Mod-1

Introduction to Economics
 Importance of Economics in real life,
business and society
• In real life,
business and
society everywhere
Economics is
present only we
fail to identify it.
Ex: Veg market –
buying and selling
– RBI repo rates
 Topic Learning Outcomes
1.1 Explain the circular flow of economic activity
1.2 Infer the concept of profit
1.3 Illustrate economics and decision making
 Introduction
• Introduction of economics can be attributed to
three reasons:-
– Growing complexities of business decision making
– Increasing use of economic logic, concepts and
theories
– Rapid increase in demand for professionally
trained managerial manpower.
 What is Managerial Economics?
Douglas - “Managerial economics is .. the
application of economic principles and
methodologies to the decision-making process
within the firm or organization.”
Pappas & Hirschey - “Managerial economics applies
economic theory and methods to business and
administrative decision-making.”
Salvatore - “Managerial economics refers to the
application of economic theory and the tools of
analysis of decision science to examine how an
organisation can achieve its objectives most
effectively.”
5
 The scope of Managerial Economics
• The scope is widely divided into two aspects
– Micro economics
– Macro economics
• Both micro and macro economics are used in
business analysis and decision making either
directly or indirectly.
• Some times the degree to which extent the
micro and macro used are varied depending on
the situation and decision of the firm.
 a. MICRO ECONOMICS APPLIED TO
OPERATIONAL ISSUES
• These are internal issues which arise within the business
organisation. Like:-
– Choice of business and nature of product
– Choice of size of the firm
– Choice of technology
– Choice of pricing
– How to promote sales
– How to face price competition
– How to decide on new investment
– How to manage profit and capital
– How to manage an inventory etc.
 b. MACROECONOMICS APPLIED TO
ENVIRONMENTAL OR EXTERNAL ISSUES
• A business operates in an external environment where the
factors like economic, political and social environment
affects its operation. Like:-
– Type of economic system in the country (Parking)
– Trends in national income, employment, savings , investment etc
(Bikes of high value)
– Working of financial institutions (Bank)
– Trends in foreign trade (Imported mobiles)
– Governments economic policy like- monetary, fiscal etc
– Socio-economic organizations like trade unions, consumers
association, producers union etc
– Political environment
– Degree of globalization (amazon.com)
 Contributions of other disciplines
• Mathematical tools:- its quantitative in nature
aids in dealing with demand, price, cost,
product, capital, wages etc where the
variables are interrelated.
• It helps in building a model which emphasizes
on minimizing cost and maximizing profit.
• Techniques like linear programming, inventory
models and game theory.
• Statistical tools:- these are used in collecting,
processing and analyzing business data,
testing and validating them before actual
application.
• Tools include theory of probability, forecasting
techniques etc.
• Operations research:- its an inter disciplinary
technique which combines economics,
mathematics and statistics to find solutions to
managerial problems.
• Tools like:- linear programming and goal
programming.
• Contribution of management theory and
accountancy:- when the conditions are
changed, both the objectives of firms and
managerial behavior change.
• It’s a great deal to integrate these two goals.
• On the other hand accounting reflects
functioning and performance of the firm.
 Profit maximization as a Objective of the
firm!!!
• The primary objective of a firm is to make
profit.
• Profit being measured quantitatively, most of
the people emphasize on profit maximization.
• The profit concept is divided into “ accounting
profit” and “ economic profit”.
• Accounting profit = TR-(W+R+I+M)
TR= Total Revenue, W= Wages and salaries, R=Rent, I=Interest, M=Cost of
Materials
• Pure (economic) Profit= Total Revenue-
(Explicit costs + implicit costs)
• Pure profit= Accounting Profit-(opportunity
cost + unauthorized payments like bribe)
Implicit cost = opportunity cost
 Alternate objectives of the firm
• Maximization of sales revenue
• Maximization of firm’s growth rate
• Maximization of managers utility function
• Making a satisfactory rate of profit
• Long run survival of the firm
• Entry prevention and risk avoidance.
 F.A.Walkers theory of Profit
• According to him profit is the rent received for
exceptional abilities of an entrepreneur.
• Profit is the difference between the earnings
of least and efficient entrepreneur.
• He assumed a state of perfect competition.
• He said each firm receives only the wages of
management which can be termed as normal
profit and no pure profit.
 Clark’s Dynamic Theory of Profit
• According to J.B.Clark, profit arise only in
dynamic economy and not in static one.
• A static economy is one in which things do not
change significantly.
• Things like:- population, capital, production
process, homogenous product, there is no
uncertainty and hence no risk etc
• Hence company can make normal profit in static
economy.
• Dynamic economy is characterized by :-
Increase in population, capital, production
technique, changes in form of organization,
increase in customer wants etc
• In the dynamic environment he take the
advantage of generic changes to make pure
profit.
• According to Clark, emergence, disappearance
and reemergence of profit is a continuous
process.
Arguments in defence of profit maximization

• Profit is indispensible for firm’s survival

• Achieving other objectives depends on firm’s
ability to make profit
• Evidence against profit maximization objective is
not conclusive
• Profit maximization objective has a greater
predicting power
• Profit is more reliable measure of firms efficiency.
 Reasons for aiming at reasonable profit

• Preventing entry of competitors

• Projecting a favorable public image
• Restraining trade union demands
• Maintaining customer goodwill
• Other factors like:-
– Managerial utility function
– Maintaining internal control by restricting firms size
and profit
– Preventing the anti- trust suits.
CIRCULAR FLOW MODEL OF THE ECONOMY

• An Economy is a system of interrelated

economic activities and transactions.
• Basic economic activities include production,
exchange and consumption.
• Economic transactions are of two types
– Products or goods flow
– Money flow
 Circular flow in a simple economy
• Households are assumed:-
– To own all factors of production
– To consume all final goods and services
– Their income consists of wages, rent, interest and
profits
• The business firms assumed :-
– To hire factors of production
– They produce and sell goods and services to households
– They do not save (no corporate saving)
• Real flows makes the product to move from
firms to households.
• Money flows from the firms to the households
in the form of factor payments as wages,
interest, rent and dividends.
• Factor payment take the form of household
incomes which in turn spend on goods and
services which acts as income for firms.
• Finally it can be summated as
Household Income=Factor payments=The money
value of output
 Fundamental concepts used in business
decisions
• The opportunity cost and decision rule
• Marginal principle and decision rule
– Marginal cost & marginal revenue
• Incremental principle and decision rule
– Incremental costs and revenue
• Contribution analysis (IR-IC)
• Equi-marginal principle
 Module 2
Demand Theory
2.1 Infer demand and supply theories
2.2 Examine elasticity’s of demand and supply
2.3 Ascertain demand and supply relation in
various situations
• The function
• Demand function = Dx = f(Px,Y,Ps,Pc,A,T,E,U)
• Concept of market
• Demand side of market
– Law of demand
– Demand schedule
– Demand curve
• Supply side of market
– Law of supply
– The supply schedule
– The supply curve
– supply function
• Shifts in demand and supply curve
 Demand and Supply decisions
Qd = 50-5P
Qs = 7.5P
Price = Rs. 1/-, Rs. 2/- , Rs. 3/-, Rs. 4/-, Rs. 5/-and Rs. 6/-

Price Demand Supply Market Effect

position on price
1 45 7.5 Shortage Rise 50
45
2 40 15 Shortage Rise 40
35

3 35 22.5 Shortage Rise 30

25
20
4 30 30 Equilibrium Stable 15
10
5 25 37.5 Surplus Fall 5
0
1 2 3 4 5 6
6 20 45 Surplus Fall
Demand Supply
 Analysis of consumer demand
• Meaning of demand (desire + ability + willingness)
• Meaning of utility
– Product perspective and customer perspective
– Total utility and marginal utility
• Law of diminishing marginal utility
Law of diminishing marginal utility
• As quantity consumed goes on increasing, the
utility derived from each successive unit goes
on diminishing, keeping all other consumption
constant.
 Law of diminishing marginal utility

Units of
commodity Total Utility Marginal Utility 160
140 145
      120 125 130
110
1 100 100 100 100
80 80
2 125 25 60 55
3 145 20 40
25 30
20 20
4 130 -15 0
-20 1 2 3 4 5-15 6-20 7 8
5 110 -20 -40
-30

6 80 -30 Total Utility Marginal Utility

7 55 -25
8 30 -25
 Law of demand
• Factors behind law of demand
– Substitution effect
– Income effect
– Utility maximizing behaviour
• Exceptions to the law of demand
– Expectations of future price increase or decrease
– Status goods
– Giffen goods
 Analysis of market demand and demand
elasticity's
• Meaning of market demand
• Kinds of demand
• Determinants of market demand
– Demonstration and snob effect
• Demand function
• Elasticity's of demand
– Price elasticity
• Arc elasticity
• Point elasticity
• Cross elasticity of demand
• Income elasticity of demand
 Demand Forecasting
• Meaning of forecasting
• Steps in demand forecasting
• Techniques of forecasting
– Survey methods
– Statistical methods