MANEGERIAL ECONOMICS

QUES 1) "Managerial Economics is the integration of/ bridges the gap between economic theory with/& business practice so as to facilitate decision making" Comment/ outline the nature and scope of Managerial Economics in light of this statement? ANS. Managerial economics in a general sense refers to the integration of economic theory with business practices. It is that branch of economics which serves as s link between abstract theory and managerial practices. Managerial economics refers to those aspects of economics and its tools of analysis most relevant to the firms decision-making process. According to Me Nair and Merriam, managerial economies consist of the use of economic models of thought to analyze business situations. Some writers consider managerial economics as the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management. The underlying idea of all these definitions is that managerial economics means economics applied in decision-making. So we may consider managerial economics as a special branch of economics bridging the gap between abstract theory and managerial practice. Nature of Managerial Economics:

The primary function of management executive in a business organisation is decision making and forward planning. Decision making and forward planning go hand in hand with each other. Decision making means the process of selecting one action from two or more alternative courses of action. Forward planning means establishing plans for the future to carry out the decision so taken. The problem of choice arises because resources at the disposal of a business unit (land, labor, capital, and managerial capacity) are limited and the firm has to make the most profitable use of these resources. The decision making function is that of the business executive, he takes the decision which will ensure the most efficient means of attaining a desired

objective, say profit maximization. After taking the decision about the particular output, pricing, capital, raw-materials and power etc., are prepared. Forward planning and decision-making thus go on at the same time. A business managers task is made difficult by the uncertainty which surrounds business decision-making. Nobody can predict the future course of business conditions. He prepares the best possible plans for the future depending on past experience and future outlook and yet he has to go on revising his plans in the light of new experience to minimize the failure. Managers are thus engaged in a continuous process of decision-making through an uncertain future and the overall problem confronting them is one of adjusting to uncertainty. In fulfilling the function of decision-making in an uncertainty framework, economic theory can be, pressed into service with considerable advantage as it deals with a number of concepts and principles which can be used to solve or at least throw some light upon the problems of business management. E.g. are profit, demand, cost, pricing, production, competition, business cycles, national income etc. The way economic analysis can be used towards solving business problems, constitutes the subject-matter of Managerial Economics. Thus in brief we can say that Managerial Economics is both a science and an art.

SCOPE OF MANAGERIAL ECONOMICS: The scope of managerial economics is very wide as it involves the application of economic concepts and analysis to all problems of areas of manager and the firm. Thus the scope of managerial economics covers the following area: Theory of demand analysis and forecasting A business firm is an economic organization which is engaged in transforming productive resources into goods that are to be sold in the market. A major part of managerial decision making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and

profit base. Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics Cost and production analysis A firms profitability depends much on its cost of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing are cause variations in cost estimates and choose the costminimizing output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production processes are under the charge of engineers but the business manager is supposed to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing practices depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of scale and cost control. Analysis of market structure and pricing theory Price theory explains how practices ere determined under different market conditions, when price discrimination is desirable, feasible and profitable; to what extent advertising can be helpful in expanding sales in a competitive market. Thus the price theory can be helpful in determining the price policy of the firm. Profit analysis and profit management Business firms are generally organized for earning profit and in the long period, it is profit which provides the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues likely to accrue to the firm at different levels of output. The more successful a manager is in reducing uncertainty, the higher are the profits earned by him. In fact, profit-

planning and profit measurement constitute the most challenging area of Managerial Economics. Theory of capital and investment decisions The problems relating to firms capital investments are perhaps the most complex and troublesome. Capital management implies planning and control of capital expenditure because it involves a large sum and moreover the problems in disposing the capital assets off are so complex that they require considerable time and labor. The main topics dealt with under capital management are cost of capital, rate of return and selection of projects.

QUES 2) Discuss the role of Managerial Economist in a Business Organization ANS. A managerial economist has been regarded as one of the most important executives of the company. This status is gaining an increasing importance in business in recent times. He is an expert in decision making and forward planning and hence is very useful for successful management. He is specialized in basic economic theory and with this knowledge he solves the problem of business management. One of the principal objectives of any management in its decision making process is to determine the key factors which will influence the business over the period ahead. In general, these factors can be divided into two categories, viz., (i) External and (ii) Internal. The external factors lie outside the control management because they are external to the firm and are said to constitute business environment. The internal factors lie within the scope and operations of a firm and hence within the control of management, and they are known as business operations. To illustrate, a business firm is free to take decisions about what to invest, where to invest, how much labor to employ and what to pay for it, how to price its products and so on but all these decisions are taken within the framework of a particular business environment and the firms degree of freedom depends on

such factors as the governments economic policy, the actions of its competitors and the like. A managerial economist helps the management by using his analytical skills and highly developed techniques in solving complex issues of successful decisionmaking and future advanced planning. The role of managerial economist can be summarized as follows: 1. He studies the economic patterns at macro-level and analysis its significance to the specific firm he is working in. 2. He has to consistently examine the probabilities of transforming an everchanging economic environment into profitable business avenues. 3. He assists the business planning process of a firm. 4. He also carries cost-benefit analysis. 5. He assists the management in the decisions pertaining to internal functioning of a firm such as changes in price, investment plans, type of goods /services to be produced, inputs to be used, techniques of production to be employed, expansion/ contraction of firm, allocation of capital, location of new plants, quantity of output to be produced, replacement of plant equipment, sales forecasting, inventory forecasting, etc. 6. In addition, a managerial economist has to analyze changes in macroeconomic indicators such as national income, population, business cycles, and their possible effect on the firms functioning. 7. He is also involved in advising the management on public relations, foreign exchange, and trade. He guides the firm on the likely impact of changes in monetary and fiscal policy on the firms functioning. 8. He also makes an economic analysis of the firms in competition. He has to collect economic data and examine all crucial information about the environment in which the firm operates. 9. The most significant function of a managerial economist is to conduct a detailed research on industrial market. 10.In order to perform all these roles, a managerial economist has to conduct an elaborate statistical analysis. 11.He must be vigilant and must have ability to cope up with the pressures.

12.He also provides management with economic information such as tax rates, competitors price and product, etc. They give their valuable advice to government authorities as well. 13.At times, a managerial economist has to prepare speeches for top management. QUES 3) Discuss the concept of Production Possibility Curve? What is the reason behind its shape? Do you think there are exceptions to it? ANS. Production possibility curve is a curve which depicts all possible combinations of two goods which an economy can produce with available technology and with full and efficient use of its given resources. Resources to satisfy human wants are not only limited but also have alternative uses. Human wants are unlimited. It is essential to make a choice between alternative uses of available resources. Due to the characteristic feature of scarce resources having alternative uses, there is maximum limit to the production of goods and services which an economy can produce with full and efficient use of available resources. It demands the diversion of some resources from producing one product to another product to increase the production of one particular goods or service. To increase the output of one product, we have to sacrifice or reduce the production of another product. Available resources can be used to produce various alternative goods which are known as production possibilities. The graph or curve showing the production possibility is called Production Possibility Curve. It is very difficult to make choice among hundreds and thousands of goods which can produce form the same resources. Although it can be used to analyze any number of commodities, economists have simplified the analysis by presuming only two goods. PP Curve also knows as Production Possibility Frontier represents different pairs or combinations of two goods which can be produced with economies given technology and resources. Production Possibility Curve is drawn on the following four assumptions: 1. Given resources are fixed.

2. Given technology remain constant and does not change. 3. Given resources are used fully and efficiently. 4. Resources are not equally efficient in production of all goods. Production Possibility Curve has two characteristics: 1. It is downward sloping from left to right. 2. Production Possibility Curve is concave (curved inwards) to the origin.

Production Possibility Schedule and Curve Production possibility curve indicates various alternatives in the form of combination of two goods which can be produced with full and efficient employment of given resources and available technology. Let us assume that with the given resources and technology an economy can produce only two goods, namely Wheat and Rice. The example of two goods is given to facilitate the problem of choosing otherwise same analysis applies to any choice of goods. Different possibilities of production of combination of Rice and Wheat in a hypothetical economy are illustrated in the following Production Possibility schedule and curve.

Production possibility Schedule and curve Different points on Production Possibility curve depicting different combinations of two goods are in fact choices that are open to society. If the economy decides

to use all its resources in the production of Rice, then the wheat cannot be produced. If the economy decides to use all its resources in the production of wheat then the production of rice will not be possible. These are two extreme possibilities. In between them, there are many other possibilities. Economy can devote a pare of its resources to the production of Rice and a part to the production to wheat. Points B, C, D and E based on the data given in the schedule gives various combination of two goods. Curve AF indicates full employment of resources. Any point below or inside production possibility curve shows the under utilization of resources. Any point above the production possibility curve shows the growth of resources. All points like A, B, C, D E and F on Production possibility curve indicates efficient utilization of resources. Indication of points on, below and above Production Possibility Curve(PPC) Any point on PPC indicates full employment and efficient use of resources. Point below PPC shows inefficient and under utilization of resources. Point above PPC indicates growth of technology and resources. When economy is producing on PP curve every point on it like A, B, C, D, E and F reflects situation of full and efficient employment of resources. This means resources like labor; land, capital etc are not idle. A production possibility curve shows the possibility of an economy in which full utilization of resources like Land, Labor, capital and technology can be employed. Under utilization or Inefficient utilization of resources shows a point below the PP curve. Wrong allocation of land or capital or labor result in under utilization of resources. A point below the Production Possibility curve denotes that the economy is not fully utilizing its productive capacity. When economy is operating at any point above the Production Possibility curve indicates situation of growth of resources or improvement of technology. This will enable the economy to grow. Outward or rightward shift of Production Possibility Curve reflects growth of resources or advancement of technology. SHAPE OF PPC The shade of a production Possibility Curve is concave (curved inwards) due to the increasing marginal opportunity cost. Increasing Marginal opportunity cost means

producing an additional item requires the sacrifice of production of another item (i.e. opportunity cost) goes on increasing. Resources specialized for the production of one item will not suite the production of another item. We have seen in the production possibility schedule above that the production of wheat is possible through the sacrifice of production of rice. Increase in the production of 1 million tonnes of wheat, sacrifice of production of rise is increasing successively from 1 million tonnes to 2 million tonnes, the from 2 to 4 million tonnes and so on indicating increasing Marginal Opportunity cost which is technically called Marginal Rate of Transformation (MRT). AS a result the shape of PPC becomes concave to the origin. EXCEPTIONS TO PPC PPC is a downward sloping curve which is concave to the origin, but in some exceptional cases PPC can be a straight line This occurs when two goods are produced without specialization of resources. Typically there is specialization which leads to the bowed out curve. For example, think of a PPF in which corn and wheat are grown on the same land. Some of this land is going to be better for producing wheat; thus, the wheat is going to take up more and more of the land. But at a certain point, you're going to be using land that will be best used for corn production. So if you use all of the land for wheat (a point either on the x or y axis of the PPF), the opportunity cost measured in corn is going to be greater than the cost of producing all wheat. Remember that the slope of the line is the opportunity cost. But when there is no specialization, producing all of one good does not incur a greater opportunity cost. Therefore the opportunity cost is constant and the slope is constant.