1.basic concepts and principles

8/11/2019 1.Basic Concepts and Principles

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Dr. Prerna Jain

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Introduction The purpose of studying economics is not to acquire a

set of ready-made answers to economic questions.

The process of selecting any one option among severalalternatives available, which may seem to be a simpledecision to you, plays a central role in economic

analysis.


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Definition and Scope of Economics Economics is the art of making the most of life.

It tries to solve the human problems of unlimited

wants and scarce resources. In the words of Keynes .. The theory of economics

does not furnish a body of settled conclusionsimmediately applicable to policy. It is a method

rather than a doctrine, an apparatus of the mind, atechnique of thinking, which help the possessor todraw correct conclusions.


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Basic Assumptions Economic theories are based on certain simplifying

assumptions:

Ceteris Paribus means otherthings being equalthestudy of some group of tendencies is isolated by theassumption other things being equal: the existence ofother tendencies is not denied, but their disturbing

effect is neglected for a time. The more the issue isnarrowed, the more exactly can it be handled.


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Rationality Economists make the assumption thatpeople act rationally. Rationality implies thatconsumers and producers measure and compare thecosts and benefits of a decision before going ahead.Thus rationality involves making a choice that gives thegreatest benefit relative to the cost.


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Types of Economic Analysis Micro and Macro

Positive and Normative

Short and Long runMarket period (in which the goods produced for sale on the market are taken

as given data and prices quickly adjust to clear markets, e.g., market for

perishable goods)

Short period (in which industrial capacity is assumed to be given)

Long period (in which the stock of capital goods, such as equipments andmachines is not taken as given)

Very Long period (in which technology, population, habits and other factors

are not taken as given, but are allowed to vary)

Partial and General Equilibrium


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Kinds of Economic DecisionsWhat to produce? (Depends on market demand, availability

of raw material and technology)

How to produce? (efficiency)

For whom to produce? (ability to pay) (according to need)

Are resources used economically?

Are resources fully employed?

Is the economy growing? (To maintain the conditions ofstability it is necessary to ensure that the productive capacity

continues to increase)


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Reality BitesWhat to produce? The Coca Cola WayThe Coca Cola company says that as a beverage company Coca

Cola aims to offer all possible alternatives by spending a lot of

time in understanding consumers lifestyle and needs. It

recognises that there are moments when people want to be

more focused on nutritional values and there are moments

when one requires mental recharge; sometimes one wants

vitality and energy boost. Therefore the company aims to cover

and cater to these different needs through its beverageportfolio. The portfolio claims to offer an appropriate level of

sweetness and functional benefits along with right packaging

and communication. (Economic Times January 2008)


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Economic Principles Relevant to Managerial

Decisions Concept of Scarcity: In view of scarcity of resources and

multiplicity of needs, the economic problem lies in making the best possible

use of resources so as to get maximum satisfaction or maximum output.

Concept of Opportunity Cost: It is the benefit forgone from thealternative that is not selected. Ex: You may be working in your hometown

and suppose you have got another job offer in a city away from your

hometown. Now if you select the new offer, you would be foregoing the

benefits of staying at home.


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Concept of Margin and Increment: Marginal analysis is thecornerstone of economic theory. The concept of marginality deals with a

unit increase in cost or revenue or utility. However, there is an inherent

problem with the marginal concept as in reality variables may not be subjectto such a unit change as explained above.

In such cases, it is always more convenient to use the incremental concept.

In other words, the incremental concept is applied usually when the changes

are not necessarily in terms of a single unit, but in bulk. In such a case, the

additional revenue earned is termed asincremental

revenue.

For Ex: an increase in the sales of a firm due to introduction of online

selling and additional costs of launching the online selling mechanism

would be termed as incremental revenue and incremental costs respectively.

If the former exceeds the latter, we can infer that the decision of introducing

the online mechanism is right.


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Discounting Principle: The core of discounting principle is that arupee in hand today is worth more than a rupee received tomorrow. In other

words, it refers to time value of money i.e., in fact the value of money

depreciates with time. It is necessary to discount future rupee to make itequivalent to current day rupee.

Why do businesses need to bother about discounting?

This is because most decisions in business situations relate to outflow and

inflow of money and resources that take place at different points of time.

Most outflows normally occur in the current period, whereas inflowsoccur only in future, therefore, in order to take the right decision, it is

necessary to discountfuture inflows to their present value level.

The simple formula for discounting is:

PVF = 1/ (1+r)n


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Managerial Economics Defined The application of economic theory and the tools of

decision science to examine how an organization canachieve its aims or objectives most efficiently.


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Managerial Decision Problems

Economic theoryMicroeconomics

Macroeconomics

Decision SciencesMathematical Economics

Econometrics

MANAGERIAL ECONOMICSApplication of economic theory

and decision science tools to solve

managerial decision problems

OPTIMAL SOLUTIONS TO

MANAGERIAL DECISION PROBLEMS


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Theory of the Firm Combines and organizes resources for the purpose of

producing goods and/or services for sale.

Internalizes transactions, reducing transactions costs. Primary goal is to maximize the wealth or value of the

firm.


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Why do firms exist? Firms exist because it would be very inefficient and costly for entrepreneurs to

enter into and enforce contracts with workers and owners of capital, land, andother resources for each separate step of the production and distributionprocess.

Instead, entrepreneurs usually enter into longer-term, broader contracts withlabour to perform a number of tasks for specific wages and fringe benefits.Such a general contract is much less costly than numerous specific contractsand is highly advantageous both to the entrepreneurs and to the workers andother resource owners.

The firm exists in order to save on such transaction costs.

By internalising many transactions, the firm also saves on sales tax and avoidsprice controls and other government regulations that apply only to transactionsamong firms.


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Value of the FirmThe present value of all expected future profits


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Limitations of the Theories of

the Firm Sales maximization

Adequate rate of profit

Management utility maximization Principle-agent problem

Satisficing behavior


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Definitions of Profit Business Profit: Total revenue minus the explicit or

accounting costs of production.

Economic Profit: Total revenue minus the explicit andimplicit costs of production.

Explicit Costs are the expenditures of the firm to

purchase or hire the inputs it requires in production. Implicit Costs refer to the value of the inputs owned

and used by the firm in its own production processes.


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Theories of Profit Risk-Bearing Theories of Profit

Frictional Theory of Profit

Monopoly Theory of Profit Innovation Theory of Profit

Managerial Efficiency Theory of Profit


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Function of Profit Profit is a signal that guides the allocation of societys

resources.

High profits in an industry are a signal that buyerswant more of what the industry produces.

Low (or negative) profits in an industry are a signalthat buyers want less of what the industry produces.


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How Is Managerial Economics

Useful? Evaluating Choice Alternatives

Identify ways to efficiently achieve goals. Specify pricing and production strategies.

Provide production and marketing rules to helpmaximize net profits.

Making the Best Decision Managerial economics can be used to efficiently meet

management objectives. Managerial economics can be used to understand logic

of company, consumer, and government decisions.


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Role of Business in SocietyWhy Firms Exist

Business is useful in satisfying consumer

wants.Business contributes to social welfare

Social Responsibility of Business

Serve customers.Provide employment opportunities.

Obey laws and regulations.

1.basic concepts and principles

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