Managerial Economics

UNTI I- Basic concepts and principles

Economics: It studies the overall economy including production, consumption, and
distribution of goods and services in a society.

Managerial Economics: It focuses on the application of economic principle and

analysis to solve managerial problems and aid to decision making within the firm.

Economics Managerial Economics

It includes both micro and
macroeconomics.
It has a wider scope.
It involves managerial economics.
IT includes all theories from production
to consumption including distribution.
IT includes analysis at macro level like
growth rate, employment.
Everything is based on certain
assumptions.
It is used in micro economics.
It has a narrow scope.
It is the branch of Economics.
IT is only concerned with profit theory.
It includes analysis of micro level like
demand, supply, and profit.
Assumptions become invalid when applied.

Nature of managerial economics:

I. It is both art and science, because it includes a lot of critical & logical
thinking, analytical analysis, it also requires techniques and method.
II. IT is micro in nature, because in this manager deals with single entity
rather than economy of whole.
III. Use macro economics as it evaluates various macro economy factors such
as market dynamics, government policy, economy changes and effect on
the company.
IV. It is multi-disciplinary as uses many tools and principles such as
accounting, finance, mathematics, statistics, production, Human
resources, marketing.
V. IT is management oriented because we are dealing with business related
problems and their policy formulating.
  Micro Economy: It studies the decisions of individuals and firms to
allocate resources of production, exchange and consumptions. It deals
with the prices and production in single market and the interaction
between different market but leaves the study of economy wide
aggregates to macroeconomics.
 Macro Economy: It studies the association between various countries
regarding hoe policies of one nation affects the other. It deals with the
study of behavior and performance of the economy in total. The most
important factors studied involves G.D.P, unemployment, inflations and
growth rate.

Difference between Micro and Macro Economy

Micro Macro
Studies: Individual entity Studies: A whole nation
Deals with: Various issues like demand, Deals with: Various issues like national
supply, factor pricing, product pricing, income, distributions, employment,
productions and consumptions. general price level.
Area of study: Studies the particular Area of study: Deals with whole economy,
market segment of the economy. studies and covers several market
segments.
Business applications: It is applied toBusiness applications: It is applied to
internal issues. environmental and external issues.
Scope: Demand, supply, product pricingScope: Nation income, distribution,
etc. employment etc.
Limitations: It’s based on Impractical Limitations: IT has been scrutinized that
presumptions like there is full the misconceptions of composition
employment within the community. sometimes failed to prove accurate
because it is feasible that what is true of
aggregate may not be true for individuals
as well.
 Relevance of managerial economics in business decisions:
i. Helpful in business planning.
ii. Helpful in business organization.
iii. Helpful in cost control.
iv. Helpful in formulating business policies.
v. Helpful in demand forecasting.
vi. Helpful in coordination of business activities.
vii. Helpful in price determination.
viii. Helpful in solution of business taxation problems.
ix. Helpful in understanding the mechanism of economy.
x. Helpful in business prediction.
xi. Helpful in optimal allocation of resources
xii. Helpful in profit planning and control.
xiii. Helpful in managerial decision.
xiv. Helpful in distribution of profit.
xv. Helpful in maintaining cost.
xvi. Helpful in research and development.
xvii. Helpful in analyzing the effect of government policies.

Fundamental principles of managerial economics

1. Incremental principle:
The major concept in this analysis are incremental cost and incremental revenue.
Incremental cost denotes change in total cost whereas incremental revenue means change in
total revenue, resulting from a decision of firm.
Incremental principle may be stated as follows: A decision is profitable only if-
I. It increases revenue more than cost.
II. It decreases some cost to a greater extent than it increases in other.
III. It increases some revenue more than in it decreases some others.
IV. It reduces cost more than revenue.

2. Opportunity cost concept:

Resources are limited but demand is unlimited, letting go an opportunity. IT may be stated as
“the cost involved in any decision consists of the sacrifice of the alternative required by the
decision”. Sacrificing in of alternatives is involved when caring out a decision requires using a
resource that is limited in supply within the firm, therefore it represents the benefits or the
revenue foregone by pursuing one course of action rather than other.
3. Concept of time perspective:
This concept was introduced by “Marshall”, according to this concept a decision maker gives
due consideration both to the short and long run. In this concept short run and long run both
effects the decision of revenue as well as cost therefore a balance must be maintained
between long and short run.
Short run: A time under which at least one factor of production is fixed and other are
variable. Fixed factors such as land, building and machines, variable factors such as raw
material and labor. In this period variable factors can be used to increase the productivity
and in this period size of business can ‘not be increases as some factors are fixed.
Long run: A period in which all factors of productions are variable as business have
sufficient time to change their factors such as land, building, labor, capital, machines etc. A
firm can increase the size of the business, increase the output using all factors of
productions.

4. Marginal principle:
Marginal generally refers to the small changes, marginal revenue is the change in total
revenue per unit change in output sold. Marginal cost refers to the change in total cost per
unit change in output produced, while incremental cost refers to change in total cost to
change in total output. If marginal revenue is greater than marginal cost than the firm should
bring change in price. Marginal analysis implies judging the impact of a unit change in one
variable on the other.

5. Equi-Marginal principle:
This principle is based on equi-marginal utility, the principle states that the input should be
allocated so that the value added by the last unit is same in all cases.
Let us assume a case, if a firm has 100 units of labor and the firm is involved in 5 activities a,
b, c, d and e then the firm can increase any one activity by employing more labor but only at
the cost of sacrifice of other, therefore it will be profitable to shift labor from low marginal
activity to high marginal value activity thus increasing the total value of all products taking
together.

Formula of Equi-marginal principle

MUa = MUb
Pa Pb
 Where MUa and MUb are marginal utility of A and b respectively and
Pa and Pb are the prices respectively.

6. Discounting principle
The concept of discounting principle is a concept of time perspective since future is
unknown and there is a lot of risk in future, thus everyone know that a rupee today is
worth more than a rupee will be two years from now.

Formula: PV= FV
(1+I)t
Where PV and FV are present value and future value respectively, I is
interest and t is time.