MANAGERIAL

ECONOMICS, 3E

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Chapter 1
Basic Concepts and
Principles
 What is Economics?
 Economics can be defined as a social science that studies economic
behaviour of the people, the individuals, households, firms, and the
government.
 Studies the production, distribution, and consumption of goods and services.
 Economic behaviour is essentially economizing behaviour.
 Economizing behaviour is the effort of the people to derive maximum gain
from the use of their limited resources—land, labour, capital, time and
knowledge, etc., which have alternative uses.
 Technically, the term ‘economizing’ means deriving maximum gains from a
given cost and alternatively minimizing cost for a given gain.

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 Why do People economize?

 Human wants, desires and aspirations are endless.

 Resources available to the people are scarce.
 People are by nature economizers.

In order to maximize their gains, people allocate their resources

between their competing wants in such a way that their total
gain is maximized. Thus, economics as a social science
studies how people allocate their limited resources to their
alternative uses with the objective of deriving maximum
possible gains from the use of their resources.

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 Definition of Economics

 Wealth Definition- Economics is the study of wealth- How

wealth is produced and distributed.
 Welfare Definition- wealth is simply a means to an end in
all activities, the end being human welfare.
 Scarcity Definition- Economics is the science which
studies human behavior as a relationship between ends and
scarce means which have alternative uses.
 Modern/ Growth Definition- Economics is the study of
how people and society end up choosing, with or without
the use of money to employ scarce productive resources that
could have alternative uses to produce various commodities
and distribute them for consumption, now or in the future,
among various persons or groups in society.

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 Nature of Economics

 Economics as an Art and a Science

ART - different theories and laws are explained with the help of
graphs, figures, tables, equations.
Also economics make use of assumptions which helps to define
the conditions for the application of theories, laws and
relationship between economic variables.

SCIENCE- a systematized body of knowledge in which

economic facts are studied and analyzed.
science have laws and theories which trace out a causal
relationship between two or more phenomena.
laws possess universal validity such as the law of demand, law
of diminishing marginal utility, etc.

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 Economics as a Positive and Normative Science

Economics is both a positive and normative science because positive

economics sets about to discover what is true about the economy,
while normative economics evaluates whether the facts found are
good or bad.

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 Basic Assumptions

 Ceteris Paribus
 Latin phrase
 “With other things (being) the same” or “all other things being
equal”.
 Rationality
 Consumers maximize utility subject to given money income.
 Producers maximize profit subject to given resources or
minimize cost subject to target return.

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Scope of Economics

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 Central Economic Problems of any
Economy

 What To Produce:
problem of allocation of resources among different goods and services (the
production of one good means a reduction in the production of
another).
selection of what should be produced and in what quantity in order to
satisfy consumer wants as best as possible using the available resources.
 How To Produce:
selection of appropriate technique of production (capital-intensive or
labour- intensive)
how to combine resources in other to produce goods and service in a more
efficient way and at a minimum cost.
The decision on which resource combination to use depends on
availability of factors and their relative prices.

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 For Whom To Produce:
how the national product is to be distributed among the
members of the society, that is, how the consumer goods and
capital goods will be distributed.
Should the economy produce goods for those with high
incomes or for those with low income? What demographic
group should production be targeted at?

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 Limitations of Economics:
 Much of the field is based on human behavior, which can be
somewhat irrational and unpredictable so it prevents the
economists from being able to predict markets' performance
accurately and know exactly how certain policies will affect
different sectors and economies.
 the problem of non-replicability- It is impossible to precisely
recreate market conditions or predict an outcome based on how
markets have behaved in the past under similar circumstances.
 problematic in normative economics- Different economists
come to completely different conclusions about what kind of
regulations and controls should be applied to various markets and
exactly what outcomes will result, there is no way to guarantee
that they are right.

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 The Concept of Managerial
Economics:
According to Baumol, a Nobel laureate in economics, economic theory
contributes to business decision making in three important ways:
 providing framework for building analytical models which can help
recognize the structure of managerial problem, determine the important
factors to be managed, and eliminate the minor factors that might obstruct
decision making.
 economics provides ‘a set of analytical methods’ which may not be
directly applicable to analyse specific business problems but they do
widen the scope of business analysis.
 Economic theory offers clarity to various economic concepts used in
business analysis, which enables the managers to avoid conceptual
pitfalls.
Economics provides models, tools and technique to predict the future course
of market conditions, ways and means to assess the risk and, thereby, helps in
business decision making.
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 Definition of Managerial
Economics:

 “Managerial Economics is economics applied in decision-making.

It is a special branch of economics bridging the gap between the
economic theory and managerial practice. Its stress is on the use of
the tools of economic analysis in clarifying problems in organizing
and evaluating information and in comparing alternative courses of
action.”
-W. W. Haynes
 “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

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 Objectives of Managerial
Economics:

 To integrate economic theory with business practice.

 To apply economic concepts and principles to solve business
problems.
 To allocate the scares resources in the optimal manner.
 To make all-round development of a firm.
 To minimize risk and uncertainty
 To help in demand and sales forecasting.
 To help in profit maximization.
 To help to achieve the other objectives of the firm like
industry leadership, expansion implementation of policies etc.

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 Characteristics of Managerial
Economics:
 Applied Economics
 Study of Business Environment
 Micro Economic Analysis
 Economics of the Firm
 Acceptance of use & utility of macro economic variables
 Normative Approach
 Emphasis on Case study
 Sophisticated and developing discipline

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 Scope of Managerial Economics:

 Managerial decision issues can be divided broadly under

two broad categories:

(a) Internal managerial issues- It refer to decision-making

issues arising in the management of the firm. Demand
Analysis, Cost Analysis, Profit Analysis, Production and
Supply Analysis, Pricing Analysis, Capital Management,
Strategic Planning and Profit Analysis.

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 Macroeconomics Applied to Business Decision- External
environmental issues
The factors which, in general, determine the economic
environment of a country are
(i) the general trend in national income (GDP), saving and
investment, prices, employment, etc.,
(ii) the structure and role of the financial institutions,
(iii) the level and trend in foreign trade,
(iv) economic policies of the government,
(v) socio-economic organizations like trade unions, consumer
associations, and
(vi) political environment.

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 Relationship of Managerial
Economics with other disciplines:

 Economics& Econometrics
 Mathematics & Statistics
 Operational Research
 Accountancy
 Psychology and Organisation Behaviour
 Management Theory

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 Economic Principles Relevant
to Managerial Decisions
 Concept of scarcity
 Unlimited human wants
 Limited resources available to satisfy such wants
 Best possible use of resources to get:
 maximum satisfaction (from the point of view of consumers) or
 maximum output (from the point of view of producers or firms)
 Concept of opportunity cost
 Opportunity cost is the benefit forgone from the alternative that is not
selected.
 Highlights the capacity of one resource to satisfy multitude of wants
 Helps in making rational choices in all aspects of business, since
resources are scarce and wants are unlimited
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 Economic Principles Relevant to
Managerial Decisions Contd…

 Concept of margin or increment

 Marginality: a unit increase in cost or revenue or utility.
 Marginal cost: change in Total Cost due to a unit change in output.
 Marginal revenue: change in Total Revenue due to a unit change
in sales.
 Marginal utility: change in Total Utility due to a unit change in
consumption.
 Incremental:applied when the changes are in bulk, say
10% increase in sales.

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 Economic Principles Relevant to
Managerial Decisions
 Discounting Principle
 Time value of money : Value of money depreciates with time
 A rupee in hand today is worth more than a rupee received tomorrow.
 Outflow and inflow of money and resources at different
points of time

PVF =
1
where (1  r) n
PVF = Present Value of Fund,
n = period (year, etc.)
R = rate of discount

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 Production Possibilities Curve

 Highlights the concepts of scarcity and opportunity cost

 Indicates the opportunity cost of increasing one item's production
(or consumption) in terms of the units of the other forgone
 Slope of the curve in absolute terms
 Assumptions
 The economy is operating at full employment.
 Factors of production are fixed in supply; they can however be
reallocated among different uses.
 Technology remains the same.

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 Production Possibilities Curve
 Shows the different
combinations of the quantities of
Technically
two goods that can be produced
Food Infeasible Area
(or consumed) in an economy at
any point of time.
FP
P  Below the curve is productively
inefficient area and above it is
FQ Q technically infeasible area, so
Productively the equilibrium will be at the
Inefficient Area curve (FP and CP at point P).
 Depicts the trade off between
any two items produced (or
O consumed).
CP CQ Clothing
 To increase the quantity of
clothing from CP to CQ some
PPC for the Society
amount of food (FP-FQ) will have
to be sacrificed. New point of
equilibrium on PPC is at Q.
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 Production Possibilities Curve
Contd…

 All points on the PPC (like P and Q) are points of maximum productive
efficiency.
 In the figure, OFp of food and OCp of clothing can be produced at Point P
and OFQ of food and OCQ respectively at point Q, when production is run
efficiently.
 All points inside the frontier are feasible but productively inefficient.
 All points to the right of (or above) the curve are technically impossible
(or cannot be sustained for long).
 A move from P to Q indicates an increase in the units of clothing produced
and vice versa.
 It also implies a decrease in the units of food produced. This decrease in
the units of food is the opportunity cost of producing more clothing.

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 Relevance of economics in business
decision making:

https://enotesworld.com/role-of-managerial-economics-in-the-b
usiness-decision-making-process
/

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 Relationship with Other Disciplines
Economic Theory
Microeconomics Quantitative Analysis
·Theory of firm ·Numeric and algebraic analysis
·Theory of consumer behaviour (demand) ·Optimization
·Production and cost theory (supply) ·Discounting and time value of money
·Market structure and competition
techniques
·Price theory
Macroeconomics ·Statistical estimation and forecasting
·National income and output ·Game theory
·Business cycle
·Inflation

Managerial Economics

Solutions to Managerial Decision Making

·Quantity and quality of product
·Price of product
·Marketing Management
·Financial Management
·Human Resource Management
·Research and Development
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 Summary
 Economics studies the choices made by individuals and societies in regard to the
alternative uses of scarce resources which are employed to satisfy unlimited
wants.
 Microeconomics is the study of the behaviour of individual economic units, such
as an individual consumer, a seller, a producer, a firm, or a product.
 Macroeconomics deals with the study of aggregates, the economy as a whole.
 Ceteris paribus is a Latin phrase, literally translated as “with other things (being)
the same”.
 The assumption of rationality means that consumers and firms measure and
compare the costs and benefits of a decision before going ahead for that decision.
 Partial equilibrium analysis studies the outcome of any policy action in a single
market only, while general equilibrium analysis seeks to explain economic
phenomena in an economy as a whole.
 Opportunity cost is the benefit forgone from the alternative that is not selected.

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 Summary
 Concept of Time value of money tells that Value of money depreciates
with time.
 Concept of Marginal/increment tells about impact of unit/proportionate
change in cost/revenue on decision making.
 Managerial economics is a means to finding the most efficient way of
allocating scarce organizational resources and reaching stated objectives.
It is micro as well as macro in nature; it has a normative bias, and deals
with partial equilibrium.
 Production Possibilities Curve (PPC) is a graph that shows the different
combinations of the quantities of two goods that can be produced (or
consumed) in an economy, subject to the limited availability of resources.
 The knowledge of managerial economics helps to understand the
interrelationships among the various functional units of any firm (namely
production, marketing, HR, finance, IT and legal)
 Decision sciences provide the tools and techniques of analysis used in
managerial economics, in particular numerical and algebraic analysis,
optimization, statistical estimation and forecasting.
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