Managerial Economics
◼ Unit I: Introduction to Economics
◼ Unit II: Production Process &
Cost Analysis
◼ Unit III: Market Structure
◼ Unit IV: Macroeconomics – I
◼ Unit V: Macroeconomics - II
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Books
◼ ME by G. Gupta
◼ ME by Geetika, Piyali Ghosh &
Choudhary
◼ ME by Peterson, Lewis and Sudhir
Unit 1
Introduction to
Economics
Economics Defined
❖ Economics is the study of how societies use scare resource to produce valuable commodities and distribute them among different people (by Samuelson)
❖ Economics is the study of how societies decide what, how and for whom to produce (by Begg &
Fischer)
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Managerial Economics
❖ Managerial Economics applies economic theory and methods to business and administrative decision-making.
❖ Managerial Economics is the application of economic principles and methodologies to the decision-making process within the firm or organization.
Types of Economic Analysis
Micro & Macro Microeconomics:
❖ It analyses the behaviour of individuals components like individuals, firms, etc.
❖ It can be described as the study of economics through a microscope.
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Types of Economic Analysis
Macroeconomics:
❖ It analyses the functioning of the economy as a whole, i.e., total production, employment, etc.
❖ It examines economy through a wide angle lens.
❖ It does away with the breakdown of individual components.
❖ Deals with what is aggregate demand and supply, National income, employment, inflation.
Types of Economic Analysis
Positive & Normative
Positive statements are factual by nature.
Example: The distribution of income in India is unequal.
Normative statements involve some degree of value judgement and cannot be verified by empirical
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Types of Economic Analysis
Short Run and Long Run
Short run is the time period not enough for consumers and producers to adjust completely to any new situation.
A Long run is a planning horizon in which consumers and producers can adjust to any new situation.
Economic Principles
◼ Concept of Scarcity
◼ Concept of Opportunity Cost
◼ Production Possibilities Curve
◼ Concept of Margin or Increment
◼ Discounting Principle
Economic Principles
◼ Concept of Scarcity
➢ Human wants are unlimited but human capacity to satisfy such wants is limited.
➢ The aim of any economic problem is to make the best possible use of resources to get maximum satisfaction or maximum output.
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Economic Principles
◼ Concept of Opportunity Cost
➢
Opportunity cost is the benefit foregone from the alternative that is not selected.
➢
A firm may have to make a choice
between quantity and quality.
Economic Principles
◼ Production Possibilities Curve
➢ PPC is a graph that shows the different combinations of two goods that can be produced in an economy subject to limited availability of resources.
➢ For a society, a PPC measures the best combination of outputs that can be achieved from a given number of inputs.
➢ The decrease in the units of one commodity is the opportunity cost of producing more of another commodity. 13
Economic Principles
◼ Concept of Margin or Increment
The concept of marginality deals with a unit increase in cost or revenue or utility.
MC
n= TC
n– TC
n-115
Economic Principles
◼ Discounting Principle
➢ Discounting refers to time value of money.
➢ Most business decisions are related to outflow and inflow of money and resources at different points of time.
Assumptions
◼ Ceteris Paribus: All other things being constant
◼ Rationality: Consumers and producers measures costs and benefits
◼ Fallacy of Composition: Whole is not true of the parts, i.e., the conclusions drawn from macroeconomics can not be taken as true for individual components
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Theory of Firm
◼ A firm is an organization that is involved in the trade of goods, services or both to consumers.
◼ A commercial organization that operated for a profit motive and participates in selling of goods and services to consumers.
Forms of Ownership of Firm
◼ Ownership is measured from the point of view of investors.
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Forms of Ownership of Firm
◼ Private Sector:
a) Sole Proprietorship: A firm in which an individual invests own capital, uses own skills in management and is solely responsible for the operations of the business.
Forms of Ownership of Firm
b) Partnership: In partnership two or more individuals decide to start a common business.
◼ Number of partners cannot be more than 20.
◼ Partnership can be registered under Partnership Act, 1932.
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Forms of Ownership of Firm
c) Joint Stock Company: A JSC is established under Companies Act, 2013 (earlier Companies Act, 1956).
◼ It is a legal entity and has perpetual existence.
◼ A company has two basic forms:
i) Private limited company: Maximum members 200, minimum can be 1.
Forms of Ownership of Firm
d) Cooperatives: A cooperative is a non- profit, non-political, non-religious, voluntary organization, formed with an economic objective.
For example: Indian Fertilizers and Farmers Cooperative (IFFCO)
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Forms of Ownership of Firm
Public Sector:
◼ In public sector, government is the investor and the owner of a business.
◼ It came into existence due to communism and the Great Depression (1929-33).
Forms of Ownership of Firm
a) Corporate (or Company):
Government invests in production activities and enters the market.
• Such firms are called as Public Sector Units (PSUs).
Example: SAIL, ONGC, NTPC, GAIL, BSNL.
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Forms of Ownership of Firm
b) Corporation or Board: Corporations normally control some of the economic activities where the government feels that its intervention is necessary.
Example: FCI, Railway board.
Forms of Ownership of Firm
c) Department: A department is run for a specific purpose such as education, health, civil administration.
Example: Police and Education (up to secondary level) are responsibilities of the state govt. while telecommunication, post & telegraph, customs are under central government.
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Forms of Ownership of Firm
◼ Joint Sector: It is the sector in which ownership and control is shared between public sector agencies and a private entity.
◼ Integration of both public and private sectors.
Objectives of a Firm
◼ Profit Maximization:
One of the goals of the firm is to maximize profit.
Profit = Revenue – Cost Cost is of two types:
i) Explicit cost – It is reflected in cash outlays.
ii) Implicit cost – It is hidden cost, i.e., not reflected in cash outlays (self consumed/opportunity cost) 29
Objectives of a Firm
◼ Profit Maximization:
Accountants consider only explicit costs while economists consider both implicit as well as explicit costs.
Consider: Items Amount (in Rs)
Sales 90,000
Cost of goods sold 40,000
Advertising 10,000
Depreciation 10,000
Objectives of a Firm
◼ Profit Maximization:
Let an MBA pour a capital of Rs 2,00,000 to start this business.
Accounting profit = 23,000 Implicit cost:
- Return on Rs 2 lakh at 5% = 10,000
- Forgone wages = 20,000 Net economic profit = Rs (7,000)
Thus, Accounting profit > Economic
profit 31
Objectives of a Firm
◼ Value Maximization:
o The firm’s aim is not to seek the maximum value of any one of the profit’s, Pi, but the maximum value of their sum adjusted properly for the time value of money.
o It deals with time value of money, i.e., profit in which year. This year? Next year?
Objectives of a Firm
Pn = Profit in period n
r = appropriate discount rate
n = no. of years the firm is expected to last.
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n 2
2 1
r) ... (1
) 1
( r)
(1 P
firm the
of Value
+ + + +
+ +
= P
nr
P
Objectives of a Firm
◼ Management Utility Maximization:
o There is separation of ownership and management.
o Oliver E. Williamson hypothesised (1964) that profit maximization would not be the objective of the managers of a joint stock organisation.
o This theory assumes that utility
Objectives of a Firm
◼ Management Utility Maximization:
o The managers can use their ‘discretion’
to frame and execute policies which would maximise their own utilities rather than maximising the shareholders’
utilities. This is essentially the principal–agent problem.
o This could however threaten their job security, if a minimum level of profit is not attained by the firm to distribute among the shareholders. 35
Objectives of a Firm
◼ Baumol’s Theory of Sales Maximization:
o This theory asserts that managers attempt to maximise the firm’s total revenue, instead of profits.
o Firms seek to achieve ‘certain level of profits’ (the profit considered satisfactory by shareholders) and within
Objectives of a Firm
◼ Baumol’s Theory of Sales Maximization:
o Salaries and other earnings of top management are linked with sales.
o Banks and financial institutions also keep an eye on the sales of the firm.
o Large growing sales give prestige to manager.
o So, most of the managers prefer sales maximization with satisfactory profits. 37
Objectives of a Firm
◼ Marris Growth Maximization:
o Robin Marris in 1964 suggested growth or size maximization as an alternate goal of firms.
o Growth means an increase in sales, assets, and /or the number of employees.
o Balanced growth of a firm is dependent on growth rate of demand for the firms
Objectives of a Firm
◼ Long Run Survival:
o It was suggested by K.W. Rothschild (1947).
o Under this objective, the firm seeks to maximize the probability of its survival into the future.
o Such an objective would be commensurate with the interests of shareholders and the management.
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Objectives of a Firm
◼ Satisficing Model:
o Herbert Simon (1956) proposed that firms do not aim at maximizing anything (Profits/sales, etc.) due to imperfections in data and inadequate ideas.
o Instead, they set-up for themselves some minimum standards of achievements which they hope will assure the firm’s survival over a long period of time.
Objectives of a Firm
◼ Other Non-Profit Objectives:
o These include the maximization of quantity and quality of output subject to a break-even budget constraints, administrators utility maximization, maximization of factor productivity and maximization of cash flows.
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