Microeconomics (from Greek prefix micro- meaning "small" + "economics") is a branch of economics that studies the behavior of how

the individual modern household and firms make decisions to allocate limited resources.[1] Typically, it applies to markets where goods or services are being bought and sold. Microeconomics examines how these decisions and behaviours affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services.[2][3] This is in contrast to macroeconomics, which involves the "sum total of economic activity, dealing with the issues of growth, inflation, and unemployment.[2] Microeconomics also deals with the effects of national economic policies (such as changing taxation levels) on the aforementioned aspects of the economy.[4] Particularly in the wake of the Lucas critique, much of modern macroeconomic theory has been built upon 'microfoundations' i.e. based upon basic assumptions about micro-level behavior. One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses. Microeconomics analyzes market failure, where markets fail to produce efficient results, and describes the theoretical conditions needed for perfect competition. Significant fields of study in microeconomics include general equilibrium, markets under asymmetric information, choice under uncertainty and economic applications of game theory. Also considered is the elasticity of products within the market system t is assumed that all firms are following rational decision-making, and will produce at the profit-maximizing output. Given this assumption, there are four categories in which a firm's profit may be considered to be.
y

A firm is said to be making an economic profit when its average total cost is less than the price of each additional product at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price. A firm is said to be making a normal profit when its economic profit equals zero. This occurs where average total cost equals price at the profitmaximizing output. If the price is between average total cost and average variable cost at the profit-maximizing output, then the firm is said to be in a loss-minimizing condition. The firm should still continue to produce, however, since its loss

would be larger if it were to stop producing. By continuing production, the firm can offset its variable cost and at least part of its fixed cost, but by stopping completely it would lose the entirety of its fixed cost. If the price is below average variable cost at the profit-maximizing output, the firm should go into shutdown. Losses are minimized by not producing at all, since any production would not generate returns significant enough to offset any fixed cost and part of the variable cost. By not producing, the firm loses only its fixed cost. By losing this fixed cost the company faces a challenge. It must either exit the market or remain in the market and risk a complete loss.

Macroeconomics (from Greek prefix "macr(o)-" meaning "large" + "economics") is a branch of economics dealing with the performance, structure, behavior, and decision-making of the entire economy. This includes a national, regional, or global economy.[1][2] With microeconomics, macroeconomics is one of the two most general fields in economics. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Macroeconomists develop models that explain the relationship between such factors as national income, output, consumption, unemployment, inflation, savings, investment, international trade and international finance. In contrast, microeconomics is primarily focused on the actions of individual agents, such as firms and consumers, and how their behavior determines prices and quantities in specific markets. While macroeconomics is a broad field of study, there are two areas of research that are emblematic of the discipline: the attempt to understand the causes and consequences of short-run fluctuations in national income (the business cycle), and the attempt to understand the determinants of long-run economic growth (increases in national income). Macroeconomic models and their forecasts are used by both governments and large corporations to assist in the development and evaluation of economic policy and business strategy.

The term "macroeconomics" stems from the term "macrosystem", coined by the Norwegian economist Ragnar Frisch in 1933.[3] It is the culmination of a longstanding effort to comprehend many of the broad elements of the field. Macroeconomic theory fused, and extended, the earlier study of business fluctuations and monetary economics. Mark Blaug, a notable historian of economic thought, proclaimed in his "Great Economists before Keynes: 1986" that Swedish economist Knut Wicksell more or less founded modern macroeconomics To try to avoid major economic shocks, such as The Great Depression, governments make adjustments through policy changes they hope will stabilize the economy. Governments believe the success of these adjustments is necessary to maintain stability and continue growth. This economic management is achieved through two types of governmental strategies:

y y

Fiscal policy Monetary policy

CHAPTER

Nature and Scope of Economics

Nowadays, understanding of economic issues has become quite indispensable for all sections in the society. Everyone wants to get rich; wants to increase their wealth holding; wants to have hold over productive resources; wants to expand their business activities. People want to earn more and more profits, and exercise control over the market and other economic system; people want to raise their living standard and enjoy more and more consumption; people want to make their future secure; everyone wants to grow from the current position; given these, people want to update their knowledge of economic issues and take advantage of that. Besides, people want to grow even in the adverse circumstances or at least

survive under these circumstances. This shows that people want to become economically stronger and viable. So that they can lead a better life style. This requires proper understanding of the economic issues. Such understandings might be developed through formal and informal methods of learning. Most of the people learn informally in the society through their experiences as they get exposed to certain real life situations. However, those who want to make a career in different dimensions, they need to learn it formally. For this, they need to learn it properly, that is possible through pursuing a formal course structure. This gives them a proper understanding of economics. They can apply this knowledge in different contexts. According to Samuelson and Nordhaus ( Economics ; sixteenth edition; 2000), Often economics appears to be an endless procession of new puzzles, problems, and difficult dilemmas. But as experienced teachers have learned, there are a few basic concepts that underpin all of economics. Once these basic concepts have been mastered, learning is much quicker and more enjoyable.

2 Engineering and Managerial Economics

DEFINITION OF ECONOMICS It is very difficult to define economics because economics is very dynamic subject. Its scope keeps on changing rather expanding. Still for proper

understanding of any subject, it becomes necessary to define it as close as possible. We begin by a general description of economics provided by Wikipedia. It describes economics as below. Economics is the social science that is concerned with the production, distribution and consumption of goods and services. The term economics comes from the Ancient Greek oikonomia, management of household, administration from oikos, house + nomos, custom or law , hence rules of the house (hold) . Current economic models developed out of the broader field of political economy in the late 19th century, owing to a desire to use of an empirical approach more akin to the physical science. Economics aims to explain how economies work and how economic agents interact. Economic analysis is applied throughout society, in business, finance and government, but also in crime, education, the family, health, law, politics, religion, social institutions, war, and science. The expanding domain of economics in the social science has been described as economic imperialism. The above description of economics shows the nature of economics in modern context. It tells that economics can be used for raising the living standard of people and their welfare. However, it also wants that economic issues or economic objectives might become a tool in the hands of people, who want to exploit it for ulterior motive like separation from others.

However, now we can discuss some formal definitions given by the economists over a period of time.

INITIAL DEFINITION OF ECONOMICS THAT RELATES TO WEALTH Adam Smith is considered to be the first to provide a formal definition of economics contained in his book, An enquiry into the nature and causes of wealth of nation published in 1776. Because of this great contribution of Adam Smith, he is regarded as the father of economics. He defined economics as the science of wealth, that is, he regarded economics as the science that studies the production and consumption of wealth. However, another great economist J.S. Mill defines economics as the practical science of the production and the distribution of wealth. This definition of J.S. Mill

Nature and Scope of Economics 3

was mentioned in the concise Oxford dictionary. J.B. Say is a French economist who is a well known classical economist. He defined economics as the science which treats of wealth, that is, economics studies about the wealth. All the above classical economists assign greater importance to the wealth as the centre of economic studies. If this definition is taken narrowly,

it creates a problem. However if the concept of wealth is defined in broader perspective to take into account scarce goods and services used to satisfy wants, etc. In that case, the definition becomes more acceptable. But it appears that these economists have defined wealth in a very narrow sense. Therefore, the definition of economics becomes quite narrow. Such limited definition of economics focussing around the wealth seems to restrict the scope of economics as such.

MARSHALL S DEFINITION OF ECONOMICS (SCIENCE OF MATERIAL WELFARE)

Like the earlier economist Marshall also believed that economics is highly related to politics but he emphasised on political economy. After marginalising the earlier definitions of economics focussing on wealth, it became necessary to come out with more acceptable and wider definition of economics. It is so because more knowledge was accumulated by this time with regard to economics. Alfred Marshall published his book, Principles of Economics in 1890. He shifted emphasis from wealth to material welfare. According to him, wealth acted only as means to attain the ends and the wealth should not be treated as end in itself. According to Marshall, End is the human welfare. He provided his definition of economics based on such distinction. According to Marshall, Political

economy or economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well-beings. Thus it is on the one side, a study of wealth; and on the other, and more important side, a part of the study of man. ( Principles of Economics , Macmillan, London p. 1, 8th edition). Thus, this definition focuses on human welfare through wealth. Another economist A.C. Pigou has also defined economics in terms of human welfare. A.C. Pigou defines economics as the range of our enquiry becomes restricted to that part of social welfare that can be brought directly or indirectly into relation with the measuring rod of money. According to Edwin Cannan, The aim of political economy is explanation of the general causes on which the material welfare of human beings depends. Thus, a

4 Engineering and Managerial Economics

group of economists like Marshall, Cannan, Pigou, etc. put the economic or material welfare of the people at the centre of study, where role of money also becomes important. Such definitions are also subject to criticism. Robbins criticised welfare definition on the ground that it includes within its purview material things alone. It ignores non-material things. He considers that in real life, the distinction between material and non-material

things is quite blurred. Secondly, although the welfare approach emphasises upon material welfare yet it is curious that they have adopted non-material definition of productivity. The material welfare approach suffers from many other criticism. Robbins s definition of economics (economics is the science of scarcity): This is a further improvement over the preceding definition of economics. Lionel Robbins provides his idea of economics in his book, An essay on the nature and significance of economic science published in 1932. Robbins has defined economics as, The science which studies human behaviour as a relationship between ends and scarce means which have alternative uses. This definition seems to emphasise on three basic issues ends, scarce means, and alternative applications. Here in this definition ends refer to human wants. It is known that wants are unlimited as some of the wants are satisfied, others become important. This is unending process. Therefore, people prioritise their wants to satisfy the most important want first. Unlike the unlimited wants, scarce means are available but its supply is quite limited. Therefore, the scarcity of goods available needs to be matched with unlimited wants. This is a big challenge for the economic science. Since scarce resources are limited in supply, according to Robbins definition, such scarce resources might be put for alternative uses. It is implied here that the alternative uses to which the commodity can be put

should be of varying degrees of importance, so that, it becomes possible to select the use or the uses to which the commodity is to be put. The scarcity definition has sharply defined the scope of economics. It has delimited the field of economics by building a boundary wall around it. There can now be no misconception or haziness about the sphere of economics. Any problem marked by scarcity of means and multiplicity of ends, becomes ipso facto an economic problem, and as such, a legitimate part of the science of economics. Samuelson has also given similar but somewhat different definition of economics as given by Robbins. He has emphasised upon the twin themes of economics scarcity and efficiency. According to Samuelson and Nordhaus (1998);

Nature and Scope of Economics 5

Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. Behind this definition are two key ideas in economics: that goods are scarce and that society must use its resources efficiently. Indeed, economics is an important subject because of the fact of scarcity and the desire of scarcity . ( Economics 16th edition, 2000, p. 4).

Positive and Normative Economics

We observe that there are different types of people or stakeholders who use economics in different ways. For example, a practising economist or a policy practitioner uses economic tools and information to make any suggestion or critical analysis. Generally, such people use economic theories and tools for proper understanding and specific forecasting of economic variables. It is because use of economic sciences is generally for proper decision making and accuracy in economic forecasting. Thus, positive statements are about facts. They state what the reality is. To be specific, economics is strictly positive in character and is concerned with merely positive statements. Since positive statements are about facts, any disagreement over such statement or analysis can be handled properly only by use of facts and their analysis. Thus, positive economics is one that deals with the real life situations or the facts or evidences. Any inferences are derived and disputed based upon such facts and analysis only. Normative economics is based on the normative statements. Normative statements are concerned with what are to be? In this case, economics is not concerned with real life experiences rather, it is concerned with, how things should operate. As against the positive economics, the normative economics can not be challenged based upon any fact. For example, if a

political leader projects his party s vision in election that the unemployment rate should be brought down to 2.0 per cent, this statement is not based upon any analysis or fact, rather it is desire or the wish or the norm applied by the particular political party. Now, if the political party comes to the power the policy maker must tune the system to realise this target. Despite there being differences between positive economics and normative economics, economics is a science having both positive and normative aspects. It is more so because economics is a social science. According to Ross D. Eckert and Richard H. Leftwich, (1988), Economic policy-making conscious intervention in economic activity with the intent of altering the course that it will take is essentially normative in character.

6 Engineering and Managerial Economics

But if economic policy-making is to be effective in improving economic well-being, it must obviously be rooted in sound positive economic analysis. Policy-makers should be cognized of the full range of consequences of the policies they recommend. ( The Price System and Resource Allocation , New York, 10th edition, p. 10) According to Samuelson and Nordhaus, (2000), positive and normative economics may be interpreted as under. Positive economics deals with questions such as: why do doctors

earn more than janitors? Does free trade raise or lower wages for most Americans? Although these are difficult questions to answer, they can all be resolved by reference to analysis and empirical evidence. That puts them in the realm of positive economics. Normative economics involves ethical precepts and norms of fairness. Should poor people be required to work if they are to get government assistance? Should unemployment be raised to ensure that price inflation does not become too rapid? There are no right or wrong

answers to these questions because they involve ethics and values rather than facts. They can be resolved only by political debate and decisions, not by economic analysis alone. (ibid., p. 8)

METHODOLOGY OF ECONOMICS Economics is also like a science but it is a social science. It deals mainly with the human behaviour. Therefore, many economists argue that economics can not be as precise a science as the natural sciences like physics, chemistry etc. The latter can be studied in the laboratory conditions where variables can be easily controlled during experiments. However, social sciences like economics can not be easily controlled. Still over a period of time economic sciences have gained maturity to develop its methodology which is proving now to be quite efficient and such methodologies can be used for efficient analysis of the economic relation-

ships and predictions can be made with sufficient accuracy that generate a sense of confidence and faith. There are two broad methods used in the economic sciences.

1. The deductive method 2. The inductive method

1. The deductive method: This method involves going from general to particular. Certain hypotheses or postulates regarding human behaviour are taken to be true and then with the help of logical reasoning and examination,

Nature and Scope of Economics 7

we try to figure out the cause and effect relationship between the factors under consideration. The following steps are involved in the deductive method. I. Firstly, a problem needs to be identified and then it should be properly specified for the study. II. The assumptions required in the study should be clear. Appropriate assumptions are crucial in economic analysis. III. After specifying the assumptions, hypotheses should be clearly framed. The hypothesis formulation requires likely relationship

among the different economic variables. IV. In the last phase, hypotheses should be tested through different tools like mathematical economics and econometrics. V. Based on the above analysis proper inference needs to be derived for specific economic decision making.

2. The inductive method: Although deductive method has strong points of merit to depend upon, this methodology seems to suffer from certain weaknesses. Therefore, economists belonging to the historical school and many other economists have favoured the inductive or empirical method. The method of induction involves going from particular to general. Here the appeal is to facts, rather than reasoning and an attempt is made to arrive at conclusions from the known facts of actual life. The inductive method required the following steps:

I. The first step, as under the deductive method, is selecting and specifying the problem that is to be studied. II. The second step involves collection of data pertaining to the problem selected for study. III. The stage of collection is followed by classification and then analysis of the data by appropriate statistical techniques. IV. The fourth stage is that of inference , i.e. drawing conclusions from

the statistical analysis conducted. The conclusions are presented in the form of economic generalisation.

ECONOMIC GOALS Any science moves with certain goals to be achieved. Economics has become now a crucial branch of knowledge. Being a social science it keeps on revising its goals from time to time. The list might be quite large, but we would like to focus only on certain major goals of economics as given under:

8 Engineering and Managerial Economics

1. A low rate of unemployment: People willing to work should be able to find jobs reasonably quickly. Widespread unemployment is demoralising and it represents an economic waste. Society forgoes the goods and services that the unemployed could have produced. 2. Price stability: It is desirable to avoid rapid increases or decreases in the average level of price. 3. Efficiency: When we work, we want to get as much as we reasonably can take out of our productive efforts. For this, efficient technology becomes quite useful. 4. An equitable distribution of income: When many live in affluence,

no group of citizens should suffer stark poverty. Given this, developing countries are strategizing goals like participatory growth and inclusive growth. 5. Growth: Continuing growth, which would make possible an even higher standard of living in the future, is generally considered an important objective. 6. Economic freedom and choice: Any economy should grow and develop in such a manner that people should get more choices and there should not be any outside pressure on their choices. 7. Economic welfare: Economic policies should be pursued in such a manner that welfare of the people or the social benefits get maximised. 8. Sustainable development: It has become a major challenge for economists to carry on the process of economic growth in such a manner that the resources are optimally utilized not only for intergenerational equity but also for sustainable development in quite long run.

SCOPE OF ECONOMICS The horizon of economics is gradually expanding. It is no more a branch of knowledge that deals only with the production and consumption. However, the basic thrust still remains on using the available resources efficiently while giving the maximum satisfaction or welfare to the people

on a sustainable basis. Given this, we can list some of the major branches of economics as under:

1. Microeconomics: This is considered to be the basic economics. Microeconomics may be defined as that branch of economic analysis which studies the economic behaviour of the individual unit, may be a person, a particular household, or a particular firm. It is a study of one particular unit rather than all the units combined together. The

Nature and Scope of Economics 9

microeconomics is also described as price and value theory, the theory of the household, the firm and the industry. Most production and welfare theories are of the microeconomics variety. Macroeconomics: Macroeconomics may be defined as that branch of economic analysis which studies behaviour of not one particular unit, but of all the units combined together. Macroeconomics is a study in aggregates. Hence it is often called Aggregative Economics. It is, indeed, a realistic method of economic analysis, though it is complicated and involves the use of higher mathematics. In this method, we study how the equilibrium in the economy is reached consequent upon changes in the macro-variables and aggregates.

The publication of Keynes General Theory, in 1936, gave a strong impetus to the growth and development of modern macroeconomics. International economics: As the countries of the modern world are realising the significance of trade with other countries, the role of international economics is getting more and more significant nowadays. Public finance: The great depression of the 1930s led to the realisation of the role of government in stabilising the economic growth besides other objectives like growth, redistribution of income, etc. Therefore, a full branch of economics known as Public Finance or the fiscal economics has emerged to analyse the role of government in the economy. Earlier the classical economists believed in the laissez faire economy ruling out role of the government in economic issues. Development economics: As after the second world war many countries got freedom from the colonial rule, their economics required different treatment for growth and development. This branch developed as development economics. Health economics: A new realisation has emerged from human development for economic growth. Therefore, branches like health economics are gaining momentum. Similarly, educational economics

is also coming up. Environmental economics: Unchecked emphasis on economic growth without caring for natural resources and ecological balance, now, economic growth is facing a new challenge from the environmental side. Therefore, Environmental Economics has emerged as one of the major branches of economics that is considered significant for sustainable development.

2.

3.

4.

5.

6.

7.

10 Engineering and Managerial Economics

8. Urban and rural economics: Role of location is quite important for economic attainments. There is also much debate on urban-rural divide. Therefore, economists have realised that there should be specific focus on urban areas and rural areas. Therefore, there is expansion of branches like urban economics and rural economics. Similarly, regional economics is also being emphasised to meet the challenge of geographical inequalities. There are many other branches of economics that form the scope of economics. There are welfare economics, monetary economics, energy economics, transport economics, demography, labour economics, agricultural economics, gender economics, economic planning, economics of infrastructure, etc.

OBJECTIVE TYPE QUESTIONS

1. Who is known as father of economics: (a) Keynes (b) Samuelson (c) Marshall (d) Adam Smith 2. Which of the following economist is credited for growth of macroeconomics: (a) Adam Smith

(b) Keynes (c) J.S. Mill (d) Karl Marx 3. In Science of material welfare formed the basis of defining economics by: (a) Adam Smith (b) Marshall (c) Robbins (d) Samuelson 4. General Theory authored by J.M. Keynes was published in: (a) 1919 (b) 1930 (c) 1936 (d) 1956 5. Which of the following economist is identified with welfare economics: (a) A.C. Pigou (b) Edwin Cannan (c) Robbins (d) Samuelson

1. (d)

ANSWER

3. (b)

2. (b)

SHORT ANSWER TYPE QUESTIONS

4. (c)

5. (a)

1. Give the definition of economics given by Adam Smith. 2. Differentiate between Microeconomics and Macroeconomics.

chief of Omaha, W arren E. Buffett, the renowned chairman andstartedexecutive of cerpartnership Nebraska-based Berkshire Hathaway, Inc., an investment

with $100 in 1956 and has gone on to accumulate a personal net worth in excess of $30 billion. It is intriguing that Buffett credits his success to a basic understanding of managerial economics. Berkshire s collection of operating businesses includes the GEICO Insurance Company, Buffalo News newspaper, See s Candies, and the Nebraska Furniture Mart. They commonly earn 30% 50% per year on invested capital. This is astonishingly good performance in light of the 10% 12% return typical of industry in general. A second and equally important contributor to Berkshire s outstanding performance is a handful of substantial holdings in publicly traded common stocks such as The American Express Company, The Coca-Cola Company, and Wells Fargo & Company. As both manager and investor, Buffett looks for wonderful businesses with outstanding economic characteristics: high rates of return on invested capital, substantial pro t margins on sales, and consistent earnings growth. Complicated businesses that face erce competition or require large capital investment and ongoing innovation are shunned.1 Buffett s success is powerful testimony to the practical usefulness of managerial

economics. Managerial economics answers fundamental questions. When are the characteristics of a market so attractive that entry becomes appealing? When is exit preferable to continued operation? Why do some professions pay well, whereas others offer meager pay? Successful managers make good decisions, and one of their most useful tools is the methodology of managerial economics.

T HE M ANAGERIAL D ECISION -M AKING P ROCESS

Managerial economics applies economic theory and methods to business and administrative decision making. Managerial economics prescribes rules for improving managerial decisions. Managerial economics also helps managers recognize how economic forces affect organizations and describes the economic consequences of managerial behavior. It links traditional economics with the decision sciences to develop vital tools for managerial decision making. This process is illustrated in Figure 1.1. Managerial economics identi es ways to ef ciently achieve goals. For example, suppose a small business seeks rapid growth to reach a size that permits ef cient use

of national media advertising. Managerial economics can be used to identify pricing and production strategies to help meet this short-run objective quickly and effectively.

See James P. Miller, Buffett Bash Is Set to Burst Over Omaha, The Wall Street Journal, May 3, 1999, C1.

CHAPTER 1 The Nature and Scope of Managerial Economics

FIGURE 1.1

THE ROLE OF MANAGERIAL ECONOMICS IN MANAGERIAL DECISION MAKING

Managerial economics uses economic concepts and decision science techniques to solve managerial problems.

Management Decision Problems Product Price and Output Make or Buy Production Technique

Internet Strategy Advertising Media and Intensity Investment and Financing

Economic Concepts Framework for Decisions Theory of Consumer Behavior Theory of the Firm Theory of Market Structure and Pricing

Decision Sciences Tools and Techniques of Analysis Numerical Analysis Statistical Analysis Forecasting Game Theory Optimization

Managerial Economics Use of Economic Concepts and

Decision Science Methodology to Solve Managerial Decision Problems

Optimal Solutions to Managerial Decision Problems

Similarly, managerial economics provides production and marketing rules that permit the company to maximize net pro ts once it has achieved growth objectives. Managerial economics has applications in both pro t and not-for-pro t sectors. For example, an administrator of a nonpro t hospital strives to provide the best medical care possible given limited medical staff, equipment, and related resources. Using the tools and concepts of managerial economics, the administrator can determine the optimal allocation of these limited resources. In short, managerial economics helps managers arrive at a set of operating rules that aid in the ef cient use of scarce human and capital resources. By following these rules, businesses, nonpro t organizations, and government agencies are able to meet objectives ef ciently. To establish appropriate decision rules, managers must understand the economic

environment in which they operate. For example, a grocery retailer may offer consumers a highly price-sensitive product, such as milk, at an extremely low markup over cost say, 1% or 2% while offering less price-sensitive products, such as nonprescription drugs, at markups of as high as 40% over cost. Managerial economics

PART I Overview of Managerial Economics

describes the logic of this pricing practice with respect to the goal of pro t maximization. Similarly, managerial economics reveals that auto import quotas reduce the availability of substitutes for domestically produced cars, raise auto prices, and create the possibility of monopoly pro ts for domestic manufacturers. It does not explain whether imposing quotas is good public policy; that is a decision involving broader political considerations. Managerial economics only describes the predictable economic consequences of such actions. Managerial economics offers a comprehensive application of economic theory and

methodology to managerial decision making. It is as relevant to the management of nonbusiness, nonpro t organizations such as government agencies, cooperatives, schools, hospitals, museums, and similar institutions, as it is to the management of pro t-oriented businesses. Although this text focuses primarily on business applications, it also includes examples and problems from the government and nonpro t sectors to illustrate the broad relevance of managerial economics concepts and tools.

Methods of Economic Analysis:

An economic theory derives laws or generalizations through two methods: (1) Deductive Method and (2) Inductive Method. These two ways of deriving economic generalizations are now explained in brief:

(1) Deductive Method of Economic Analysis:

The deductive method is also named as analytical, abstract or prior method. The deductive method consists in deriving conclusions from general truths, takes few general principles and applies them draw conclusions. For instance, if we accept the general proposition that man is entirely motivated by selfinterest. In applying the deductive method of economic analysis, we proceed from general to particular. The classical and neo-classical school of economists notably, Ricardo, Senior, Cairnes, J.S. Mill, Malthus, Marshall, Pigou, applied the deductive method in their economic investigations.

Steps of Deductive Method:

The main steps involved in deductive logic are as under: (i) Perception of the problem to be inquired into: In the process of deriving economic generalizations, the analyst must have a clear and precise idea of the problem to be inquired into.

(ii) Defining of terms: The next step in this direction is to define clearly the technical terms used analysis. Further, assumptions made for a theory should also be precise. (iii) Deducing hypothesis from the assumptions: The third step in deriving generalizations is deducing hypothesis from the assumptions taken. (iv) Testing of hypothesis: Before establishing laws or generalizations, hypothesis should be verified through direct observations of events in the rear world and through statistical methods. (Their inverse relationship between price and quantity demanded of a good is a well established generalization).

Merits of Deductive Method:

The main merits of deductive method are as under: i. This method is near to reality. It is less time consuming and less expensive. ii. The use of mathematical techniques in deducing theories of economics brings exactness and clarity in economic analysis. iii. There being limited scope of experimentation, the method helps in deriving economic theories. iv. The method is simple because it is analytical.

Demerits of Deductive Method:

It is true that deductive method is simple and precise, underlying assumptions are valid. There is big, IF, in the statement. The shortcomings of the deductive approach are as under:

i.
The deductive method is simple and precise only if the underlying assumptions are valid. More often the assumptions turn out to be based on half truths or have no relation to reality. The conclusions drawn from such assumptions will, therefore, be misleading. Professor Learner describes the deductive method as armchair analysis. According to him, the premises from which inferences are drawn may not hold good at all times, and places. As such deductive reasoning is not applicable universally. The deductive method is highly abstract. It require: a great deal of care to avoid bad logic or faulty economic reasoning. As the deductive method employed by the classical and neo-classical economists led to many facile conclusions due to reliance on imperfect and incorrect assumptions, therefore, under the German Historical School of economists, a sharp reaction began against this method. They advocated a more realistic method for economic analysis known as inductive method.

ii. iii.

(2) Inductive Method of Economic Analysis:

Inductive method which also called empirical method was adopted by the Historical School of Economists". It involves the process of reasoning from particular facts to general principle. This method derives economic generalizations on the basis of (i) Experimentations (ii) Observations and (iii) Statistical methods. In this method, data is collected about a certain economic phenomenon. These are systematically arranged and the general conclusions are drawn from them. For example, we observe 200 persons in the market. We find that nearly 195 persons buy from the cheapest shops, Out of the 5 which remains, 4 persons buy local products even at higher rate just to patronize their own products, while the fifth is a fool. From this observation, we can easily draw conclusions that people like to buy from a cheaper shop unless they are guided by patriotism or they are devoid of commonsense.

Steps of Inductive Method:

The main steps involved in the application of inductive method are: (1) observation (2) formation of hypothesis (3) generalization and (4) verification.

Merits of inductive method:

i. ii. iii. iv.
It is based on facts as such the method is realistic. In order to test the economic principles, method makes statistical techniques. The inductive method is, therefore, more reliable. Inductive method is dynamic. The changing economic phenomenon are analyzed and on the basis of collected data, conclusions and solutions are drawn from them. Induction method also helps in future investigations.

Demerits of inductive method:

The main weaknesses of this method are as under: i. If conclusions drawn from insufficient data, the generalizations obtained may be faulty. ii. The collection of data itself is not an easy task. The sources and methods employed in the collection of data differ from investigator to investigator. The results, therefore, may differ even with the same problem. iii. The inductive method is time-consuming and expensive.

Conclusion:
The above analysis reveals that both the methods have weaknesses. We cannot rely exclusively on any one of them. Modern economists are of the view that both these methods are complimentary. They partners and not rivals. Alfred Marshall has rightly remarked: Inductive and Deductive methods are both needed for scientific thought, as the right and left foot are both needed for walking. We can apply any of them or both as the situation demands.

hases of Business Cycle in Business and Financial Market After understanding what are business cycle and their characteristics, we will take each phase of business cycle in detail. Prosperity or Expansion:

This phase of business cycle is called the upswing. This phase is in the upper half of the cycle. To start with, we will try to see how this phase begins. It starts from equilibrium position. When the demand increases, the demand of raw material also increases and so the employment which again leads to increase in employment in other industry. As the consumption increases, general employment also increases. The wages, salaries, interest rates, taxes and the cost do not increase in the same proportion

and consequently profit margins go up. There is a general feeling of optimism, and the production capacity of the economy is fully utilized. The rise in general price is marked in this phase. In this phase, investment activity increases due to increase in demand for consumption goods. This optimistic sentiment can be seen in real estate and share market boom. Manufacturers pile up stock with improved prospects of increase in demand. This activity of producers increase in production is faster than consumption. But this process cannot be indefinitely continued. This phase ends and turns into phase of recession. The factors for recession to start are, when the gap between cost and price starts rising and the profit margin declines. This happens because of scarcity felt in different factor market and therefore the price of factors of production rises. Recession: This is a turning period, which is relatively shorter. But in this phase the production of consumer goods do not decline immediately. The demand for consumer goods fall with lag but the fall in demand for capital goods falls drastically. Producers cancel their future investment programmers so the demand for machinery decreases and therefore the capital goods manufacturing sectors respond more quickly. In this period over optimism gives way to over pessimism. All the investment seems unprofitable and so there is collapse in Marginal Efficiency of Capital. The employment situation gets bad as investment activity declines. This is referred as mild recession but when recession is severe it is called crisis. Depression or Contraction:

This phase is a phase of low economic activity. There is a fall in production and employment throughout the economy. But it is not uniform in all sectors. The fall in demand for consumer goods is less than the fall in demand for machines and equipment. During depression, the expenditure on durable goods fall more than consumer goods. Therefore, the production and employment is affected in the sectors producing durable goods. Agriculture sectors are not much affected, as it is necessary for subsistence. The producers and wholesalers start liquidating their inventories piling up during prosperity phase. This phase shows low economic activity with fall in production, fall in employment and fall in general price level and the profit margins also. Producers are not interested to venture fresh investment as the MEC totally collapses. The price structure is distorted as for some goods, price falls a little; whereas for some goods, the price vertically collapses making the income distribution worst and this prolongs the phase of depression. On the other hand, not all the costs fall at an equal rate; as wages and salaries tend to be sticky during this period due to trade unions about labour laws. Rents, interest rates and taxes come down slowly, while price falls down continuously and cost rigidity washes away the profit margins for producer. Turning point of depression is trough, which is a very short period but sometimes it is for 3-5 years. For e.g. the Great depression of 1930s. After this, the recovery phase starts. Recovery:

This phase is gradual. It starts when the price stops falling. This is said to start when the piled up stock is exhausted. Now, the producers start planning for production. This generates employment and income, which again leads to demand for consumer goods. The MEC starts improving. This leads to correction of price and so also to the relationship between cost and price. The profit starts replacing looses and recovery gathers momentum. Rising price encourages companies towards new investment and projects. This phase of recovery takes the economy to the phase of prosperity. Thus, the cycle is again ready to repeat itself. Now we know what a business cycle and the phases of business cycle. In the next section, we will try to understand the theories of business cycle. They will explain you the causes of business cycle