MANAGERIAL ECONOMICS

WHAT IS ECONOMICS?

Economics is the study of allocation of

scarce resources among alternate uses.

Economics is the study of how

individuals and groups make decisions with limited resources as to best satisfy their wants, needs and desires.
Economics is on one side the study of

wealth and on the other and more important side, a part of the study of man.

ECONOMICS

MACRO MICRO

Macro Economics

Micro Economics

Studies the economic system in aggregate Looks at the total output of a nation and the way the nation allocates its resources

Studies the behavior of an individual decision making unit like an individual/household/

firm

of land, labour, capital, etc. to promote trade and growth

MACRO ECONOMICS RELATES TO ISSUES SUCH AS

NATIONAL INCOME SAVINGS INVESTMENT EMPLOYEMENT TAX COLLECTIONS FOREIGN TRADE MONEY SUPPLY PRICE LEVEL

GOVERNMENT EXPENDITURE - To curtail Fiscal Deficit

Raise taxes Cut spending Borrow Print

Easiest politically Results in inflation It is a tax on those holding money

Managerial Economics
Analyses the process

Through which a manager uses economic theories

to address the complex problems of business world

and then, take rational decisions

in such a way that the perceived objectives of the firm may be attained

THE MANAGER OF A FIRM FACES THE FOLLOWING BASIC ISSUES

Choice of product
Choice of inputs Distribution of the firms revenues

Rationing
Maintenance and expansion

OBJECTIVES OF A FIRM
Maximization of Profit

Maximization of

sales revenue Maximization of growth rate Maximization of managers utility function Making satisfactory rate of profit

GOALS OF A FIRM
Market share

Customer satisfaction
ROI Technological advancement Long run survival Entry prevention & risk avoidance

Social/Environmental concerns

BASIC ECONOMIC
RESOURCES
MONEY MACHINE MATERIALS LABOUR TIME SKILL TECHNOLOGY

CONCEPTS

1. CHOICES AND DECISIONS

CHOICES ALTERNATE USES

WHETHER TO STUDY FULL TIME MBA OR MCA OR LAW WHETHER TO KEEP MONEY IN SB OR TD OR INVEST IN BUSINESS OR SHARES

OPPORTUNISTIC COST

BASIC ECONOMIC

CONCEPTS

2. HUMAN ACTION PURPOSEFUL BEHAVIOUR 3. SCARCITY

If anything is scarce, it is a subject of economics.

Otherwise, it is not a subject matter of economics.

4. TRADE OFF
Economics is about trade off If you get one thing, you cannot get another thing. You

have to give up one for the other.

BASIC ECONOMIC
5. INCREMENTAL CONCEPT

CONCEPTS

While adding a new business/buying new input/adopting new process

6. DISCOUNTING CONCEPT

If a decision affects costs and revenues in the long run, they should be discounted. A rupee in future is less in value

7. TIME PERSPECTIVE

Short term and long term impact due to decisions say pricing decision

8. MARGINAL CONCEPT

Marginal utility of the product. Marginal utility is derived from the additional unit consumed.

BASIC ECONOMIC
9. EFFCIENCY AND PRODUCTIVITY

CONCEPTS

How well resources are used in order to get maximum output. Productivity means with one of input, how much output you get.

Productivity per worker Productivity per machine

10. MEANS = RESOURCES = INPUT

TIME, MONEY, LAND, LABOUR, CAPITAL, NATURAL RESOURCES

11. UTILITY
Subjective benefit a particular person gets by using a particular goods

12. GOOD (ECONOMIC GOOD)

BASIC ECONOMIC
13. MODEL

CONCEPTS

Theoretical abstract representation over relationship between two or more economic variables. Out put depends on in put (capital, labour, etc) Every model has four fundamentals

Theory Variables Assumptions Causation

Example: Inflation

Causation: Increasing money supply (Value of money falls, prices increase)

BASIC ECONOMIC
14. ECONOMIC PROFIT Vs. ACCOUNTING PROFIT

CONCEPTS

Accounting profit ignores opportunity cost Economic profit is arrived at after taking into account opportunity cost.

EXAMPLE An individual sets up a shop in a building owned by him and puts in work by himself. The business makes a profit of Rs. 2 lacs. No rent for his premises and no salary for his work were paid. ACCOUNTING PROFIT Rs.2,00,000

LESS NOTIONAL RENT

NOTIONAL SALARY

Rs.1,44,000
Rs. 96,000 Rs.2,40,000 --------------

ECONOMIC PROFIT/LOSS

(-)

Rs. 40,000 --------------

POSITIVE ECONOMIC PROFIT = Revenue exceeds all costs including opportunity cost.

For economic purposes, economic profit and not accounting profit has to be used. Opportunity cost is subjective. Accountants want documents to account.

BASIC ECONOMIC
15. NORMAL PROFIT

CONCEPTS

Suppose one has invested capital. How much interest he will get

on his investment under competitive condition. Interest on the capital + risk premium

16. EXCESS PROFIT -- GETTING MORE THAN NORMAL PROFIT

You cannot get excess profit in the long run because competition

will emerge. Govt. also steps in to prevent excess profit being made by various measures , EXAMPLE: Micro Finance, Financing against gold jewellery.

INCREMENTAL CONCEPT EXAMPLE

You want to purchase a machine costing Rs.10,00,000/-. When you approached a

nationalised bank, they offered to lend to the extent of 80% of the cost of machine at an interest rate of 10%. You do not have margin money of Rs.2,00,000/-. When you approached a private sector bank, they agreed to lend 90% of the cost of the machine but @ 12%. What is the incremental cost in terms of % of interest on the incremental amount of Rs.1,00,000 borrowed for one year

Working for incremental financing cost

Financing cost = Loan amount x Interest rate First case = 8,00,000 x 0.10 = 80,000 Second case = 9,00,000 x 0.12 = 1,08,000 Incremental Financing Cost = 1,08,000 80,000 = 28,000 Incremental amt. borrowed= 1,00,000 Incremental Financing cost % = Incremental cost/ Incremental borrowing 28,000/1,00,000 = 0.28 = 28%

DISCOUNTING CONCEPT EXAMPLE

You are in a position to invest Rs.1 crore in a project. You

have choice of two projects and have to choose the most profitable project. Discounting rate/Cost of funds is 15%. Cash inflow over a 5 year period is as follows: Year Project A Project B I 10,00,000 0 II 10,00,000 5,00,000 III 10,00,000 5,00,000 IV 10,00,000 10,00,000 V 10,00,000 32,50,000 Which project you will choose?

Working for discounting concept example

CASH FLOW VALUE PRESENT VALUE YEAR CASH FLOW PRESENT PROJECT B PROJECT A

10,00,000
10,00,000 10,00,000 10,00,000

8,69,565
7,56,144 6,57,516 5,71,753

I
II III IV

0
5,00,000 5,00,000 10,00,000

0
3,78,072 3,28,758 5,71,753

10,00,000
50,00,000

4,97,176 V
33,52,154

32,50,000
TOTAL

16,15,824
52,50,000 28,94,507

Present Value = Cash flow/r to the power of n

CIRCULAR FLOW OF ACTIVITY

HOUSEHOLDS OWN AND CONTROL RESOURCES AND SELL

THEM TO BUSINESSES BUSINESSES USE THE RESOURCES TO MAKE FINISHED PRODUCTS BUSINESSES TAKE FINISHED PRODUCTS AND SELL THEM TO HOUSEHOLDS GOODS AND SERVICES HOUSEHOLDS RESOURCES BUSINESSES

CIRCULAR FLOW OF ACTIVITY Continued

HOUSEHOLDS PURCHASE GOODS AND AVAIL SERVICES RESULTING IN EXPENDITURE

FLOW OF PAYMENTS TO BUSINESSES FROM HOUSEHOLDS. HOUSEHOLDS/INDIVIDUALS WORK FOR BUSINESSES, RENT THEIR PREMISES TO BUSINESSES AND INVEST IN BUSINESSES. ALL THESE ACTIVITIES GENERATE INCOME FLOW OF PAYMENTS TO HOUSEHOLDS FROM BUSINESSES. THE FLOW OF PAYMENTS IN AN ECONOMY IS A CIRCULAR FLOW

DEMAND ANALYSIS
DETERMINANTS OF DEMAND
PRICE INCOME PRICES OF RELATED GOODS i.e. SUBSTITUTE AND COMPLEMENTARY GOODS ADVERTISING AND SALES PROMOTION

DETERMINANTS OF DEMAND Contd.

POPULATION AVAILABILITY OF CREDIT SEASON OF THE YEAR WEATHER ONES STATUS GEOGRAPHIC LOCATION OF THE BUYERS EXPECTED FUTURE TREND IN PRICES CHANGES IN CONSUMER TASTES NEEDS AND PREFERENCES CHANGES IN CONSUMER CREDIT FACILITIES

MEANING OF DEMAND
Demand in economics means desire to buy

backed by adequate purchasing power.

Mere desire or wish cannot buy goods. The

demand for goods, therefore, denotes that someone is able and willing to buy the goods. Example: Car

THE LAW OF DEMAND

The relation of price to sales is known in economics as the

Law of Demand.

The Law of Demand states that higher the price, lower the

demand and vice versa, other things remaining the same.

Law of Demand states, ceteris paribus (keeping other

factors constant), there is an inverse relationship between price and quantity demanded. reduce the quantity demanded and a fall in price will lead to an increase in the quantity demanded.

In simple terms it means, an increase in price will tend to

DEMAND SCHEDULE

PRICE DEMANDED Rs.500 Rs.400 Rs.300 Rs.200

QUANTITY

1,000 units 1,200 units 1,500 units 2,000 units

DEMAND CURVE
The Law of Demand or the Price-Quantity Relationship is also

portrayed graphically in the form of a chart which is called the Demand Curve.

It is a convention among economists to portray price-quantity

relationship by representing physical quantity on the horizontal (X) axis and the price on the vertical (Y) axis.

The Demand Curve slopes downward from left to right indicating

that when price rises, less is demanded and when price falls, more is demanded. This kind of a slope is also called as negative slope.

The demand curve concentrates exclusively on the price-quantity

relationship. The relationship between quantity demanded and other variables are not shown by the Demand Curve.

DEMAND FUNCTION
The price-quantity relation is also expressed

algebraically in the form of the following equation: Q = f(P) which means that quantity demanded is a function of price.

CHARACTERISTICS OF LAW OF DEMAND

INVERSE RELATIONSHIP

PRICE IS AN INDEPENDENT VARIABLE AND DEMAND IS A DEPENDANT VARIABLE

OTHER THINGS REMAIN THE SAME REASONS UNDERLYING THE LAW OF DEMAND Income Effect Substitution Effect

EXCEPTIONS TO THE LAW OF DEMAND

GIFFEN GOODS

LUXURY OR VEBLEN GOODS - GOODS PURCHASED FOR THEIR SNOB APPEAL or OSTENTATION. Example: Diamonds, art

work, BMW car

FEAR OF FUTURE CANGE - SPECULATIVE

MARKET

INDIVIDUAL DEMAND AND MARKET DEMAND

INDIVIDUAL DEMAND

The quantity demanded by an individual purchaser at a given price is known as individual demand. MARKET DEMAND
The total quantity demanded by all the

purchasers together is known as market demand.

MARKET DEMAND - EXAMPLE

Price per dozen eggs Rs. 48 46 44 42 40 38 36 Quantity demanded in dozen by A B C D E Total

1 2 3 4 5 6 7

3 4 5 6 7 8 9

0 1 3 5 6 7 8

0 0 1 2 3 4 5

0 0 0 1 2 3 4

4 7 12 18 23 28 33

MARKET RESEARCH AND LAW OF DEMAND

Law of demand is not the last word on

consumer behavior. Rather, sales executives have often found the Law of demand irrelevant for their purposes. Market research has propounded, on the basis of empirical investigations, certain propositions and hypotheses. Some of them are as follows:

MARKET RESEARCH AND LAW OF DEMAND Contd.

The more confidence a person has in price information as a

predictor of quality, the more likely he will be to choose a high priced rather low priced item.

A person who perceives himself as experienced in

purchasing a product will generally choose a low priced item, but an inexperienced person will select a high priced one. more difficult to judge product quality and (b) feel that he has less ability to make accurate quality judgments than one who chooses a low priced item.

A person who selects a high priced item will (a) believe it is

MARKET RESEARCH AND LAW OF DEMAND Contd.

Consumer is not rational always. Consumer behavior

is baffling. Sometimes, low price results in low sales and when the price is increased, sales increase. The reason: Higher price was essential if the products real advantages were ever to be noticed.
Consumers purchasing behavior is mostly repetitive.

This is against the formulation advocated in economic theory that the consumer tries to reach the optimum in every transaction and every time.