Module 1

Managerial Economic
What is Economic?
Economics is a social science that studies how individuals, businesses, governments, and
societies make choices about the allocation of scarce resources to satisfy unlimited wants
and needs. It analyses the production, distribution, and consumption of goods and services.
At its core, economics examines how individuals and societies manage resources and make
decisions in order to maximize their well-being.
Nature of economic
1. Economics as a Science
Science deals with systematic studies that signify the cause-and-effect relationship. In
science, facts and figures are collected and are analysed systematically to arrive at any
certain conclusion.

2. Economics as an Art
It is said that “knowledge is science, action is art.” Economic theories are used to solve
various economic problems in society. Thus, it can be inferred that besides being a social
science, economics is also an art.

3.Economics as a Social Science

economics is treated as a social science because of the following features:

 It involves a systematic collection of facts and figures.

 Like in science, it is based on the formulation of theories and laws.
 It deals with the cause-and-effect relationship.
Economics is classified as a social science because it examines human behaviour and
interactions in the context of economic activities. It analyses how individuals, businesses,
governments, and societies make choices and allocate resources to satisfy their needs and
wants.
4.Micro economic
Microeconomics focuses on individual economic agents, such as consumers, firms, and
markets. It studies how these agents make decisions regarding resource allocation,
production, pricing, and consumption. Microeconomics explores topics like supply and
demand, market equilibrium, consumer behaviour, and firm behaviour.

5. Macroeconomics:
Macroeconomics deals with the behaviour and performance of the entire economy
or large sectors of it. It examines aggregated variables such as national income, inflation,
unemployment, economic growth, and fiscal and monetary policies. Macroeconomics aims
to understand and influence factors that impact the overall economic conditions of a
country or region.
6. Multidisciplinary:
Economics often draws insights from other disciplines, such as mathematics, statistics,
psychology, sociology, political science, and history. It integrates knowledge and methods
from these various fields to enhance understanding and provide a comprehensive analysis
of economic issues.
7. Normative economics:
Normative economics deals with value judgments and policy recommendations. It
involves assessing economic outcomes in terms of what ought to be, rather than describing
and explaining how things are. Normative statements are subjective and depend on
individual or societal preferences. Economists may use normative analysis to provide
guidance on policy decisions and advocate for specific economic objectives.

Scope of Managerial Economic

1. Analysing and Forecasting: Managerial economics involves analysing economic data

and trends to make informed decisions. This includes studying market conditions,
consumer behaviour, and industry dynamics. Forecasting helps managers anticipate
future trends and adjust strategies accordingly.

2. Cost and Production Analysis: Managers use economic tools to analyse costs and
production processes. This includes evaluating factors of production, cost structures,
economies of scale, and resource allocation to maximize efficiency and productivity.

3. Pricing Decision Policies and Practices: Managerial economics assists in determining

optimal pricing strategies. It involves assessing factors such as market demand,
competition, production costs, and customer preferences to set prices that maximize
revenue and profitability.

4. Profit Management: Maximizing profits is a key objective for most organizations.

Managerial economics provides techniques for profit optimization by examining
revenue generation, cost minimization, and pricing strategies.

5. Government Relations: Understanding the impact of government policies and

regulations is crucial for effective decision-making. Managerial economics helps
managers navigate the regulatory environment, assess compliance costs, and
anticipate changes in government policies that could affect the organization.

6. Management of Public Sector Enterprises: Managerial economics also applies to the

public sector, where government agencies and entities must make resource
allocation decisions and manage public resources efficiently. It involves evaluating
public goods, cost-benefit analysis, and optimizing social welfare.

Micro economic

Microeconomics is a branch of economics that focuses on the study of individual economic

units such as households, firms, and markets. It examines how these units make decisions
regarding the allocation of scarce resources and how their interactions shape the overall
economy. Microeconomics analyses factors such as supply and demand, pricing, production,
consumption, and market behaviour

Let's consider the market for smartphones. In this scenario, the individual economic units
are the smartphone producers (firms) and the consumers (households).

1. Supply and Demand: The supply side refers to the firm’s producing smartphones,
determining how many units they are willing and able to produce at different price
levels. The demand side represents the consumers, determining how many
smartphones they are willing and able to purchase at different price levels.

2. Price Elasticity: Microeconomics also explores the concept of price elasticity, which
measures the responsiveness of demand or supply to changes in price. For instance,
if the price of smartphones increases, microeconomics would study how this affects
the quantity demanded by consumers. It would also analyse whether the demand
for smartphones is elastic (highly responsive to price changes) or inelastic (less
responsive to price changes)

3. Consumer Behaviour: Microeconomics delves into consumer decision-making

processes. For example, it investigates how consumers make choices between
different smartphone brands based on factors such as price, features, and brand
loyalty. It analyses the utility consumers derive from different options and how they
allocate their limited income to maximize satisfaction.

4. Firm Behaviour: Microeconomics examines the decision-making process of firms in

the smartphone market. It investigates how firms determine the quantity of
smartphones to produce, the cost of production, pricing strategies, and profit
maximization. It also explores factors such as technological advancements and
competition that influence the behaviour of firms in the market.

Macro-Economic

Macroeconomics is a branch of economics that studies the behaviour and

performance of an entire economy. It focuses on key economic indicators such as
GDP (Gross Domestic Product), inflation, unemployment, interest rates, and
government policies, among others. Macroeconomics examines the overall
behaviour and trends in the economy as a whole rather than specific individual
markets or industries.

To provide an example of macroeconomics, let's consider the concept of inflation.

Inflation refers to the sustained increase in the general price level of goods and
services over time. Macroeconomists analyse inflation to understand its causes,
consequences, and potential policy interventions.

For instance, suppose a country experiences a period of high inflation.

Macroeconomists would investigate the factors contributing to this inflation, such as
 excessive money supply, supply chain disruptions, or changes in government
policies. They would also study the effects of inflation on different sectors of the
economy, including its impact on consumers' purchasing power, businesses'
production costs, and the overall economic growth.

Role of managerial Economic

1. Demand Analysis and Forecasting: Managerial economics helps managers

understand customer demand patterns, analyze market conditions, and forecast
future demand for products or services. This information enables them to optimize
production levels, pricing strategies, and resource allocation.

2. Cost Analysis: Managerial economics provides tools and techniques for analysing
costs and identifying cost drivers. Managers can use this information to make
decisions regarding production processes, cost control, pricing strategies, and
resource allocation to achieve cost efficiency and maximize profitability.

3. Pricing Decisions: Managerial economics assists managers in determining optimal

pricing strategies based on demand elasticity, cost structures, and market
conditions. By analysing pricing models and conducting price sensitivity analysis,
managers can set prices that maximize revenue and achieve competitive advantage.

4. Production and Supply Decisions: Managerial economics helps managers make

decisions related to production levels, capacity utilization, and supply chain
management. It considers factors such as economies of scale, production costs,
resource availability, and market demand to ensure efficient production processes
and optimal allocation of resources.

5. Investment Analysis: Managerial economics provides analytical tools for evaluating

investment opportunities and capital budgeting decisions. It helps managers assess
the profitability and feasibility of investment projects, considering factors such as
cash flows, discount rates, risk analysis, and return on investment.

6. Risk and Uncertainty Analysis: Managerial economics enables managers to assess

and manage risks associated with decision-making. It provides techniques for
analysing uncertainty, conducting risk assessments, and developing risk mitigation
strategies, such as diversification, insurance, or contingency planning.

7. Market Structure and Competitive Analysis: Managerial economics helps managers

understand the market structure, competitive forces, and industry dynamics in
which their organizations operate. This knowledge allows them to identify
competitive advantages, formulate effective marketing strategies, and respond to
market changes and competitor actions.
 8. Government Policy Analysis: Managerial economics considers the impact of
government policies, regulations, and taxes on business operations. It helps
managers understand the economic implications of government interventions and
assists in formulating strategies to comply with regulations or advocate for
favourable policies.

BASIS FOR POSITIVE ECONOMICS NORMATIVE ECONOMICS

COMPARISON
Meaning A branch of economics based on A branch of economics based on values,
data and facts is positive opinions and judgement is normative
economics. economics.
Nature Descriptive Prescriptive
What it does? Analyses cause and effect Passes value judgement.
relationship.
Perspective Objective Subjective
Study of What actually is What ought to be
Testing Statements can be tested using Statements cannot be tested.
scientific methods.
Economic issues It clearly describes economic It provides solution for the economic
issue. issue, based on value.

Managerial decision-making process

1. Establishing Objectives: This step involves clearly defining the goals and objectives
that the decision should achieve. It's important to have a clear understanding of
what you want to accomplish before proceeding.

2. Defining the Problem: In this step, the manager identifies and defines the problem
or the decision that needs to be made. It's essential to have a clear understanding of
the issue at hand and what needs to be resolved or improved.

3. Identifying Possible Alternative Courses of Action: Once the problem is defined, the
manager generates a range of potential solutions or alternative courses of action.
Brainstorming, research, and gathering input from others can help generate a variety
of options.

4. Evaluating Alternative Courses of Action: In this step, each alternative is carefully

analysed and evaluated. This may involve considering the advantages,
disadvantages, potential risks, costs, and benefits associated with each option.
Decision criteria and decision-making models may be used to assess and compare
the alternatives.

5. Implementing and Monitoring the Decision: After selecting the best alternative, the
manager moves forward with implementing the decision. This step involves putting
the chosen course of action into practice. Additionally, it is important to monitor the
 implementation to ensure that it is progressing as planned. Regular monitoring and
feedback allow for adjustments if necessary.

Principles of Economics

1. People face trade-offs: Everyone faces decisions that put one option above the other.
Most decisions, especially economic ones, involve trading off one thing for another. In
society, one of the main trade-offs we experience is between efficiency and equity.
Efficiency refers to something we can get the most out of, especially if the resource is
scarce. Equity implies that all members of society benefit equally from a resource. The
theory is that people will make good decisions if they thoroughly understand both options.
However, what usually ends up happening in life and in economics is that one item, either
efficiency or equity, is chosen above the other. For example, the way students decide to
spend their time or how governments allocate budgets can be examples of the trade-offs
people face.
2. The cost of something is what you give up to get it: Since people face these trade-offs, a
decision requires a comparison of the costs against the benefits of alternative courses of
action. Sometimes, the most obvious action or answer isn’t the first one you would think of.
Each item has an opportunity cost, in other words, what you’re giving up to get it. So, when
facing a decision, people should understand the opportunity cost involved in that decision
and in each action. For example, some people consider only the cost of an action, but not
the time involved. Cooking dinner at home is cheaper than ordering from a restaurant, but
takes up a lot more time than calling to place an order.

3. Rational people think at the margin: In general, economists like to assume that people
are rational thinkers. Still, they look at marginal changes to describe small adjustments to
the plan of action. Another way of looking at this is that people make decisions when they
think at the margin, or around the edge of a plan of action. For example, the decision of
whether or not to take an extra class in your semester is an incremental decision that will
have you comparing marginal costs and benefits. When considering marginal changes, we as
consumers are looking for the maximum satisfaction on our purchases that fit with our
budgets and incomes. So, we look for ways to achieve maximum satisfaction within the
constraints of what we are willing to pay for a commodity, and the decisions it takes to get
there are influenced by marginal changes and rational thinking.

4. People respond to incentives: This economic principle isn’t surprising but makes a lot of
sense when we consider the last few principles. Since consumers make decisions by
comparing benefits and cost, what happens when that scale changes? That’s where
incentives play a part. Incentives inspire consumers to act by offering up an extra reward to
those people who will change their behavior. Incentives can also be positive or negative,
meaning you can incentivize people to do something or not to do something. For example, a
positive incentive would be offering employees a bonus if they work extra hours. However, a
negative incentive can be exemplified by extra taxes governments might put on things like
fuel that encourage people to use it less.

5. Trade can make everyone better off: This one seems obvious, but trade can be a positive
for all parties involved. It’s not like a competition where one side wins and the other loses. In
trade, all parties can win by focusing on what they’re best at. The best example of this is
countries that benefit from trading with each other. Most countries don’t have all the
resources they need to function effectively, so they turn to other countries for more or even
cheaper resources that they can trade. It also allows for a wider variety of goods to become
available in the country, which increases competition on a global scale. When you think
about trade between countries, let’s say between the U.S. and Canada, neither side “wins,”
but both benefit in different ways from a trade partnership.
6. Markets are usually a good way to organize economic activity: A lot of countries used to
have a centrally planned economy but are now moving towards market economies. In a
market economy, decisions are made collectively by millions of households and firms that
have a stake in the economy. If you think about it, it’s like a cycle. Households decide where
they’ll work, and firms decide who they want to hire and what to produce. These two parties
interact in the market economy where decisions are guided by self-interest. Sometimes, the
market economy or aspects of it fail, and that’s where governments have to step in to
implement policy. But usually, the interaction between households and firms are guided
almost automatically, seemingly by an ‘invisible hand’ that helps direct economic activity.
The result is that households and firms consider prices when looking at what to buy and sell,
and they both look at costs and social benefits, which ultimately ends in a society’s welfare
being increased.

7. Government can sometimes improve market outcomes: We touched on the

government interfering in the market in the last economic principle in the form of policy
creation, but why does the government need to intervene when we have the invisible hand?
Well, the hand actually relies on the government for protection. The market will only work if
certain rights are enforced, and the hand needs help in organizing economic activity within
the market, namely, to promote both efficiency and equity. Markets can fail when they fail to
allocate resources efficiently, and this happens as a result of externality, which is when an
action produces an impact on the well-being of a bystander, or in this case, of society. An
example of this is pollution and the well-being of the environment. Without the intervention
of governments, the market could have a negative impact without even meaning to.
Additionally, the invisible hand might not focus on how to distribute resources equitably and
instead may reward individuals based on their production.

8. A country’s standard of living depends on country production: As we know, there are

different standards of living in different countries, and this is directly correlated to the
country’s productivity. Not only that, but the changes over time of standards of living can
also be quite significant. For example, even in high-income countries, the Western world has
made leaps and bounds in what we consider to be the standard of living. When compared to
lower-income countries, the growth of the standard of living is slower. This growth can be
traced back to the goods and services produced in each country. In places where workers are
able to produce more goods, the standard of living is higher, and vice versa. To increase the
living standard, there need to be public policies that affect it without negatively impacting
productivity by way of increasing education and providing better access to tools and
technology.

9. Prices rise when the government prints too much money: This one is relatively simple.
Prices follow inflation, and a high rate of inflation increases costs, so economic policymakers
aim for a lower level of inflation to keep the market moving. In most cases of a high rate of
inflation, the cause is that there’s too much money in circulation. When governments print
more money and there’s more available, its value decreases.
10. Society faces a short-run trade-off between inflation and unemployment: Another
result that occurs when there’s more money circulating is a lower rate of employment.
Economists use the Phillips Curve to trace the correlation between the two, which helps
them understand market and business cycles. The Phillips Curve aims to push inflation and
unemployment in opposite directions. Policymakers can impact inflation and unemployment
by altering how much money is printed, as well as the amount of government taxes.
Therefore, the policies that are implemented by governments and policymakers have a
direct impact on the market and economy and can severely impact the rates of inflation and
unemployment.

Importance of Managerial Economic

1. Decision making: Managerial economics provides analytical tools and frameworks

that help managers make informed decisions. It involves assessing costs, benefits,
and trade-offs, and applying economic principles to evaluate alternatives and select
the most efficient and effective course of action.
2. Resource allocation: Managerial economics aids in allocating scarce resources
efficiently. It involves analyzing the costs and benefits associated with different
resource allocation options, optimizing production processes, and determining the
optimal allocation of resources to maximize output and minimize costs.
3. Planning and forecasting: Managerial economics provides tools for forecasting
future market conditions, demand patterns, and economic trends. This information
helps managers develop business plans, set goals, and make strategic decisions to
adapt to changing market conditions.
4. Pricing and market strategy: Managerial economics assists in setting prices and
formulating market strategies. By considering factors such as demand elasticity,
production costs, and competitor behavior, managers can determine optimal pricing
strategies, develop pricing models, and design effective marketing campaigns to
maximize revenue and market share.
5. Risk management: Managerial economics helps managers assess and manage risks
associated with business decisions. By analyzing uncertainties, estimating
probabilities, and evaluating potential outcomes, managers can make risk-informed
decisions, implement risk mitigation strategies, and optimize risk-return trade-offs.
6. Government and regulatory policies: Managerial economics helps managers
understand the impact of government policies and regulations on business
operations. It involves analyzing the costs and benefits of compliance, evaluating the
effect of taxes and subsidies, and assessing the implications of regulatory changes on
pricing, production, and market strategies.

Profit Maximization

Profit maximization is a strategy of maximizing profits with lower expenditure, whereby a

firm tries to equalize the marginal cost with the marginal revenue derived from producing
goods and services. Economists Hall and Hitch’s theory says that every firm’s sole moto
should be to generate profits. Classical economists assume the same.
It is the prime target of every firm and is necessary for their progress. Companies can
maximize profits by increasing the price or reducing the production cost of the goods. Firms
adjust influential factors like selling price, production cost, and output levels to realize their
profit goals.

Theoretically, the point at which the marginal cost and marginal revenue become equal
allows for the maximum gap between the MR and MC. As a result, the profit at this point is
always maximum.

However, if the management decides to use sub-standard raw materials for production due
to the profit maximization calculator indicating them to lower their production costs, their
customer base could have adverse effects. Therefore, drawing a fine line between profit
maximization and quality management is a critical aspect of the process.

Graph

Profit maximization output is derived taking many aspects into consideration. Initially, the
profit becomes equal to the cost subtracted by revenue which can be plotted graphically.
Then, the graph can be constructed using the revenue and cost as variables plotted against
the function of output, as shown below in the supply and demand graph:

Profit Maximization Graph

One of the major conditions to maximize profits is that the marginal revenue and marginal
cost must be equal (MC = MR). It is the equilibrium point on the graph. Producers or firms
achieve equilibrium when there is the widest gap (maximum difference) between MR and
MC; and TR and TC.

In the above graph, Q1 (output) is the point that intersects MR and MC. The above graph
shows that if the firm produces less output than equilibrium quantity Q1, then MR becomes
greater than MC. As a result, the firm is gaining more revenue than the cost it is spending on
producing goods, leading to an overall enhancement of profit.

As the output by the firm approaches the level of Q1, initially, the MR is slightly greater than
MC.

Subsequently, as the output crosses Q1, the marginal cost will substantially increase over
the marginal revenue. As a result, the firm will experience a revenue loss.

Baumol’s Model of Sales Revenue Maximisation

W.J.Baumol suggested

Sales Revenue maximisation as an alternative goal to profit maximisation.

Managers only ensure acceptable level of profit, pursuing a goal which enhances their own
utility.

Baumol’s Model : (contd.)

Rationale of the Hypothesis:

1.Management has been separated from ownership in modern times.

2.This has given powers to Managers who pursue their own goals rather than the goal of the
owners.

3.Managers ensure a minimum acceptable level of profit to satisfy the shareholders, but
would pursue a goal which enhances their own utility.

Baumol’s Model : (contd.)

Why Managers attempt to maximise sales rather than profits:-

 Incomes of top executives are closely related to sales rather than profits.
 Banks and financial institutions are impressed by the amount of sales and treat this
as a good indicator of the performance of the firm.
 Large and continuing sales enhance prestige of the Managers, who ensure regular
distribution of dividends.
 A steady performance with satisfactory amount of profits is preferably to irregular
spectacular profits in some one or two years. Having shown high profits,if the level is
not maintained, it will lead to discontent of shareholders.
 Large sales strengthens the competitive power of the firm vis-avis competitors, while
low or declining sales diminishes this power of bargaining.

Separation of ownership and management combined with the desire for steady
performance which ensures satisfactory profits, tend to make the managers risk avoiders.
Top Managers in the modern firm are generally reluctant to adopt highly promising but risk-
prone projects. But this approach stabilises the economic performance of the firm and leads
to development of orderly markets.

Basic assumptions in Baumol’s

Static Models:

 A firm’s decision making is limited to a single period. During this period, the firm
attempts to maximise total revenue rather than physical volume of sales.
 Sales revenue maximisation is subject to provision of minimum required profit to
ensure a fair dividend to shareholders, thus ensuring stability of his job.
 Conventional Cost and Revenue functions are assumed – Cost curves are U-shaped,
Demand curve is downward sloping.

Marris’s Theory of

The Managerial Enterprise “In Corporate firms, there is structural division of

ownership and management which allows managers to set goals which do not
necessarily conform with those of the owners. The shareholders are the owners.
Their utility function includes variables such as profits, size of output, size of capital,
market share and public image.

The Managers have other ideas. Their utility function

includes variables such as Salaries, Job security,Power and status.

 The owners want to maximise their utility while the managers attempt maximisation
of their own utility.
 Both utilities do not necessarily clash, because the most of the variables of both the
utilities, have a strong relationship with a single variable i.e., size of the firm.
 It is reasonable to assume that maximising the long-run growth of any indicator is
equivalent to maximising the long-run growth rate of the others.
 Owners being interested in the growth of the firm want maximisation of the growth
of the supply of capital, which is assumed to maximise the owner’s utility.
 Managers wanting to maximise rate of growth of the firm rather than absolute size
of the firm, believe that growth of demand for the products is an appropriate
indicator of the growth of the firm.

There are two constrains in the Marris’s Model:

1. The Managerial Team Constraint: Since Management is a teamwork, hiring new

managers does not expand managerial capaqcity immediately. New managers take
 time to get integrated in the team. Managerial tream constraint sets limits to both
the rate of growth of demand and rate of growth of capital.
2. The Job Security Constraint: Managers want job security. Job security attained by
pursuing a prudent financial policy which requires the three crucial financial ratios to
be maintained at optimum levels.

Liquidity Ratio: Current ratio – ratio of liquid assets to total assets.

Low liquidity increases the risk of insolvency (risk=+ve)

Leverage/Debt or Debt-Equity ratio: ratio of debt to total assets.

High debt-equity ratio exposes the firm to bankruptcy.(risk=+ve)

Profit retention ratio: High retention of profits, adds to the reserves contributing to
the growth of capital.(risk= -ve)

Combining all the above into a single parameter will amount to financial constraint
of the firm.

Policy variables in Marris’s balanced growth model are as follows:

1. The firm has the freedom to choose its financial policy, as it subjectively determines the
three financial ratios, liquidity ratio, leverage/debt ratio and retention ratio.

2. The firm can decide its diversification rate, either by expanding the range of its products,
or by merely effecting a change in the style of its existing range of products. OR it can adopt
the two policies simultaneously.

3. Price is not a policy variable of the firm. It is a parameter. Price is taken as given by the
oligopolistic structure of the market. Production costs are also taken as given.

4.The firm has the freedom to decide the level of it advertising and R&D. Since Price and
Production Costs are given, increase in advt. & R&D, will imply lower profit marginand vice-
versa.

Marris’s Model:
The rate of growth of demand for the products of the firm:

The firm is assumed to grow by diversification and not by merger or acquisition.

The growth of demand for the products of the firm depends on the rate of diversification
and the proportion of successful new products.

The rate of growth of capital supply:

The shareholders who are the owners, wish to maximise company's capital, which is the
measure of the size of the firm.

The main source of finance for the growth of the firm is profit but the management can
retain only part of it, for another part has to be distributed as dividend.

The rate of growth of capital is determined by three factors: the three financial ratios
determined by the managers constituting the financial security constraint, the average rate
of profit, and the rate of diversification.

Williamsons Theory of managerial discretion Williamson is of the opinion that the managers
of a modern business firm organised as a corporate unit do not maximise the profits which
result in the maximisation of the utility of the owners. Onstead they maximise their own
utility using their discretion. However, for their job security,managers attempt to ensure a
certain minimum of profit to shareholders in the form of dividends. Thus profit is a
constraint to the manager’s discretion.

Managers’ utility depends on such variables as salary, job security, power, prestige, status,
job satisfaction and professional excellence. Of these variables only salary can be quantified.
Therefore, Williamson uses measurable variables like staff empenditures, managerial
emoluments and discretionary investment in the utility function of managers on the
assumption that these are the source of the job security and reflect power, prestige, status
and professional achievements of managers.

Basic Concepts:

The demand for the firm. The firm’s demand curve is assumed to be downward sloping and
is defined by the function

X = f1 (P, S, e)
P = f2 (X, S, e)

Where X = output, P = price, S = staff expenditure

e = a demand shift parameter reflecting autonomous changes in demand.

The demand is negatively related to price and is assumed to be positively related to staff
expenditure and to the shift factor.

Various concepts of Profit:

The actual profit: Sales Revenue minus production costs and less staff expenditure.

Π=R–C–S

The reported Profit : Π is the profit that the firm reports to the tax authorities. It is the

actual profit less tax deductible managerial emoluments.(M)

Π=Π−Μ=R–C–S-Μ

Various concepts of profit:

Minimum Profit: Πο is required to satisfy the shareholders. If this profit is not earned, the
shareholders will either sell their shares or change the top management, adversely affecting
the job security of managers.

Πο < ΠR – T (T= Tax)

The Discretionary Profit: ΠD is the amount of profit left after subtracting the minimum profit
and the tax from the actual profit.

ΠD = Π − Πο − Τ

Discretionary Investment: ID – Discretionary investment is the amount that is left from the
reported profit after subtracting the minimum profit and the tax from the reported profit.

ID = ΠR − Πο - T