managerial economics tutorial

Introduction

Upcoming of Managerial Economic is due to three factors; Complexity in business decision-making Use of economic concept, theories &

tools of economic analysis Increase in demand for trained

managerial manpower.

1DR JAYANTDUBEY, BTIRT,SAGAR

What Economic is?

It is a social science. It studies how people, individual, households, firms etc. maximizes its gains from limited resources. In Economics this maximizing factor is termed as “optimizing behavior”. Ex. Firm produces goods & services.

Economics is a study of the choice-making behavior of the people. In reality choice-making is not simple as it looks because world is very complex & decision is taken under risk and uncertainty.

Analytical tools & techniques, economic laws and theories combined to form the body of economics.


Managerial Economics

ME can be defined as the study of economic theories, logic and tools of economic analysis that are used in the process of business decision-making.

Econimic theories and techniques of economic analysis are applied to analyze business problems, evaluate business options and opportunities to arrive at an appropriate business decision.


Managerial Decision Areas • Evaluation of investible funds• Selection of Business Area• Choice of product• Determining Optimum Output• Determining price of a product• Determining Input-combination & Technology

Application of Economic Concepts and theories In Decision-Making

Use of Quantitative Methods• Mathematical Tools• Statistical Tools• Econometrics

Managerial EconomicsApplication of Economic Concepts, Theories and Analytical Tools to find Optimum Solution to BusinessProblems

4

DR JAYANTDUBEY, BTIRT,SAGAR

Definitions :

ME is concerned with the application of application of economic concepts and economics to the economic concepts and economics to the problems of formulating rational decisionproblems of formulating rational decision making. “Mansfield”

It is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management. “Spencer and Seigelman”


Scope of ME

Economics has two major branches: Microeconomics and Macroeconomics


The internal issues are; What to produce How much to produce Choice of technology Choice of price How to promote sale How to face price competition How to decide on new investment How to manage profit and capital How to manage inventoryMicroeconomic theories deal with most of these

Ques

Microeconomics Applied to Operational or Internal Issues


Theory of Demand

Demand theory deals with consumer’s behavior. It answer the questions such as; How do the consumer decide whether or not to

buy a commodity? How do they decide on the quantity of a

commodity to be purchased When do they stop consuming the commodity? The behaviour of consumer when the price,

taste and preference changes etc.


Theory of Production and Production decision

It explains the relationship between input and output

It also explain under what conditions costs increase or decrease

How can the output be maximized from limited input.


Analysis of Market Structure and Pricing Theory:

It explains how price is determined under different kind of market conditions.

When price discrimination is desirable, feasible and profitable.


Profit Analysis & Profit Management

Making the profit is the most common objective of all the businesses. But due to many factor such as risk uncertainty etc. it is not possible for the firm to make profit every time.


Theory of Capital and Investment Decisions:

Capital is the expensive factor. It is the foundation of business. Its allocation and management is the most important factor. The issue related to capital are; choice of investment project Accessing the efficiency of capital and Efficient allocation of capital.


Macroeconomics Applied to Business Environment:

It contains factor by which general business environment in which a business operates.

They are related to economic, social and political atmosphere of the country.

The factors of economic environment of a country are;


The type of economic system in the country, General trends in national income,

employment, prices, saving and investment, Trend in the working of financial institutions,

such as banks, insurance, Trend of foreign trade, Trend of labor supply and strength of the

capital market, Govt. economic policies ex. Industrial, fiscal, Social factors ex. Property rights, customs

and habits, etc.


Nature of Economics:

Eco can be viewed as a science or an art. It can be also be classified as pure and applied economics or positive and normative (directive) economics.


Nature of Economics (cont’d):

As science it is defined as a systematic body of knowledge that explains the relationship between cause and effects. In economics, relevant facts are system-atically collected, classified and analyzed. Another character of it is that its results are easily measurable. Money is used as measuring rod in eco for organizational & individual economic activities.


As an Art eco deals with the wants, needs and demand of human beings. An art, is a system-atized body of knowledge, which provides specific solutions to specific problems.

According to J.M. Keyens “A system of rules for the attainment of a given end” eg. Consum- ption theory provides us with the law of substitution, this tells a consumer how to maximize his satisfaction at a given level of expenditure.



The study of eco helps us to understand the nature & cause of economic problems which arise due to unlimited human wants & limited resources and enables us to develop policies, programs and strategies for dealing with them. Eco also helps us to answer the basic qu. such as; What to produce? how to produce? for whom to produce?



Thus, we can say that eco is about how society allocates its scarce resources? how economy works? how businesses & govt. make a decisions? and how these decisions affects the individuals?

Economic decisions are an integral part of a business whether at a firm level or at an international level. Knowledge of economic helps a business to become more profitable through proper allocation of resources and help govt. in their budgetary & trade related decisions.



Basic Economic Tools

The basic mathematical tools used in economic analysis are; Functional Relationship Concept of Slope & its application Elementary differential Calculus Optimization Techniques Regression Analysis


Functional Relationship bet’n Economic Variables:

Economic Variable: any economic quantity, value or rate that varies on its own or due to change in its determinants is an economic variable. Eg. Demand for product, supply, cost, product price, sales per unit of time, revenue, profit, labor, money demand and supply, interest rate, wage rate, advertisement and all economic variable. Many of these economic variable are interrelated and interdependent. The interrelated and interdependent of economic variable implies that a change in one variable causes a change in the value of the other related variable. Eg.a) Advertisement Expenditure and salesb) Income and consumer expenditure


Dependent & Independent Var:

A variable whose value depend on the value of other variable and

An independent variable is one whose value changes on its own or is assumed to change due to certain outer (exogenous) factor. Eg. Price of petrol depends on increase in import oil price. Domestic oil is dependent & international oil is independent variable.


Endogenous & Exogenous Var:

An endogenous var is one whose value is determined within the model or framework of the analysis. These are in the model as dependent variable, ex. The variables in production. These are also called ‘controlled’ variable and;

an exogenous var is one whose value is determined outside the model. These are inputs of the model. Eg. Money supply, tax rates, Govt. expending, time and weather. These are also known as ‘uncontrolled’ variable


Concept of Functions:

As we know that most of the economic var are interrelated and interdependent. In most cases, economic var have cause and effect relationship. The relationship between any two or more variable can be expressed in a tabular, a graphical and in a functional form.


Eg. Relation between price and no. of Pizza sold:

Pizza Price & Demand for Pizza

Price of Pizza

No. of Pizza sold

10 00

8 10

6 20

4 30

2 40

00 50 Demand for Pizza

Piz

za P

rice/

Uni

t


Table shows that there is a relationship between the price of pizza and its quantity demanded per week. It shows as price of pizza decreases demand increases. Figure shows the demand curve. This gives the law of demand. We can conclude that; There is inverse relationship between the pizza

price and demand for it & For each fall in price of pizza by Rs. 2, quantity

demanded increases by Rs.10.


i- The Function

A mathematical technique of stating the relationship between two or more variable having cause and

effect relationship.

DP =f (PP) where DP=Demand for Pizza

PP = Price of Pizza

Suppose there are 2 variable X & Y and these variable are so related that value of Y depends systematically on the value of X. i.e. var Y & X are related in cause and effect manner. Then

Y= f (X)27DR JAYANTDUBEY, BTIRT,SAGAR

The above relation ship shows that the variable are related to each other. But fails to reveal that:

i- Nature of relationship.

ii- Quantitative measure of relationship or the degree of relationship.


ii- Concept of Slope and its uses

Def.: The rate of change in the dependent variable as a result of a change in the independent variable.

The slope of a line or the curve shows how strongly or weekly are the two variable related. The steeper the curve or line, the weaker the relationship and the flatter the curve or line it shows stronger relationship.


Concept of Slope and its uses (Contd)

With respect to demand curve, slope is the ratio of change in the dependent variable (D) to the change in the independent variable (P). The movement down the demand curve or the demand curve gives the decrease in price (-ΔP) & the consequent increase in demand (ΔD). The ratio (-ΔP/ ΔD) gives the slope of the demand curve.


iii- Differential Calculus

It is applied to analyze and to find the solution to the wide range of economic problems and to business decision-making, especially where an analyst or business decision-maker has to find an optimum solution to a problem.

It provides a technique of measuring the marginal change in the dependent variable (Y) due to a change in the independent variable (X) when the change in X approaches zero. The measure of such a change is called derivatives.

Mathematically

X

Y

X

YY

0lim


iv- Optimization Techniques:

It is the technique of finding the value of the independent variable that maximizes or minimizes the value of the dependent variable. Eg. Simplex method, transportation problem, assignment problem, replacement problem etc.


v- Regression Technique:

It is used to quantify the relationship between two or more economic variable. Regression is used to estimate the nature & extent of the relationship between two or more related variables. It is used to study the cause & effect relationship between the variables.


Some Basic Principles:

Opportunity cost Principles, Incremental Principles, Principle of Time Perspective, Discounting Principle


Opportunity Cost Principle

By opportunity cost of a decision it is meant that the sacrifice of alternatives required by that decision. If there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than it’s opportunity cost. Opportunity cost is the minimum price that would be necessary to retain a factor-service in it’s given use. It is also defined as the cost of sacrificed alternatives. For instance, a person chooses to forgo (to give up) his present lucrative (profitable) job which offers him Rs.50000 per month, and organizes his own business. The opportunity lost (earning Rs. 50,000) will be the opportunity cost of running his own business.


Marginal and Incremental Principle This principle states that a decision is said to be rational and

sound if given the firm’s objective of profit maximization, it leads to increase in profit, which is in either of two scenarios-

If total revenue increases more than total cost. If total revenue declines less than total cost.

Marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal generally refers to small changes. Marginal revenue is change in total revenue per unit change in output sold. Marginal cost refers to change in total costs per unit change in output produced (While incremental cost refers to change in total costs due to change in total output). The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price.


Principle of Time Perspective

According to this principle, a manger/decision maker should give due emphasis, both to short-term and long-term impact of his decisions, giving apt significance to the different time periods before reaching any decision. Short-run refers to a time period in which some factors are fixed while others are variable. The production can be increased by increasing the quantity of variable factors. While long-run is a time period in which all factors of production can become variable. Entry and exit of seller firms can take place easily. From consumers point of view, short-run refers to a period in which they respond to the changes in price, given the taste and preferences of the consumers, while long-run is a time period in which the consumers have enough time to respond to price changes by varying their tastes and preferences.


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.


A Managerial Economist is an expert who advices business mgt in economic matters and problems faced by the business organization. He also takes business decisions & formulate forward plans. He works as a business analyst and an advisor in the firm.

DR JAYANTDUBEY, BTIRT,SAGAR 39

Role & Responsibilities of Managerial Economists:

Role of managerial Economists (cont’d):

When economist needs a price, interest rate or other quantity to use in an analysis, he will tend to look to the product and financial markets for an answer rather than "building it up" from accounting costs.

Economists are trained to think in terms of marginal change. Economists are generally well-versed in mathematics and statistics and tend to approach problems using those tools. Economists are comfortable with probabilities and will build models incorporating them.


When an economist needs a price, interest rate or other quantity to use in an analysis, he will tend to look to the product and financial markets for an answer rather than "building it up" from accounting costs. Economists are trained to think in terms of marginal change. Economists are generally well-versed in mathematics and statistics and tend to approach problems using those tools. Economists also are comfortable with probabilities and will build models incorporating them. We are trained in doing simulation studies.



Managerial economics (also called business economics), is a branch of economics that applies microeconomic analysis to specific business decisions. As such, it bridges economic theory and economics in practice. It draws heavily from quantitative techniques such as regression analysis and correlation, Lagrangian calculus (linear). If there is a unifying theme that runs through most of managerial economics it is the attempt to optimize business decisions given the firm's objectives and given constraints imposed by scarcity, for example through the use of operations research and programming.



Responsibilities of Managerial Economists:

A Managerial Economists has to perform specific functions for business mgt. The specific fn’s are; Sales Forecasting Market Research Economic Analysis of competing firms Pricing problems of the industry Evaluation of capital projects. Security and investment analysis and forecasting. Production & inventory control Environmental forecasting Advice on international trade & foreign exchange


Demand Analysis & Forecasting

Concept of Demand & Demand Fn’s: The amount of a good that a consumer is willing to buy or able to purchase over a period of time, at a certain price is known as the quantity demanded of that good. Demand is a relationship between the price and the quantity demanded other things remaining constant.

If X1 is the quantity demanded and P1 is price per unit of goods other things remains constant ( means factors which influence the decision of the customer to buy) the demand fn is given by

X1= f (P1) i.e. quantity demanded depends on price



Price 500 450 400 350 300 250 200

Quty 2Lks 3 Lks 4Lks 5Lks 6Lks 7Lks 8 Lks

Example; The no. of jackets sold per month at Chhandigarh is given below;

Interpretation: The graph shows that the demand curve is downward

sloping. A change in the quantity demanded is a movement along the demand curve caused by a change in the price of the good. A decrease in price is reflected by a corresponding increase in the amount of quantity demanded. The inverse relationship between price and demand is shown in the demand curve.

Downward slope of the demand curve reflects the law of demand, which states that other things remaining the same, if the price of any good decreases its quantity demanded increases and vice-versa.



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managerial economics tutorial