as a financial asset as it can be exchanged for goods &
services.
The objectives of the Central Bank exercising its control over money, interest
rates & Credit conditions. The instruments of monetary policy include reserve
requirements, bank rate, open – market operations, etc.
 
3) International Trade Policy: -
Trade policies relate to tariff & non-tariff trade regulations that limit or
promote the imports & exports of a country.
4) Exchange Rate Policy: -
The Foreign exchange rate of a country influences the international trade of
A country. The Foreign exchange rate can be described as the rate at which one
Country’s currency is exchanged against the currency of the other country.
The Foreign exchange rate is the rate & which a countries currency can be
exchanged with a foreign currency.
5) Prices & Income Policy: -
The working of the market economy is influenced by price & income
policies. Under this policy government sets the prices of some goods &
services & determines the wages. These measures are undertaken by the
government to control inflation & protect jobs in the domestic market.
6) Employment Policy: -
Policies that are aimed at generating more employment
opportunities are referred to collectively as employment policy.
Similarly, the government sometime provides free training facilities to
unskilled labour, to make them fit for new skilled jobs.

Basic concepts in Macro Economics

 
1. Stock & Flow Variable: -
A stock variable is measured at a specific point in time or a
stock signifies the level of variable at a point in time.
A flow variable represents the change in the level of
variable over a period of time.
2.Equilibrium and disequilibrium: -
Equilibrium is a state of balance between opposing forces or action.
Disequilibrium is the absence of equilibrium. It does not mean a motionless state where
no action takes place. Rather it is a state where the action is repetitive in nature.
 
3.Statics and dynamics: -
Static models, which do not consider explicitly the behaviour of variables
from one time period to another, are called static models.
Dynamic models consider the movement of variables over different time
periods & these models describes the movement of variables from one disequilibrium
position to another.