ECONOMICS FOR MANAGEMENT

UNIT 1
 CONTENT

Meaning, nature and scope of Managerial Economics

Relationship between Economic theory and Managerial
Economics
Role of Managerial Economics in Business Decisions
Concepts of :
Opportunity cost
Time Value of Money
Marginalism, Equilibrium and Equi-marginalism and
their role in business decision making.
 ECONOMICS

•It’s the study of scarcity, the study of how people use

resources and respond to incentives, or the study of
decision-making. It often involves topics like wealth and
finance, but it’s not all about money. Economics is a
broad discipline that helps us understand historical
trends, interpret today’s headlines, and make
predictions about the coming years.
•Economics ranges from the very small to the very large.
The study of individual decisions is
called microeconomics. The study of the economy as a
whole is called macroeconomics.
 SCARCITY AND EFFICIENCY

The first question which comes here is what is Economics?

Economics is the study of how society chooses to use productive
resources that have alternative uses, to produce commodities of
various kinds, and to distribute them among different groups.
Two key ideas in economics:
• Scarcity of goods
• Efficient use of resources
Scarcity of goods
The word scarce is closely associated with the word limited or
economic as opposed to unlimited or free. Scarcity is the central
problem of every society.
• Concept lies at the problem of resource allocation and problem
of a business enterprise.
 SCARCITY AND EFFICIENCY

• •The managers who decide on behalf of the corporate unit or

the national economy always face the economic problem of
Scarcity of good quality of materials or skilled technicians

TECHNICAL DEFINITION OF “SCARCITY”

• In economic terms it can be termed as “ Excess of Demand”
• Any time for any thing if its demand exceeds its supply, that
thing is said to be
scarce.
• Scarcity is a relative term: Demand in relation to its supply
determines the element of scarcity.
 EFFICIENCY OF RESOURCES

• Economy makes best use of its limited resources. That

brings the critical notion of efficiency. Efficiency denotes
most effective use of a society’s resources in satisfying
people’s wants and needs.
• For this a body of economic principles and concepts has
been developed
to explain how people and also business react to the
situation. Economics provide optimum utilization of scarce
resources to achieve the desired result. It provides the basis
for decision making. Economics can be studied under two
heads:
1. Micro Economics
2. Macro Economics
 MICRO ECONOMICS

Micro Economics:
It has been defined as that branch where the unit of
study is an individual, firm or household.
It studies how individual make their choices about what to
produce, how to produce, and for whom to produce, and
what price to charge.
It is also known as the price theory and is the main source
of concepts and analytical tools for managerial decision
making.
Various micro-economic concepts such as demand, supply,
elasticity of demand and supply, marginal cost, various
market forms, etc. are of great significance to managerial
economics.
 MACROECONOMICS

Macro Economics:
• It’s not only individuals and forms that are faced with
having to make choices. Governments face many such
problems. For e.g. How much to spend on health; How much
to spend on services; How much should go in to providing
social security benefits.
•This is the same type of problem faced by all of us in our
daily lives but in different scales. It studies the economics as a
whole.
•It is aggregative in character and takes the entire economy as
a unit of study. Macro economics helps in the area of
forecasting.
•It includes National Income, aggregate consumption,
 MANAGERIAL ECONOMICS

“Managerial Economics is the integration of economic

theory with business practice for the purpose of
facilitating decision-making and forward planning by
management.”
-Spencer & Siegelman

“The purpose of Managerial Economics is to show how

economic analysis can be used in formulating business
policies.”
-Joel Dean
 DECISION MAKING

Following are the various economic concepts which are

useful for managers for decision making:

• Income elasticity of • Production function

demand
Price elasticity of demand
• Cost and output
relationship
• Opportunity cost
• Multiplier
• Propensity to consume
• Marginal revenue product
• Demand theory
• Theory of firm: price, output
and investment decisions
• Money and banking
• Public finance and fiscal and
monetary policy
• National income
• Theory of international trade
 OPPORTUNITY COST PRINCIPLE:

•OC of a decision is the sacrifice of alternatives required by

that decision; OC represents the benefits or revenue forgone
by pursuing one course of action rather than another.
• OC are not recorded in the accounting records of the firm,
but have to be met if the firm aims at optimization.
• When ever a manager takes or makes a decision, he
chooses one course of action, sacrificing the other
alternatives. We can evaluate the one chosen in terms of the
other (next best) which is sacrificed. All decisions which
involve choice must involve opportunity cost principle.
•OC may be either real or monetary, either implicit or
explicit, either non-quantifiable or quantifiable
 OPPORTUNITY COST PRINCIPLE:

Decisions involving opportunity cost includes;

• Make or buy; Breakdown or preventive maintenance of
machines; Replacement or new investment decision; direct
recruitment from outside or Departmental promotion.
•Accountant never considers opportunity cost, he considers
only explicit costs
Accounting Profit = revenue-recorded costs.
Economic profit=revenue – (explicit+ implicit costs) i.e.
Economic profit= Accounting profit-opportunity costs.
 OPPORTUNITY COST PRINCIPLE:

Decision principle should be minimization of opportunity costs,

given objectives and constraints. By the opportunity cost of a
decision is meant the sacrifice of alternatives required by that
decision. For e.g.
• 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. 1000as cash in hand for one
year is the rate of interest, which would have been earned had the
money been kept as fixed deposit in bank.
 TIME VALUE OF MONEY

•The time value of money (TVM) is the concept that money

available at the present time is worth more than the identical
sum in the future due to its potential earning capacity.
•This core principle of finance holds that, provided money can
earn interest, any amount of money is worth more the sooner it
is received.
•TVM is also sometimes referred to as present discounted value.
•The time value of money draws from the idea that rational
investors prefer to receive money today rather than the same
amount of money in the future because of money's potential
to grow in value over a given period of time.
 TVM

•Further illustrating the rational investor's preference,

assume you have the option to choose between receiving
$10,000 now versus $10,000 in two years.
• It's reasonable to assume most people would choose the
first option. Despite the equal value at time of disbursement,
receiving the $10,000 today has more value and utility to the
beneficiary than receiving it in the future due to
the opportunity costs associated with the wait. 
•Such opportunity costs could include the potential gain on
interest were that money received today and held in a
savings account for two years.