Managerial Economics

IntroductionIntroduction

EconomicsEconomics

The economics derived from the Greek word

(Oikos: “a house” & nomos: manager)(Oikos: “a house” & nomos: manager) means a prudent management of once

house hold affairs . But, it has now come to mean the study of business affairs in general. So can say economics is study of managing maximum gains out of scarce resources

Management + EconomicsManagement + Economics

DefinitionDefinition“Managerial economics is concerned with

the application of economic principles and methodologies to the decision process with in the organization .it seeks to establish rules and principles to facilitate the attainment of the desired economic goals of management.”

- douglas

Key points of definitionKey points of definition

• Decision making

• Economic methodology

• Economic goals of firm

Decision makingDecision making

It is the process of selecting best out of alternative opportunities open to the firm.

Economic methodologyEconomic methodology

It is a relation between ideas , thoughts , intuitions & experience with economic tools& techniques .

Economic goals of firmEconomic goals of firm

In the nutshell it is making maximum gains out of available resources

Scopes of managerial economicsScopes of managerial economics

• Micro – when something is concerned with individual (person firm or household)

• Macro – something related to the environment as a whole

Micro economic theoriesMicro economic theories

• Operational issues

. Theory of production

. Theory of price determination

. Theory of profit & capital budgeting

. Theory of demand

Macro economic theoriesMacro economic theories

• Environment or external issues

• Theories of national income

• Theories of economic growth & fluctuations

• Theories of national trade &monitory mechanism

• Theories of government policies

Why do managers need to know Why do managers need to know managerial economics?managerial economics?

• What to produce?• How to produce?• For whom to produce?• How much to produce?

so that can organization generate maximum gains.

& economics has the ans to all these problems

But economic theories are too theoretical to applied directly to the business decision making but when knowledge logic & analytical tools are added to these theories it becomes managerial economics

which helps the manager in rational business decision making.

ObjectivesObjectives of of

businessbusiness firmfirm

““Profit”Profit”

As a sole objectiveAs a sole objective

ProfitProfit

Different things to different people

Example- commission

salary

fees , ect

In economic terms profit means In economic terms profit means pure profit or economic profitpure profit or economic profit

• Economic profit - It is difference between actual earning & opportunity cost

• Opportunity cost – it is the expected income forgone form second best alternative

Profit theoriesProfit theories

Theory of rentTheory of rent by , by , profprof. . F.A. walkerF.A. walker

“profit is the rent of ability”

Rent – remuneration for the use of land to land lord

Profit – reward for ability of entrepreneur

According to professor walker

As rent is the difference between least & the most fertile land similarly, profit is the difference between earnings of the least & the most efficient entrepreneurs

CriticismCriticism

- Rent & profit are not similar . rent is always positive

. profit is positive as well as negative

- Absence of marginal entrepreneur

- profit is not the rent of ability

Dynamic theoryDynamic theory by , prof. J.B.clarkby , prof. J.B.clark

According to clark – profit arises in a dynamic economy not in static .

CriticismCriticism

• All economies are dynamic

• Profit is not the result of each change

• Theory ignores uncertainty & risk taking

Theory of riskTheory of risk By , Prof. HawleyBy , Prof. Hawley

“NO RISK NO GAIN”

CriticismCriticism

• All risk do not lead to profits

• Profit is to avoid risk

• There is no direct relationship between risk & profit

Theory of innovation by, prof. schumpeter

Profit is reward for innovation

Theory of uncertainty bearing by, prof. knight

“Profit is the reward for

uncertainties bearing”

Criticism

• uncertainty is not measurable

• Profit is not the reward for uncertainty bearing only

Other business objectivesOther business objectives

• Sales revenue maximization

• Maximization of firms growth rate

• Consumer satisfaction

• Long run survival

• Entry prevention

Consumer behavior :Utility

Meaning

“ utility is want satisfying power of commodity’’

• Utility is subjective/not measurable

• Utility is variable

• Utility is different from usefulness

• No legal or moral connotations

Characteristics:

Total utilityTotal utility

It is sum of the utility derived by the consumer from the number of units of goods & services he consumed.

TuTun n = U= Uxx + U + Uyy + U+ Uzz

total utility

0

10

20

30

40

50

60

70

1 2 3 4 5 6

total utility

No. of units consumed

Total utility

1

2

3

4

5

6

30

50

60

65

60

45

MARGINAL UTILITYMARGINAL UTILITY

It is the change in total utility obtained from the consumption of additional unit of commodity .

MU = change in TU

change in Q

no.of units consumed

Total utility Marginal utility

1 30 30

2 50 20

3 60 10

4 65 5

5 60 -5

6 45 -15 -20

-10

0

10

20

30

40

50

60

70

1 2 3 4 5 6

total utility

marginal utility

Law of diminishing marginal utilityLaw of diminishing marginal utility

As the quantity consumed of a commodity increases , the utility derived from each successive unit decreases , consumption of all other commodities remaining the same.

No. of units consumed

Marginal utility

1 30

2 20

3 10

4 5

5 -5

6 -15

marginal utility

-20

-15

-10

-5

0

5

10

15

20

25

30

35

1 2 3 4 5 6

marginal utility

AssumptionAssumption

• No small units are consumed

• Taste & preference remain same

• There must be continuity in consumption

• Consumer should be of sound mental health

Consumer’s EquilibriumConsumer’s Equilibrium

• Consumer will attain its equilibrium (maximum satisfaction) at the point, where marginal utility of a product divided by the marginal utility of a rupee, is equal to the price.

• Consumer’s equilibrium = Marginal utility of a product

Marginal utility of a rupee

= its price

Steps:Steps:

• Generation of alternatives

• Evaluation of alternatives

• Choice of the best alternative

Assumptions:Assumptions:

• Consumer behaviour is rational.• Consumer behaviour is consistent.• There are two commodities in consideration.

Law of Equi-Marginal UtilityLaw of Equi-Marginal Utility

• This law states that the consumer maximizing his total utility will allocate his income among various commodities in such a way that his marginal utility of the last rupee spent on each commodity is equal.

• Or• The consumer will spend his money income

on different goods in such a way that marginal utility of each good is proportional to its price

Limitations of Law of Equi-Limitations of Law of Equi-Marginal UtilityMarginal Utility

• ## It is difficult for the consumer to know the marginal utilities from different commodities because utility cannot be measured.

• # Consumer are ignorant and therefore are not in a position to arrive at an equilibrium.

• # It does not apply to indivisible and inexpensive

commodity.

The Budget Constraint,The Budget Constraint,or Budget Lineor Budget Line

Part of an Indifference MapPart of an Indifference Map

An Indifference CurveAn Indifference Curve