PART – B

1. State the objectives of Modern Firm. (APRIL 2012)

The main objectives of firms are:
1. Profit maximisation, 2. Sales maximisation, 3.Increased market share/market
dominance, 4. Social/environmental concerns. 5. Profit satisficing, 6. Co-operatives/
1. Profit Maximisation:
 The firm may create a minimum level of profit to keep the shareholders happy,
but then maximise other objectives, such as enjoying work, getting on with other
workers.
 This ‘principal-agent‘ problem can be overcome, to some extent, by giving
managers share options and performance related pay although in some industries
it is difficult to measure performance.
2. Sales maximisation
 Firms often seek to increase their market share – even if it means less profit. This
could occur for various reasons:
 Increased market share increases monopoly power and may enable the firm to put up
prices and make more profit in the long run.
 Increasing market share may force rivals out of business. Some firms may actually
engage in predatory pricing which involves making a loss to force a rival out of
business.
3. Growth maximisation
This is similar to sales maximisation and may involve mergers and takeovers. With
this objective, the firm may be willing to make lower levels of profit in order to increase in
size and gain more market share. More market share increases their monopoly power and
ability to be a price setter.
4. Long run profit maximisation
The firms may sacrifice profits in the short term to increase profits in the long run.
For example, by investing heavily in new capacity, firms may make a loss in the short run but
enable higher profits in the future.
5. Social/environmental concerns
A firm may incur extra expense to choose products which don’t harm the environment
or products not tested on animals. Alternatively, firms may be concerned about local
community / charitable concerns.
 Some firms may adopt social/environmental concerns into part of its branding. This
can ultimately help profitability as the brand becomes more attractive to consumers.
 Some firms may adopt social/environmental concerns on principal alone – even if it
does little to improve sales/brand image.
6. Co-operatives
Co-operatives may have completely different objectives to a typical PLC. A co-
operative is run to maximise the welfare of all stakeholders – especially workers. Any profit
the co-operative makes will be shared amongst all members.
Diagram showing different objectives of firms
2. State the relationship between managerial economics and accounting.(APRIL 2013)
Accounting and managerial economics:
Accounting data and statement constitute the language of business are the days when
accounting was treated as just bookkeeping. Now its for more behind bookkeeping. Cost and
revenue information and their classification are influenced considerably by the accounting
profession. Familiar with generation, interpretation, and use of accounting data. The focus of
accounting within the enterprise is fast changing from the concept of bookkeeping to that of
managerial decision making.
3. Explain positive and normative analysis. (APRIL 2014)
Positive economics:
It deals with description and explanation of economic behaviour, Economics and Managerial
economics. Managerial economics draws on positive economics by utilizing the relevant theories
as a basis for prescribing choices. A posi t i ve
s t at em ent i s a st at e m ent about what i s a nd whi ch cont ai ns n o indication of app
roval or disapproval. It’s not like that positive statement
isa l w a y s r i g h t , p o s i t i v e s t a t e m e n t c a n b e w r o n g . P o s i t i v e s t a t e m e n t i
s a statement about what exists.
Normative economics:
It is concerned with prescription or what ought to be done. In norma
t i v e economics, it is inevitable that value judgment are made as to what should and
what s h o u l d n o t b e d o n e . M a n a g e r i a l e c o n o m i c s i s a p a r t o f n o r m a t i v
e economics as its focus is more on prescribing choice and action and less on
explaining what has happened. It expresses a judgment about whether a situation is desirable or
undesirable.
4. Explain the fundamental concepts that aid decision-making. (APRIL 2015)
The decision-making process consists of: (a) identifying the problem (b) diagnosing
the situation, (c) collecting and analyzing data relevant to the issue, (d) ascertaining solutions
that may be used in solving the problem, (e) analyzing these alternative solutions, (f)
selecting the one that appears most likely to solve the problem, and (g) implementing it.
Nevertheless the manager must be as rational as possible, drawing upon all available
techniques and guidelines in choosing among the various alternatives. Some of the
techniques that are most useful in this process include the Laplace criterion, the maximin
criterion, the maximize criterion marginal analysis financial analysis, and the Delphi
technique.
The creativity and decision making, creative thinking has four stages: preparation,
incubation, illumination, and verification. There are a number of techniques that can be used
to help stimulate creative thinking. Two of the most popular are brainstorming and the
Gordon technique.
5. Explain the scope of Managerial Economics.(APRIL 2016)
Managerial Economics is a developing subject. The scope of managerial economics
refers to its area of study. Managerial economics has its roots in economic theory. The
empirical nature of managerial economics makes its scope wider. Managerial economics
provides management with strategic planning tools that can be used to get a clear perspective
of the way the business world works and what can be done to maintain profitability in an ever
changing environment.
Managerial economics refers to those aspects of economic theory and application
which are directly relevant to the practice of management and the decision making process
within the enterprise. Its scope does not extend to macro-economic theory and the economics
of public policy which will also be of interest to the manager. While considering the scope of
managerial economics we have to understand whether it is positive economics or normative
economics.
6. Discuss the uses of managerial economics (APRIL 2017)
1. Deciding the price of a product and the quantity of the commodity to be produced.
2. Deciding whether to manufacture a product or to buy from another manufacturer.
3. Choosing the production technique to be employed in the production of a given
product.
4. Deciding on the level of inventory a firm will maintain of a product or raw material.
 5. Deciding on the advertising media and the intensity of the advertising campaign.
6. Making employment and training decisions making decisions regarding further
business investment and the mode of financing the investment.
7. Tools of managerial economics can be applied equally well to decision problems of
non-profit organizations.
8. Managerial economics is helpful in making optimal decisions, one should be aware
that it only describes the predictable economic consequences of a managerial
decision.
7. State the relationship between managerial economics and macro-economics.
(NOV 2012) (NOV 16)
Microeconomics studies the actions of individual consumers and firms. Managerial
economics is an applied specialty of this branch. Macroeconomics deals with the
performance, structure, and behaviour of an economy as a whole. Managerial economics
applies microeconomic theories and techniques to management decisions. It is more limited
in scope as compared to microeconomics. Macroeconomists study aggregate indicators such
as GDP, unemployment rates to understand the functions of the whole economy.
Microeconomics and managerial economics both encourage the use of quantitative
methods to analyze economic data. Businesses have finite human and financial resources;
managerial economic principles can aid management decisions in allocating these resources
efficiently. Macroeconomics models and their estimates are used by the government to assist
in the development of economic policy.
Macroeconomics deals with the study of entire economy. It considers all the factors
such as government policies, business cycles, national income, etc.
8. Describe the five kinds of internal economies. (NOV 2013)
"Internal economies are those economies in production which occur to the firm itself when it
expands its output or enlarge its scale of production".
Types of Internal Economies of Scale
Following are the types of Internal economies of scale:
1. Administrative or Managerial Economies 2. Technical Economies, 3. Marketing
Economies or Commercial Economies 4. Indivisibility, 5. Financial Economies
1. Administrative or Managerial Economies
When a firm expands its output or enlarges the scale of production it follows the principle of
division of labour and creates special departments e.g. marketing, production, cost,
processing cost accountant, marketing manager etc. and as a result production process works
smoothly. The entrepreneur gives attention to more important jobs e.g. import and export
problems, credit from banks and concessions from the government etc. The administrative
expenditures do not increase proportionally with the output and thus the firm benefits.
2. Technical Economies
Technical economies arise due to the large scale production because there is a mechanical
advantage in the use of large machines. Technical economies may arise due to large size of
the plant because it requires less energy, less staff, and proportionately less cost of installing
the plant. Specialized persons can only be employed with large machinery and plant. Thus,
large scale producer benefits from specialists.
3. Marketing Economies or Commercial Economies
These economies arise from the purchase of raw material and sale of finished goods. When
output of a firm increases, it purchases large quantity of raw material and gets preference by
the firms they deal with e.g., freight concession, cheap credit and prompt delivery etc.
4. Indivisibility
We can get total benefit from most of the factors of production when they are being used at
full capacity. If smaller output is being produced it means that they are not working according
to their efficiency. This may be due to indivisibility of factors of production.
5. Financial Economies
Another type of internal economies of scale is financial economies, these may arise due to the
reason that large scale firms have better credit facilities i.e. credit at cheaper rates, concession
from the government for credit
9. Explain the common elements emphasized by managerial economists. (NOV
2014)
The following aspects may be said to be inclusive under managerial economics:
 Demand analysis and forecasting.
 Cost and production analysis.
 Pricing decisions, policies and practices.
 Profit management.
 Capital management.
Demand Analysis and Forecasting:
A business firm is an economic organization, which transforms productive resources
into goods that are to be sold in a market. A major part of managerial decision-making
depends on accurate estimates of demand. This is because before production schedules can be
prepared and resources are employed, a forecast of future sales is essential. This forecast can
also guide the management in maintaining or strengthening the market position and enlarging
profits. The demand analysis helps to identify the various factors influencing demand for a
firm’s product and thus provides guidelines to manipulate demand. Demand analysis and
forecasting, thus, is essential for business planning and occupies a strategic place in
managerial economics. It comprises of discovering the forces determining sales and their
measurement. The chief topics covered in this are:
 Demand determinants
 Demand distinctions
 Demand forecasting.
Cost and Production Analysis.
Production analysis is narrower in scope than cost analysis. Cost and production
analysis are:
 Cost concepts and classifications
 Cost-output relationships
 Economics of scale
 Production functions
 Cost control.
Pricing Decisions, Policies and Practices.
Pricing is a very important area of managerial economics. In fact price is the origin of
the revenue of a firm. As such the success of a business firm largely depends on the accuracy
of price decisions of that firm. The important aspects dealt under area, are as follows:
 Price determination in various market forms
 Pricing methods
 Differential pricing product-line pricing and price forecasting.
Profit Management.
Business firms are generally organized with the purpose of making profits. In the long
run, profits provide the chief measure of success. In this connection, an important point worth
considering is the element of uncertainty existing about profits. This uncertainty occurs
because of variations in costs and revenues. These are caused by factors such as internal and
external. Thus profit planning and measurement make up the difficult area of managerial
economics. The important aspects covered under this area are:
 Nature and measurement of profit.
 Profit policies and techniques of profit planning.
Capital Management.
Capital management implies planning and control and capital expenditure. In this procedure,
relatively large sums are involved and the problems are so complex that their disposal not
only requires considerable time and labor but also top-level decisions. The main elements
dealt with cost management are:
 Cost of capital
 Rate of return and selection of projects.
The various aspects outlined above represent the major uncertainties, which a business firm
has to consider demand uncertainty, cost uncertainty, price uncertainty, profit uncertainty and
capital uncertainty.
10. Identify the relationships of managerial economics with applied economics.
(NOV 2014)
Managerial Economics is economics applied to decision making. It is a special branch
of economics, bridging the gap between pure economic theory and managerial practice.
Economics has two main branches—micro-economics and macro-economics.
Micro-economics:
‘Micro’ means small. It studies the behaviour of the individual units and small
groups of units. It is a study of particular firms, particular households, individual prices,
wages, incomes, individual industries and particular commodities. Thus micro-economics
gives a microscopic view of the economy.
The roots of managerial economics spring from micro-economic theory. In price
theory, demand concepts, elasticity of demand, marginal cost marginal revenue, the short and
long runs and theories of market structure are sources of the elements of micro-economics
which managerial economics draws upon.
Macro-economics:
‘Macro’ means large. It deals with the behaviour of the large aggregates in the
economy. The large aggregates are total saving, total consumption, total income, total
employment, general price level, wage level, cost structure, etc. Thus macro-economics is
aggregative economics.
It examines the interrelations among the various aggregates, and causes of
fluctuations in them. Problems of determination of total income, total employment and
general price level are the central problems in macro-economics.
Macro-economies is also related to managerial economics. The environment, in
which a business operates, fluctuations in national income, changes in fiscal and monetary
measures and variations in the level of business activity have relevance to business decisions.
The understanding of the overall operation of the economic system is very useful to the
managerial economist in the formulation of his policies.
Macro-economics contributes to business forecasting. The most widely used model in
modern forecasting is the gross national product model.
11. Examine the role of cost in managerial decision making. (NOV 2014).
1. Direct and Indirect Cost 2. Opportunity Vs. Outlay Cost 3. Relevant Costs and Irrelevant
Costs 4. Past vs. Future Cost 5. Traceable (Separable) and Common Costs 6. Out of Pocket
and Book Costs 7. Committed and Discretionary Costs 8. Marginal and Incremental or
Differential Cost and Others.
Direct and Indirect Cost:
These costs are incurred that can be directly attributed to the production of one unit of a
commodity. It is usually possible to determine the cost of raw materials, labour inputs and
machine time involved with production of each unit.
Direct and indirect costs do not necessarily coincide with the economist’s concepts of fixed
and variable costs. The criterion used by the economist to draw a distinction between fixed
and variable cost is whether or not the cost varies with the level of output. But the criterion
used by the accountant is whether or not the cost is separable with respect to the production
of individual units of output.
Opportunity Vs. Outlay Cost:
The concept of cost which normally enters into the accounts of a business is known as outlay
cost. Outlay cost refers to the actual expenditure incurred on raw materials and other
productive facilities. Such costs involve “financial expenditure at some time and hence are
recorded in the book of accounts.”
The opportunity costs “take the form of profits from alternative ventures that are foregone by
using limited facilities for a particular purpose. Since they represent only sacrificed alter-
natives, they are never recorded as such in the financial accounts.”
Opportunity costs are implicit in nature. If a firm cannot use the raw material it has already
purchased, and no one else can be found who wants it, then the material is valueless
irrespective of what was originally paid for it. If we use it for one purpose it cannot obviously
be used for another.
Relevant Costs and Irrelevant Costs:
Costs that will be incurred as a result of a decision are known as relevant costs. These are
relevant for future decision-making. On the contrary, costs that have already been incurred
irrespective of what is being done by the firm at present are irrelevant costs. They have no
relevance as far as current decisions are concerned.
Past vs. Future Cost:
“The Most of the important managerial uses to which cost information is put actually require
forecasts of future costs, rather than ‘actual costs’, i.e., unadjusted records of past
costs.” Since managerial decisions are always forward-looking, cost forecasting is essential.
Cost forecasting is essential for expenditure control, projection of future income statements,
capital investment decisions, pricing, and decision on developing new products and dropping
old products.
Traceable (Separable) and Common Costs:
Business managers often find it necessary to draw a distinction between common and
traceable (separable) costs. Most modern business firms produce more than one product and
are thus faced with the problem of common costs. In such cases, it is difficult to attribute
costs to particular products inasmuch as they result from the mix of products rather than one
product taken at a time.
However, by applying incremental reasoning, it is possible to resolve much of the confusion
that arises when managers try to determine which costs are common and which are traceable
to a particular product. It is quite easy to determine how much a change in output of a single
product, brings about a change in a particular kind of cost. But it is quite difficult to
determine a product’s fair share of that cost.
Out of Pocket and Book Costs:
Out-of-pocket costs refer to cost that involve “current payments to outsiders as opposed to
book costs, such as depreciation, that do not require current cash expenditures”. The
payments for raw materials are an out-of-pocket cost. However, all out-of pocket costs are
not variable, e.g., the night watchman’s salary.
Book costs can be “converted into out-of-pocket costs by selling assets and leasing them back
from the buyer”. For example, you can sell your factory building but can continue to use it by
paying rent to the new owner. The rental payment then replaces the depreciation charge and
interest cost of owned capital.
Committed and Discretionary Costs:
Businessmen and economists often speak of “completely fixed expense”. This expression is
open to diverse interpretations.
The following cost concepts are distinguished:
`(a) Escapable Costs:
(b) Stand-by Fixed Costs:
(c) Committed Costs:
(d) Discretionary Costs:
Marginal and Incremental or Differential Cost:
Marginal cost has been defined as the addition to total cost which results from the production
of one extra unit. This conception is of limited value for decision-making, because an
increment of one unit is often too small to have any operational significance.
The concept of incremental or avoidable (escapable) cost generalizes the concept of marginal
cost. And, for most practical decision problems, the two terms incremental cost and
differential cost are used synonymously. Underlying these two cost concepts is the notion of
a change in the total costs resulting from the implementation of a decision.
12. Explain the characteristics of managerial economics. (NOV 15)
Characteristics Of Managerial Economics.
• Managerial economics is micro-economic in character.
• Managerial economics largely uses that body of economic concepts and principles,
which is known as Theory of the Firm or Economics of the Firm.
• Managerial economics is concrete and realistic.
• Managerial economics belongs to normative economics rather than positive
economics.
 Managerial economics is prescriptive rather than descriptive. It remains confined to
descriptive hypothesis.
• Managerial economics also simplifies the relations among different variables without
judging what is desirable or undesirable.
 Managerial economic has been described as normative microeconomics of the firm.
• Macroeconomics is also useful to managerial economics