Dr.

Prerna Jain
1
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 several
alternatives available, which may seem to be a simple
decision to you, plays a central role in economic
analysis.
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 conclusions
immediately applicable to policy. It is a method
rather than a doctrine, an apparatus of the mind, a
technique of thinking, which help the possessor to
draw correct conclusions.
Basic Assumptions
Economic theories are based on certain simplifying
assumptions:

Ceteris Paribus means other things being equal the
study of some group of tendencies is isolated by the
assumption other things being equal: the existence of
other tendencies is not denied, but their disturbing
effect is neglected for a time. The more the issue is
narrowed, the more exactly can it be handled.
Rationality Economists make the assumption that
people act rationally. Rationality implies that
consumers and producers measure and compare the
costs and benefits of a decision before going ahead.
Thus rationality involves making a choice that gives the
greatest benefit relative to the cost.
Types of Economic Analysis
Micro and Macro
Positive and Normative
Short and Long run
Market 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 and
machines 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
Kinds of Economic Decisions
What 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 of
stability it is necessary to ensure that the productive capacity
continues to increase)
Reality Bites
What to produce? The Coca Cola Way
The 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 beverage
portfolio. The portfolio claims to offer an appropriate level of
sweetness and functional benefits along with right packaging
and communication. (Economic Times January 2008)

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 the
alternative 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.










































Concept of Margin and Increment: Marginal analysis is the
cornerstone 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 subject
to 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 as incremental 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.
Discounting Principle: The core of discounting principle is that a
rupee 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 it
equivalent 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 inflows
occur only in future, therefore, in order to take the right decision, it is
necessary to discount future inflows to their present value level.
The simple formula for discounting is:
PVF = 1/ (1+r)
n


Managerial Economics Defined
The application of economic theory and the tools of
decision science to examine how an organization can
achieve its aims or objectives most efficiently.
Managerial Decision Problems
Economic theory
Microeconomics
Macroeconomics
Decision Sciences
Mathematical Economics
Econometrics
MANAGERIAL ECONOMICS
Application of economic theory
and decision science tools to solve
managerial decision problems
OPTIMAL SOLUTIONS TO
MANAGERIAL DECISION PROBLEMS
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.
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, and
other resources for each separate step of the production and distribution
process.
Instead, entrepreneurs usually enter into longer-term, broader contracts with
labour to perform a number of tasks for specific wages and fringe benefits.
Such a general contract is much less costly than numerous specific contracts
and is highly advantageous both to the entrepreneurs and to the workers and
other 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 avoids
price controls and other government regulations that apply only to transactions
among firms.
Value of the Firm
The present value of all expected future profits
1 2
1 2
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(1 ) (1 ) (1 ) (1 )
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PV
r r r r

1 1
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t t t
t t
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TR TC
Valueof Firm
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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
Definitions of Profit
Business Profit: Total revenue minus the explicit or
accounting costs of production.
Economic Profit: Total revenue minus the explicit and
implicit 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.
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
Function of Profit
Profit is a signal that guides the allocation of societys
resources.
High profits in an industry are a signal that buyers
want more of what the industry produces.
Low (or negative) profits in an industry are a signal
that buyers want less of what the industry produces.
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 help
maximize 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.
Role of Business in Society
Why 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.