Introduction

It is the integration of
economic principles with
What is business management practices
Managerial
Economics??? It is essentially applied
economics in the field of
business management.
 Managerial Economics
(Definitions)

 Integration of Economic theory with business

practice for purpose of facilitating decision
making and forward planning by management
- Spencer & Siegelman
 It is concerned with the application of
economic concepts and economics to the
problems of formulating rational decision
making -Mansfield
 Why do Managers need to
know Economics?
 Economic theories contribute in building
analytical models, which help to recognize the
structure of managerial problems
 Economic theories do enhance analytical
capabilities of business analyst
 They offer clarity to various concepts used in
business analysis, which enables the managers to
avoid conceptual pitfalls
 Decision Problems faced by firms

What should be the price of the product?

What should be the size of the plant to be installed?

How many workers should be employed?

What is the optimal level of inventories of finished

products, raw material, spare parts, etc.?

What should be the cost structure?

Relationship between Economics & Management

Business Management
Economics theory Decision Problems

Managerial Economics
Application of Economics
to
solving business problems

Optimal Solutions to
Business problems
 Micro Takes help Normative
economic in from Macro rather positive
Chief character economics in nature
characteristics
(Nature) of
Managerial
Economics
It is both Mainly based Helps in
conceptual on “Theory of making wise
(theory) and Firm” choices
Metrical(quan
titative)
 Managerial Economics
Significance

 Reconciling traditional theoretical concepts in

relation to the actual business behavior and
conditions
 Estimating economic relationships
 Predicting relevant economic quantities
 Formulating business policies and plans
 Managerial Economics : Scope

Incorporate micro and macroeconomics to deal with business problems

Microeconomics - micro means a small part Concerned with analysis of behavior of

individual economic variables such as individual consumer or a producer or price of a
particular commodity

Macroeconomics - concerned with aggregate behavior of the

economy as a whole
Microeconomics applied to (operational) internal
issues

Production and
Demand Analysis Cost analysis
Supply analysis

Analysis of
Capital and
market structure
Profit Analysis Investment
and Pricing
Decisions
Theory
Macroeconomics applied
to external issues
(Economic Environment )

 Type of Economic system of

a country
 Study of Macro variables
 Study related to foreign trade
 Study of Government policies
– Monetary, Fiscal
 He not only
studies the
He is an economic trends
economic at macro level but
advisor to a also interpret
firm their relevance to
Role of a the particular
industry

Managerial General task of

Economist Task of making

managers to use
readily available
information in
specific outside environment
decisions to make a decision
that furthers the
goals of organization
Decisions to be taken by
Managerial economist
 Production scheduling
 Demand Estimation and Forecasting
 Analysis of market to determine
nature and extent of competition
 Pricing problems of industry
 Assist business planning process
 Advising on investment and capital
budgeting
 Analyzing and forecasting
environmental factors
 Opportunity Cost Principle

Marginal Principle
Basic
Economic Incremental Principle
Principles for
Managerial Equi - Marginal Principle

Decision Time Perspective Principle

making
Discounting Principle
 Opportunity Cost
 Related to
alternative uses of
scarce resources
 Opportunity cost of
availing an
opportunity is the
expected income
foregone from second
best alternative
 Difference between
actual earning and its
opportunity cost is
called economic gain.
Opportunity Cost
 Marginal Principle

Marginal Principle refers to
change in total of any
quantity due to a unit change
in its determinant
for example,
Companies use marginal
1. The cost to produce one
analysis as a decision-making
more widget,
tool to help them maximize
2.The profit earned by adding their potential profits.
one more worker.
 Incremental Principle

This principle states that a decision is said to rational and sound if the given firm’s objective
of profit maximization, it leads to increase in profit which happens in either of these two
scenarios
 If total revenue increases more than total cost
 If total revenue declines less than total cost
 Incremental Principle
Incremental Incremental
Cost Revenue

A decision is clearly a profitable one if

 It increases revenue more than costs.
 It decreases some cost to a greater extent than it increases others.
 It increases some revenues more than it decreases others.
 It reduces costs more than revenues.
 limitations

 The concept cannot be generalized because observed behavior of

the firm is always vari­able.
 The concept can be applied only when there is excess capacity in
the concern.
 The concept is applicable only during the short period.
Time Perspective
Principle
Discounting
Principle
Discounting
Principle
 • This principle suggests that available
Equi - resources (inputs) should be so
between the alternative options
allocated
that the
Marginal marginal productivity gains (MP)
various activities are equalized
from the

Principle
  In the words of Ferguson, "Law of equi-
marginal utility states that to maximise utility,
Equi - Marginal consumers way allocate their limited incomes
among goods and services in such a way that the
Principle marginal utilities per rupee of expenditure on the
last unit of each good purchased will be equal"
(Def)
 According to Marshall, "if a person has a thing
which he can put to several uses, he will
distribute it among these uses in such a way that
it has the same marginal utility in all"
Theory of Firm

 A firm is an entity that

draws various types of
factors of production
in different amounts
from the economy, and
converts them into
desirable output(s),
through a process with
the help of suitable
technology.
Economists have
identified four factors
of production

 Land
 Labour
 Capital and
 Enterprise
 An entrepreneur is a
person (or group of
persons) who decide(s) The process of identifying the
to undertake the potential sources of the factors
responsibility of the such as land, labour and capital,
inherent risks in starting collecting them in required
a business. quantities and assigning them
specific tasks as per their skills
is the subject matter of
organization.
 Forms of Ownership
 Ownership is always measured from the point of view of investors (entrepreneurs)
 Businesses may be organized in various forms, depending on their size, nature and need
for resources.
 Three broad categories of business organizations are
 Private sector (wholly owned by people, individually, or as a group)
 Public sector (owned, managed and controlled by government) and
 Joint sector (owned and managed jointly by individuals and government)
 Forms of Ownership

Private Joint Public

Individual Collective Company corporation Department

Proprietorship

Partnership Company Cooperative

 Firm and Industry
Examples
• shoe industry
• vehicle manufacturing
An industry may be defined industry
as a group of firms • banking industry
• transport industry
producing broadly similar
• Entertainment
commodities or offering industry etc.
complementary services.
Objectives of firm Alternate Objectives of
firm
 Profit maximisation
 The satisficing principle ( Satisfy + sacrificing)
 Sales maximisation  Survival
 Corporate social responsibility
 Revenue maximisation
 Increasing market share
 Baumol’s Model
 Helps in determining the
minimum amount of cash that a
manager can obtain by
converting securities into cash.
 Cash balances are refilled and
brought back to normal levels
by the sale of securities. The
average cash balance is C/2.
 The firm buys securities as and
when it has above-normal cash
balances.
 Baumol model’s Assumptions

 The firm is able to forecast its cash requirements in an accurate way.

 The firm’s payouts are uniform over a period of time.
 The opportunity cost of holding cash is known and does not change with time.
 The firm will incur the same transaction cost for all conversions of securities into cash.
 Marris’s Hypothesis
(Maximization of Growth Rate)

 Two sets of goals

 Owners (shareholders) aim at profits and market share
 Managers aim at better salary, job security and growth
 Both achieved by maximizing balanced growth of the firm (G)
 Growth rate of demand for the firm’s products (GD )
 Growth rate of capital supply to the firm (GC )
 Marris’s Hypothesis
(Maximization of Growth Rate)

 Constraints in the objective of maximization of balanced growth

 Managerial Constraint
 Financial Constraint

 Criticism
 Ignores the role of other constraints to growth pattern of the firm
 Williamson’s Model
 Managers apply their discretionary power to maximize their own utility
function
 Constraint of maintaining minimum profit to satisfy shareholders
 Utility function of managers (Um) depends on:
 managers’ salary (measurable)
 Job security
 Power
 Status
 Professional satisfaction
 Power to influence firm’s objective