MANAGERIAL

ECONOMICS
LESSON-1 FUNDAMENTAL OF MANAGERIAL ECONOMICS

PREPARED BY: RAHUL KUMAR

(ASST. PROFESSOR—ECONOMICS)
INTRODUCTION:

People have limited needs that are to be satisfied if they are to survive as human beings.
1. Material Needs: Shelter, food, clothing, transportation, safety & protection ,
communication.
2. Psychological needs: Attachment, self-esteem enhancement, increasing pleasure and
avoiding of pain etc.
3. Emotional needs: Respect, Importance, Security, Inclusion, Acceptance etc.
But, Sadly no human being choose to live such a basic life because of human wants (desire
for the consumption of goods and services are unlimited).
CONTINUED……

• Example.. Bigger house, more friends, more salary, more luxury etc.
• Therefore, the basic economic problem is that resources to fulfil all these desires are limited which
brings us to make choices.
• Economics is the study of the allocation of scarce resources, the choices that are made by economic
agents.
• Types of economies: Household economy, local economy, national economy, international economy
• Economic problems: what to produce? How to produce? When to produce? For whom to produce?
CONTINUED…..

• Free goods: The resources which are not scarce are called free goods.
• Economic Goods: The resources which are scarce are called economic goods.
• A good grasp of economics is vital for all managerial decision making, for designing, and
understanding public policy and to appreciate and realize how an economy functions.
• For example.. Managers, CEO’s of large corporates, managers of small companies, non-
profit organizations, service centers etc. can’t succeed in business without a grasp on
understanding of economy & how market forces create both opportunities and constraints
for business enterprises.
REASONS FOR STUDYING ECONOMICS…

• It is a study of society and as such is extremely important.

• It trains our mind and enable us to think systematically about the problems of business
and wealth.
• From a study of the subject it is possible to predict the economic trends with some
precision.
• It helps in choosing us from various economic alternatives.
• We learn to optimize our quick cognitive response.
DEFINITIONS….

• Economics is the science of making decisions in the presence of scarce resources.

• Resources are anything used to produce a good or service to achieve the goal.
• Economic decisions involve allocation of scarce resources so as to best meet the managerial
goal.
• The nature of the managerial decisions varies depending on the goals of the manager.
• A manager is a person who directs resources to achieve the stated goal and he/she has the
responsibility for his/her actions as well as for the actions of individuals ,machines and other
inputs under the manager’s control.
CONTINUED…

• Managerial economics is the study of how scarce

resources are directed most efficiently to achieve
managerial goals. It is a valuable tool for
analyzing the business situations to take better
decisions.
ECONOMICS

• Economics can be divided into two broad categories:

• Micro-economics Macro-economics
• Micro-economics focuses on the behaviour of the individuals, firms and their interaction in
markets.
• Macro-economics is the study of the economic system as a whole. This is related to issues
such as determination of national income, savings, investments, employment at aggregate
levels, tax collection, government expenditure, foreign trade, money supply etc.
NATURE OF MANAGERIAL ECONOMICS:

• Managerial economics is concerned with the analysis of finding optimal solutions to decision making
problems of business firms (micro economic in nature).
• Managerial economics is a practical subject therefore it is pragmatic.
• Managerial economics describes, what is the observed economic phenomenon (positive economics) and
prescribe what ought to be (normative economics).
• Managerial economics is based on strong economic concepts (conceptual in nature).
• Managerial economics analyses the problems of the firms in the perspective of the economy as a whole
(macro in nature)
• It helps in finding optimal solutions to the business problems. (problem solving).
CIRCULAR FLOW OF
THE ECONOMIC
ACTIVITY

This circular flow of the

economy depicts the two
sector-model of the
economy.
PRINCIPLES OF MANAGERIAL ECONOMICS:

• Marginal and Incremental Principle: This principle actually states that a decision is said to be
rational and sound only if given the firm’s objective of profit maximization, leads to increase in
profit which may be possible in either of two scenarios:
1) If total revenue increases more than total cost.
2) If total revenue declines less than total cost
Marginal analysis basically depicts the impact of a unit change in one variable over other.
Marginal revenue is change in total revenue per unit change in output.
CONTINUED…

• Incremental analysis is different from the marginal analysis because incremental analysis
focus on change in performance of a firm due to change in the managerial decision
whereas, marginal analysis focus on change in performance due to change in input or
output.
• Hence, we can say that incremental analysis is generalization of marginal concept.
• Incremental analysis focus on the policy factors.
EXAMPLE:

• A simple situation in everyday life provides an example of incremental

analysis. Consider a worker leaving work to travel home. Groceries are
required and can be purchased at slightly higher prices at a store on the
way from the work place to the home, or at lower prices by driving to a
store 3 miles (4.82 km) from home. The worker decides to purchase the
groceries on the way home since no incremental travel costs are involved,
and the incremental difference in grocery prices will be less than the value
the worker places on the time and other costs required to drive to the more
distant store.
CONTINUED..

• The incremental principle may be stated as follows: A decision is a profitable one if—
1.it increases revenue more than cost
2.it decreases some costs to a greater extent than it increases others
3.it increases some revenues more than it decreases others and
4.it reduces cost more than revenues.
CONTINUED:

• Suppose a firm gets an order that brings additional revenue of Rs 3,000. The cost of
production from this order is:
• Rs.
• Labour 800
• Materials 1,300
• Overheads 1,000
• Selling and administration expenses 700
CONTINUED

• But suppose the firm has some idle capacity that can be utilized to produce output for new
order. There may be more efficient use of existing labor and no additional selling and
administration expenses to be incurred. Then the incremental cost to accept the order will
be:
• Rs.
• Labour 600
• Materials 1,000
• Overheads 800
EQUI-MARGINAL PRINCIPLE :

• Marginal utility is the utility derived from the additional unit of a commodity consumed.
• Law of equi-marginal utility says that a consumer will achieve the equilibrium when
marginal utilities of various commodities he/she consumes are equal. According to
modern economists this law has been formulated in the form of law of proportional
marginal utility.
•  It states that the consumer will spend his money-income on different goods in such a way
that the marginal utility of each good is proportional to its price, i.e.,
• It means MUx / Px = MUy / Py = MUz / Pz
OPPORTUNITY COST PRINCIPLE

• The opportunity cost of a decision means the sacrifice of alternatives required by that
decision.
• For example: The opportunity cost of the funds employed in one’s own business is equal
to the interest that could be earned on those funds if they were employed in other
ventures.
• The opportunity cost of using a machine that is useless for any other purpose is zero since
its use requires no sacrifice of other opportunities.
For any managerial decision or any decision opportunity cost is the most relevant cost.
CONTINUED…

• Formula for opportunity cost:

Return from the most profitable investment Return from investment selected

Interpretation of opportunity cost: Opportunity cost is the value of something when a

certain course of action is chosen. The benefit or value that was given up can refer to decisions in
your personal life, in an organization, in the country or the economy, or in the environment, or on
the governmental level.
Another example where student considers the cost of 4-year university education by calculating total
hostel, tuition, and other expenses for the period. They could also include the cost of the opportunity of
missing 4-years of salary in their calculations.
CONCEPT OF TIME PERSPECTIVE:

• In economics, we generally draw a distinction between short-run and long-run time period.
• This time perspective has nothing to do with the calendar period like year, month or week.
• It is basically relevant to our decision making and it is based on the speed at which we make
decision in any organization and vary the factors of production.
• The time in which we generally change very few factors of production is called short-run.
• The time in which we can change almost each factors of production is called long-run.
DISCOUNTING PRINCIPLE:

• According to this principle, if a decision affects costs and revenues in long-run, all those costs
and revenues must be discounted to present values before valid comparison of alternatives is
possible. This is essential because a rupee worth of money at a future date is not worth a rupee
today. Money actually has time value. Discounting can be defined as a process used to transform
future dollars into an equivalent number of present dollars. For instance, $1 invested today at
10% interest is equivalent to $1.10 next year.
• FV = PV*(1+r)t
• Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is
the discount (interest) rate, and t is the time between the future value and present value.
UTILITY:

• Utility is the level of satisfaction a consumer derives from consuming a good or

service. When the product or service is useful to the consumer’s needs or wants, they
can achieve a certain level of utility from consuming it.
• Expected utility: Expected utility is the utility that an economic agent is expected to
reach in the future given several probable outcomes. Expected utility value is a
probability concept used when several future outcomes are possible. It is calculated by
multiplying each possible utility outcome by the probability of its occurrence and then
adding them up. Expected utility theory deals with decision-making under
uncertainty.
CONTINUED….

• Subjective Utility: Subjective utility is utility based on an individual's perceived level of satisfaction from
consuming a good or service. Subjective utility is not based on market judgment. It is based on how attractive
an individual perceives the benefit of using a good or service.
• Marginal Utility: Marginal utility is the satisfaction that a person receives from consuming an additional unit
of the same good or service.

• Example: If John is drinking his first glass of water and gets 10 units of satisfaction, the
marginal utility he derives from the first glass is 10 units. He then has a second glass of
water and gets 8 units of satisfaction. The marginal utility he derives from the second glass
is 8 units. With the third glass, he gets only 7 units of satisfaction. Thus, the marginal
utility he derives from the third glass is 7 units.
TOTAL UTILITY:

• Total utility is the aggregate satisfaction a person receives from the consumption of
all the units of the same good or service.
• Total utility is derived from adding every marginal utility from each additional unit.
• Example: Continuing with our previous example, where John derived 10, 8, and 7
units of utility from the glasses of water, the total utility that John would derive is 10
+ 8 + 7 = 25 units.
CONTINUED:
• The Equation for total utility = MU-1+MU-2+MU-3……..MU-N
• Where MU-N is the marginal utility derived from the consumption of Nth unit of the
good. Number of
Marginal utility Total utility
glasses of water
1 10 10
2 8 18
3 7 25
4 4 29
5 0 29
6 -2 27
RELATIONSHIP B/W MU & TU

• As the table shows, the marginal utility decreases with the addition of further units, whereas the
total utility increases until a certain point. At that point, which is 5 glasses of water, the total utility
reaches its maximum and starts declining.

• As the number of units increases, MU decreases, and TU increases.

• When TU reaches its maximum level, MU is 0. At that unit, the marginal utility is 0.
• MU starts to get negative and TU starts decreasing.