MANAGERIAL ECONOMICS & ACCOUNTANCY

Learning Objectives
 Understand the framework within which we are going to
study Managerial Economics

 State the nature and form of economic analysis

 Spell out the interrelation of Managerial Economics with

other disciplines

 Identify the role of Managerial Economist in business

decision making
Managerial Economics can be defined
as the discipline which deals with
the application of economic theory to
business management
 WHAT IS
ECONOMICS
Economics is the study of
how individuals and
societies choose to use the
scarce resources that
nature and previous
generations have provided.
 Economics is the study of the production
and consumption of goods and the transfer
of wealth to produce and obtain those
goods.
 THE ECONOMIC PROBLEM
1 What is produced 2 How is it produced 3 Who gets what is produced

Resources Producers Households

Allocation Distribution
of resources of Output

Three basic questions must be answered in order to

understand an economic system:
• What gets produced?
• How is it produced?
• Who gets what is produced?
 Business
Economics Management
-theory and - Decision
Methodology problems

Managerial
Economics
-Application of Economics
-to solvimng business
problems

Optimal solutions
to business
problems
# Main functions of a Manager – Decision Making &
Forward Planning

# Organisations work & take decisions in uncertainty

# Economic theory helps in decision making in

uncertainty frame work.
 Decision-making can be delineated as a
process where a particular course of
action is chosen from a number of
alternatives

 This demands an unclouded perception of

the technical and environmental conditions,
which are integral to decision making.
Nature

# Macro economics

# Micro economics

#Positive vs. Normative

Macroeconomics : The branch of economics
that examines the economic behavior of
aggregates—income, employment, output,
and so on—on a national scale.
MACRO ECONOMICS

#The study of aggregate or total level of economic

activity in a country

#Studies the flow of factors of production (land,

labor, capital, organization, and technology) from
the resource owner to the business firms and then
from the business firms to the households

#Total National Income, Total employment, Total

investment etc.
MACRO ECONOMICS –Contd.

Deals with price level in general

Level of employment in the economy

Aggregate consumption, Aggregate

investment, price level, and National
Income

Tools – National income analysis, balance

of payments, theories of employment etc.
Microeconomics
The branch of economics that examines
the functioning of individual industries
and the behavior of individual decision-
making units—that is, business firms
and households.
 MICRO ECONOMICS

# The study of an individual consumer or a firm

(Theory of Firm or Price Theory)

#Deals with behavior and problems of single

individual and of micro organization

#Applies concepts such as Price Theory, Law of

Demand and theories of market structure etc.
 Micro vs. Macro Economics

#Microeconomics looks at the individual unit—the

household, the firm, the industry. It sees and
examines the “trees.”

#Macroeconomics looks at the whole, the aggregate. It

sees and analyzes the “forest.”
 THE DIVERSE FIELDS OF ECONOMICS

TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

DIVISION OF
ECONOMICS PRODUCTION PRICES INCOME EMPLOYMENT

Microeconomics Production/output in Price of individual Distribution of Employment by

individual industries goods and services income and individual businesses
and businesses wealth and industries

How much steel Price of medical care Wages in the auto Jobs in the steel
How much office Price of gasoline industry industry
space Food prices Minimum wage Number of employees
How many cars Apartment rents Executive salaries in a firm
Poverty Number of
accountants

Macroeconomics National Aggregate price level National income Employment and

production/output unemployment in
the economy

Total industrial output Consumer prices Total wages and Total number of jobs
Gross domestic Producer prices salaries Unemployment rate
product Rate of inflation Total corporate
Growth of output profits
 Positive ECONOMICS

# An approach to economics that seeks to

understand the behavior and the operation
of systems without making judgments.

#It describes what exists and how it

works.
 NORMATIVE ECONOMICS
#An approach to economics that analyzes
outcomes of economic behavior, evaluates
them as good or bad, and may prescribe
courses of action.

#Also called as policy economics

 Management
Problems

Economic Theory Decision

Sciences
Managerial
Economics

Economic Study of Functional

Methodology: Areas:
Descriptive Model Accounting, Finance,
Prescriptive Model and Marketing

Optimal
Decision
Managerial Economics is a discipline that
is designed to facilitate a solid foundation of
economic understanding for business
managers and enable them to make informed and
analyzed managerial decisions, which are in
keeping with the transient and complex business
environment.
CHARACTERISTICS OF ME

# ME is micro – economic in character

# ME uses – theory of firm

# ME is prgamatic

# ME belongs to Normative Ecnomics

# Macro economics is also useful to ME

 SCOPE OF MANAGERIAL ECONOMICS

* Demand Analysis and Forecasting

•Cost Analysis

• Production and Supply analysis

• Pricing decisions

• Profit Management

• Capital Management
 USES OF MANAGERIAL ECONOMICS

# Helps in building suitable tool kit from traditional

economics

# Helps in reaching a variety of business decisions

in a complicated environment

Provides a number of tools and techniques

Provides most of the concepts that are needed for the analysis
of business problems E.g., FC, VC, NPV, Elasticity of demand etc.

Product-mix; Production technique and the input-mix that is least

costly; level of output and price for the product; Investment decisions;
Advertisement Budget etc.
Objectives of a Business Firm

Demand Analysis and Demand Forecasting

Production and Cost

Competition

Pricing and Output

Profit

Investment and Capital Budgeting

Product Policy, Sales Promotion and Market

Strategy
Economics and Managerial Decision Making

# Questions that managers must answer :

- What are the risks involved?

RISK is the chance or possibility that actual future

outcomes will Differ from those expected /
forecasted today
 Types of Risks

-Changes in demand & supply conditions

-Technological changes and the effect of

competition

-Changes in interest rate and inflation rates

-Exchange rates for companies engaged in

international trade

-Political risk for companies with foreign operations

 Concept of scarcity
•The starting point of any economic analysis is the existence of
human wants(unlimited).

Demand
Resources

•All desirable things(resources) are short in supply compared to our

needs(demand).The decision should made to optimally utilize
them.

So the economic problems lies in making the best possible use of

resources.

•In order to get maximum satisfaction (consumer point of view)

or maximum output (producers point of view)
 Economics

 Operations Research

 Mathematics

 Statistics

 Accountancy

 Psychology
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 Offshoot of Economics

 Economics - theoretical concepts; ME –

application of these in real life

 Both are concerned with the problems of

scarcity and resource allocation

 Economist – study of ‘markets’; ME – Studies

the impact of such markets on the
performance of a given firm
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 Provides an understanding of general
economic environment within which the firm
operates

 Provides a framework to solve the resource

allocation problems

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 Decision making

 ME – ‘problems of DM’; OR – Solving the

managerial problems

 OR is the tool for finding the solutions of a

managerial problem

 ‘Model building’

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 OR models – Linear Programming, Queuing,
Transportation, Optimization techniques etc.

 OT – minimization of costs and maximization

of revenues

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 Tools and techniques of mathematics such as
algebra, calculus, exponentials, vectors,
input-output tables

 Facilitates derivation and exposition of

economic analysis

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 Empowers the manager to deal with the
situations of risk and uncertainty through its
techniques such as probability

 Statistical techniques – averages, measure of

dispersion, correlation, regression, time
series, interpolation, probability etc.

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 Provides accounting information relating to
costs, revenues, receivables, payables,
profits/losses etc.

 Objective is to record, classify and interpret

the given accounting data

 ME profusely depends upon accounting data

for decision making and forward planning

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 Consumer psychology

 Customer reaction to a given change in price

or supply

 Contributes towards understanding the

behavioral implications, attitudes and
motivations of each of the micro economic
variables such as consumer, supplier/seller,
investor, worker or an employee

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 BASIC TOOLS IN MANAGERIAL ECONOMICS

# Opportunity Cost Principle

# Incremental principle

# Principle of Time perspective

# Discounting principle

# Equi – marginal principle

Opportunity Cost
Scarcity of resources is one of the
more basic concepts of economics.
Scarcity necessitates trade-offs, and
trade-offs result in an opportunity cost.
OC - Contd

While the cost of a good or service

often is thought of in monetary
terms, the opportunity cost of a
decision is based on what must
be given up (the next best alternative)
as a result of the decision. Any
decision that involves a choice
between two or more options has
an opportunity cost.
 Concept of opportunity cost
•The managerial economist has to make
rational choices in all aspects of business
because of scarce resources and unlimited
wants.

•Opportunity cost is the benefit from alternative that is not selected.

A B C D
Opportunity cost is the value of something
when a particular course of action is
chosen. Simply put, opportunity cost is
what you must forgo in order to get
something. The benefit or value that was
given up can refer to decisions in your
personal life, in a company, in the
economy, in the environment, or on a
governmental level.
OC – Contd.

Note that an opportunity cost

only considers the next best
alternative to an action, not
the entire set of alternatives.
Points to Remember:
# All decisions which involve choice must involve O.C calculations

# O.C costs may be either real or monetary, either implicit or explicit

either quantifiable or non – quantifiable,

# O.C is directly applicable to manager’s different decision areas such

as make or buy, breakdown or preventive maintenance of M/Cs,
direct rect. from outside or departmental promotion to man a post etc.

# Minimization of O.C. should be the decision principle of a manager

for optimal allocation of resources.
PROBLEM:
Suppose that Russ has budgeted $20 a month to buy candy bars,
music downloads, or some combination of each. If Russ buys
only candy bars he can obtain 40 bars a month; if he buys
only downloads, he can buy 20 a month.

What is the price of a candy bar?

What is the price of a music download?
What is the opportunity cost of a music download?
What is the opportunity cost of a candy bar?
Would the opportunity cost of each good change if Russ
decided to increase his monthly budget to $30 for the
two items?
Upon graduating from high school, Stewart has a choice of working
full-time or attending college full time. College tuition and books cos
t $10,000 annually. If he went to college, he would have to live near the
college where the average monthly rent would be $700. If he worked,
he could make $30,000 annually and would live in a less expensive area
where the average monthly rent would be $500

What would be Stewart's opportunity cost of attending college?

Incremental Principle
Two major concepts in this analysis are incremental cost
and incremental revenue.

Incremental cost denotes change in total cost

Incremental revenue means change in total revenue

resulting from a decision.

 Incremental Principle
Incremental concept involves estimating the impact of decision
alternatives on costs and revenues, emphasizing the changes
in total cost and total revenue resulting from changes in prices
Products, procedures, investments or whatever may be at stake
in the decision.
Incremental Principle can be stated as:

“A decision is obviously a profitable one if ----

# it increases revenue more than costs

# it decreases some costs to a greater extent than it increases others;

# it increases some revenues more than it decreases others and

# it reduces costs more than revenues

Limitations of Incremental Concept:

# The concept cannot be generalised as observed

behaviour of a firm is always variable.

# The concept can be applied only when there is excess

capacity.

# The concept is applicable only during short period.

The principle of time perspective can be stated as:

“ A decision should take into account both the short – run

and long – run effects on revenues and costs and maintain
the right balance between the long – run and short – run
perspectives.”
The discounting principle can be stated as:

“If a decision affects costs and revenues at future dates

, it is necessary to discount those costs and revenues
to present values before a valid comparison of alternatives
is possible.”
 A = P(1+r)

A
P= ------------
(1+r)
Equi – marginal principle
 The law of Diminishing Marginal Utility states
 that the marginal utility derived on the
 consumption of every additional unit goes
 on diminishing, other things remaining the same.
No. of sweets Amount of Total Utility Marginal Utility

1 20 0
2 35 15
3 47 12
4 55 8
5 55 0
6 48 -7
Law of Equi- Marginal Utility

“A person can get maximum utility with

his given income when it is spent on
different commodities in such a way
that the marginal utility of money spent
on each item is equal”
This principle deals with allocation of the available
resources among alternative activities. According
to this principle, an input should be so allocated
that the value added by the last unit is the same
in all cases.

This generalisation is called the equi-

marginal principle.
Marginal Utility Schedule of a Consumer

Units Bought Marginal Utility obtained from

Pants Shirts

1 40 35
2 32 28
3 28 20
4 20 10
5 10 8
 Micro-economic in character, where the unit
of study is a firm

 Normative and not positive micro economics

 Makes economic theory more application

oriented; pragmatic

 Takes the help of macro economics also

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 Solve the problems of decision making and
forward planning

 Making decisions and processing information

can take two general forms:

 Specific Decisions

 General Tasks

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 Production scheduling
 Demand forecasting
 Market research
 Economic analysis of the industry
 Investment appraisal
 Security management analysis
 Advice on foreign exchange management
 Advice on trade
 Pricing and the related decisions
 Analyzing and forecasting environment

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 External Factors

 Internal Factors

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 General economic condition

 Demand for the product

 Input cost

 Market conditions of raw material and

finished product

 Government’s economic policies

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 Production, sales and inventory schedules of
the firm

 Forecasts future trend

 Provide the pricing and profit policies

 Investment decisions

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