MANAGERIAL ECONOMICS

Ms.HEMASHREE K
AP- MBA
HICET
 MANAGERIAL ECONOMICS
● Meaning
● Nature,
● Scope
● Managerial Economics –
Micro and Macroeconomics-
● Relationship between
OVERVIEW managerial economics and
other disciplines
● Roles and Responsibilities of
managerial economist
● Basic economic tools for
Decision Making.
 CONCEPT OF ECONOMICS

● Economy and Economics are two different

things/terms.
● Economy is the system of production,distribution
& consumption of goods and services that a
society uses to tackle the problem of scarcity of
resources.
● Economics refers to the conditions under which
goods and services are produced in a society and
the way the people are gainfully employed.
 Three Economic Questions?

● Economic system is the way in which a

society decides the 3 fundamental
questions
1. What to produce?
2. How to produce?
3. For whom to produce?
THE CIRCULAR FLOW OF ECONOMIC
ACTIVITY
 INTRODUCTION OF ECONOMICS

● Economics is a social science concerned

chiefly with the way society chooses to
employ its limited resources which have
alternative uses, to produce goods and
services for present and future
consumption.
 Introduction of Economics
Many Economist define economics in different
ways. The set of definitions given by different
economists can broadly be classified into 4
categories
1. Wealth- Adam Smith
2. Material welfare- Alfreed Marshall
3. Scarcity- Lionel Robbins
4. Growth- Paul A.Samuelson
Wealth - Adam Smith

“A Science which studies the nature &

causes of the wealth of nations”
Welfare- Alfred Marshall

“Economics is a mankind of ordinary

business of life, its enquiry how he gets his
income and how he spend it”
Scarcity- Lionel Robbins

“Economics is the science which studies

human behavior as relationship between
Ends & Scare means which have alternative
uses”
Growth- Paul A Samuelson

“Economic is the study of how man and society chooses, with or

without uses of money, to employ scarce resources which have
alternative uses to produce various commodities over time and
distribute them for consumption now and in the future among
various people and group of society.
 Nature of Economics
● Economics as a Science
● Economics as an Art
● Economics a Positive Science
● Economics a Normative Science
● Economics a Social Science.
 Scope of Economics

● Micro- economics is the branch of economics that

examines the functioning of individual industries and
the behavior of individual decision- making units- that
is, business firms and households.
● Macro- economics is the branch of economics that
examines the economic behavior of aggregates-
income, output, employment and so-on---- on a
national scale.
SCOPE OF ECONOMICS

ECONOMICS

MICRO MACRO
ECONOMICS ECONOMICS
Concepts of Micro Economics
● Micro Economics is the branch of economics that
examines the functioning of individual industries and
the behavior of individual decision- making units- that
is, business firms and households.
● Product Pricing- (Theory of Demand, Production &Cost)
● Factor Pricing- (Rent, wages,Interest, Profits)
● Theory of economics Welfare
Concepts of Macro Economics
● Macro-economics is the branch of economics that
examines the economic behavior of aggregates-
income, output, employment and so-on---- on a
national scale.
● National income
● Employment
● Inflation
● Growth
Difference between Microeconomics and
Macroeconomics
Concept of Managerial Economies
“ Managerial Economies applies the principles and method of
economies by applying the concept, the branches of economics,
analyzes problems faced by management of a business or other
types of organizations and to help find solutions that advance
the best interests of such organizations”
-Davis and Chang
Definitions of Managerial Economics

Mansfield: Managerial Economics is concerned with the

application of economics concepts and economics to the
problems of formulating rational decision making.
Douglas: Managerial Economics is concerned with
application of economics principles and methodologies
to the decision making process within the firm or
organisation. It seeks to establish rules and principles to
facilitates the attainment of the desired economic goals
of management.
MEANING OF MANAGERIAL ECONOMIES
NATURE / CHARACTERISTICS OF
MANAGERIAL ECONOMICS
Significance of Managerial Economics
❖ Business Planning
❖ Cost Control
❖ Price Determination
❖ Business Prediction
❖ Profit planning & control
❖ Inventory Management
❖ Manages Capital
 Managerial economics relationship with other
disciplines:
Managerial economics relationship with other disciplines:

● Many new subjects have evolved in recent years due to the

interaction among basic disciplines.

● Managerial economics can be taken as the best example of

such a phenomenon among social sciences.

● Hence it is necessary to trace its roots and relationship with

other disciplines.
OTHER AREAS RELATED TO MANAGERIAL ECONOMICS

1. Managerial Economics Relationship with Economics

2. Managerial Economics and accounting

3. Managerial Economics and Mathematics

4. Managerial Economics and Statistics

5. Managerial Economics and Operations Research

6. Managerial Economics and the theory of Decision- making

7. Managerial Economics and Computer Science

Managerial Economics Relationship with Economics
 Management theory and accounting:
Managerial economics has been influenced by the developments in management theory
and accounting techniques.

Accounting refers to the recording of pecuniary transactions of the firm in certain

books. A proper knowledge of accounting techniques is very essential for the success
of the firm because profit maximization is the major objective of the firm.

• Managerial Economics requires a proper knowledge of cost and revenue information

and their classification.

• A student of managerial economics should be familiar with the generation,

interpretation and use of accounting data. The focus of accounting within the firm is
fast changing from the concepts of store keeping to that if managerial decision making,
this has resulted in a new specialized area of study called “Managerial Accounting”.
 Managerial Economics and mathematics:
• The use of mathematics is significant for managerial economics in view
of its profit maximization goal along with optional use of resources.

• The major problem of the firm is how to minimize cost, how to maximize
profit or how to optimize sales.

• Mathematical concepts and techniques are widely used in economic

logic to solve these problems

• Mathematical symbols are more convenient to handle and understand

various concepts like incremental cost, elasticity of demand etc.,
Geometry, Algebra and calculus are the major branches of mathematics
which are of use in managerial economics.
 Managerial Economics and Statistics:
● Managerial Economics needs the tools of statistics in more than
one way.
● A successful businessman must correctly estimate the demand
for his product. He should be able to analyses the impact of
variations in tastes, Fashion and changes in income on demand
only then he can adjust his output.
● Statistical methods provide and sure base for decision- making.
Thus statistical tools are used in collecting data and analyzing
them to help in the decision making process. •
● Managerial Economics also make use of correlation and multiple
regressions in related variables like price and demand to estimate
the extent of dependence of one variable on the other. The theory
of probability is very useful in problems involving uncertainty.
 Managerial Economics and Operations Research

● Operation research provides a scientific model of the system

and it helps managerial economists in the field of product
development, material management, and inventory control,
quality control, marketing and demand analysis.

● The varied tools of operations Research are helpful to

managerial economists in decision- making.
Managerial Economics and the theory of Decision- making:

• The Theory of decision-making is a new field of knowledge grown in this

century.

• Most of the economic theories explain a single goal for the consumer i.e.,
Profit maximization for the firm. But the theory of decision-making is
developed to explain multiplicity of goals due to lot of uncertainty.

• As such this new branch of knowledge is useful to business firms, which

have to take quick decision in the case of multiple goals.

• Viewed this way the theory of decision making is more practical and
application oriented than the economic theories.
 Managerial Economics and Computer Science
• Computers have changed the way of the world functions and
economic or business activity is no exception.

• Computers are used in data and accounts maintenance, inventory

and stock controls and supply and demand predictions.

• What used to take days and months is done in a few minutes or

hours by the computers

• In most countries a basic knowledge of computer science, is a

compulsory programme for managerial trainees.
Economics
Managerial Economics
Managerial Economist
Managerial Decision
Making Process
● Business decision making is essentially a process of
selecting the best out of alternative opportunities open
to the firm.

● The steps in next slides put managers’ analytical ability

to test and determine the appropriateness and validity
of decisions in the modern business world.
The Rational Decision-Making Process
Step 1: Identify the Problem

● Though this starting place might seem rather obvious, a failure to

identify the problem clearly can derail the entire process. It can
sometimes require serious thought to find the central issue that
must be addressed.
● For example, you have taken a new job and you may initially decide
you need to find a new car for commuting back and forth from work.
However, the central problem is that you need a reliable way to
commute to and from work.
Step 2: Establish Decision Criteria

● In this step, the decision maker needs to determine what is relevant in

making the decision.

● This step will bring the decision maker’s, and any other stakeholder’s
interests, values and preferences into the process.

● To continue our example, let’s assume you are married. Some of the
criteria identified might include budget, safety, functionality, and reliability.
Step 3: Weigh Decision Criteria

● Because the criteria identified will seldom be equally important, you

will need to weight the criteria to create the correct priority in the
decision.

● For example, you may have weighted budget, safety, and reliability
as the most important criteria to consider, along with several other
slightly less critical criteria.
Step 4: Generate Alternatives

● Once you have identified the issue and gathered relevant information,
now it is time to list potential options for how to decide what to do.

● Some of those alternatives will be common and fairly obvious options,

but it is often helpful to be creative and name unusual solutions as well.

● The alternatives you generated could include the types of cars, as well
as using public transportation, car pooling and a ride-hailing service.
Step 5: Evaluate Alternatives

● After creating a somewhat full list of possible alternatives, each alternative

can be evaluated.

● Which choice is most desirable and why? Are all of the options equally
feasible, or are some unrealistic or impossible?

● Now is the time to identify both the merits and the challenges involved in
each of the possible solutions.
Step 6: Select the Best Alternative

● After a careful evaluation of alternatives, you must choose a solution.

● You should clearly state your decision so as to avoid confusion or
uncertainty.
● The solution might be one of the particular options that was initially listed, an
adaptation of one of those options, or a combination of different aspects
from multiple suggestions.
● It is also possible that an entirely new solution will arise during the
evaluation process.
Question:
The Ashok have a large family with 12 children. They need to pick a new car that will
serve everyone, including 4 teenagers who are driving age or approaching it. Their
criteria include safety, gas mileage, reliability, and seating for 14. They are following
the rational decision-making process so that they can have a family discussion
without heated words. What is the next step?

1. Generate Alternatives

2. Weigh the decision Criteria

3. Identify the Problem

Modern business conditions are changing so fast
and becoming so competitive and complex that
personal business sense, intuition and
experience alone are not sufficient to make
appropriate business decisions.
It is in this area of decision making that
economic theories and tools of economic
analysis contribute a great deal.
● Economic theory offers a variety of concepts and
analytical tools which can be of considerable
assistance to the managers in his decision
making practice.
● These tools are helpful for managers in solving
their business related problems.
● These tools are taken as guide in making
decision.
Basic economic tools for Decision Making.
1. Opportunity cost principle
2. Incremental principle
3. Principle of the time perspective
4. Discounting principle
5. Equi-marginal principle
Opportunity cost
● The opportunity cost of the funds employed in one’s own
business is the interest that could be earned on those funds if
they have been employed in other ventures.
● The opportunity cost of using a machine to produce one product
is the earnings forgone which would have been possible from
other products.
● The opportunity cost of holding Rs.1000 as cash in hand for one
year is the 10% rate of interest, which would have been earned
had the money been kept as fixed deposit in bank.

It's clear now that opportunity cost requires process of finding

sacrifices. If a decision involves no sacrifices, its opportunity cost is
nil. For decision making opportunity costs are the only relevant
costs.
 Opportunity Cost Principle

● Opportunity cost of anything is the cost of

the next best alternative which is given
up.
● It is also called as alternative cost or
transfer cost.
 Incremental Principle/ Principle of
Incrementalism

● The main objective of Incremental principle is

maximizing the profit.

● By increasing in the production, the total cost of

the product raises and simultaneously profit also
rises.
Incremental Principle/ Principle of Incrementalism

● Two important incremental concepts used in

managerial economics are Incremental Cost and
Incremental Revenue.
● Incremental Cost is a change in total cost resulting
from a decision
● Incremental Revenue means the change in total
revenue resulting from a decision
 Incremental Cost
● It is the total cost incurred due to an additional unit of product being
produced.

Example: When i company makes and implements managerial decisions

regarding the production of goods or services, the extra cost arising from this
decision is its incremental cost.

❖ Incremental cost arising from:

❖ Changing the level of product output
❖ Buying additional or new materials
❖ Hiring extra labour
❖ Adding new machine or replacing the existing one
Hence, Incremental Cost is a change in total cost resulting from a decision
 How incremental cost and incremental revenue affect each
other:

❖ If your incremental cost in manufacturing a product unit is lower than the

incremental revenue you earn from selling that unit---> your business earns

a profit. OR IC<IR

❖ If your incremental cost in manufacturing a product unit is higher than the

incremental revenue you earn from selling that unit --> your business suffers

a loss. OR IC>IR
Example:
suppose that you have a business that manufactures
smartphones and expect to sell 20,000 units. It costs you $100 to
manufacture each smartphone, and your selling price per
smartphone is $300.

a. Calculate Incremental Cost.

b. Calculate Incremental Revenue
c. Company’s status (Profit or loss)
Incremental cost
You calculate your incremental cost by multiplying the number of smartphone units with the
manufacturing cost per smartphone unit.
So, in this case, you will have:
20,000 x 100 = 2,000,000. So, incremental cost is $2,000,000.
Incremental revenue
You calculate your incremental revenue by multiplying the number of smartphone units with the
selling price per smartphone unit.
So, you will have:
20,000 x 300 = 6,000,000. So, incremental revenue is $6,000,000.
When you compare the two, it is clear that the incremental revenue is higher than the incremental
cost. By subtracting the incremental cost from the incremental revenue, you arrive at a profit of
$4,000,000.
By doing this type of cost analysis in advance, you can estimate how much you should budget for
your business and how much profit you might make. You can then decide if it makes business sense
or not to expand operations.
Incremental Principle

Incremental concept involves estimating the impact of

decision alternatives on costs and revenue,
emphasizing the changes in total cost and total
revenue resulting from changes in prices, products,
procedures, investments or whatever may be at
stake in the decisions.
 Principle of Time Perspective

● “A decision by the firm should take into account of

both short-run and long-run effects on revenues and
cost
● Maintain the right balance between the long run
and short run.
Eg: ABC is a firm engaged in continuous production of X commodities (long run). In the
production process, it is having daily an ideal time (free time) for few hours. In that
ideal time, firm can take an order for manufacturing other similar goods instead of
wasting time. By manufacturing goods in the ideal time firm does not incur any extra
fixed cost like (salaries, wages and rent and) because it is constant. So the fixed cost is
absent in the production which is done in the ideal time. Generally in production of
goods, fixed and variable cost (raw material & labour) is present. However, here the
production made in the ideal time, fixed cost is absent. This shows the cost is reduced
in production that is made in the ideal time. Investment made in the business can also
be recovered very quickly and in short time.
 Discounting Principle

❏ Discounting principle explains about the comparison of

money value in present and future time.
❏ One of the fundamental ideas in Economics is that a rupee
tomorrow is worth less than a rupee today.
Example:1
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.
Answer

Normally a person chooses first offer only. Why

because “today rupee is having more worth
than tomorrows rupee”
 This is true for two reasons-

• The future is uncertain and there may be uncertainty

in getting Rs. 100/- if the present opportunity is not
availed of,
• Even if he is sure to receive the gift in future, today’s
Rs.100/- can be invested so as to earn interest say as
8% so that one year after Rs.100/- will become 108.
Example:2

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.
 Equi – marginal Principle

● Equi-marginal principle is one of the widely used concepts in

managerial economics. This principle is also known the principle of

maximum satisfaction - by allocating available resource to get
optimum benefit .

● This principle provides a basis for maximum utilization of all the inputs

of a firm so as to maximize the profitability.

Marginal Productivity Formula
Marginal Utility(MU) =TUn-TU(n-1)
 Budget $10 Rational Women/men Consumer behaviour pattern
Lemonade (Product A) Sandwiches (Product B)

Quantity Total Marginal MU/P Quantity Total Marginal MU/P

($2 per Utility Utility ($2 per Utility Utility
item) item)

1 30 1 13

2 55 2 25

3 75 3 36

4 90 4 46

5 100 5 55