managerial economics class1

8/2/2019 Managerial Economics Class1

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MANAGERIAL

ECONOMICS

S.R.PANDA


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ECONOMICS

The word economy comesfrom a Greek word

oikonomia for one whomanages a household.

is the study of how society

manages its scarceresources.Studiesproduction , distribution &

consumption of goods &


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. . . means that society haslimited resources and therefore

cannot produce all the goods andservices people wish to have.

Scarcity . . .

Unlimited

wantsScarcity Society

chooses


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ECONOMICS???

SCIENCE THAT DEALS WITH ALLOCATIONOF SCARCE MEANS OF PRODUCTIONTOWARDS SATISFACTION OF HUMAN

WANTS .

- RESOURCES ARE SCARCE

- IT CAN BE PUT INTO MANY USES

EXAMPLE : GIFT FROM GOD


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An enquiry into nature & causes of wealth ofnations -------Adam Smith

Economics is the study of mankind in theordinary business of life ,it examines thatpart of individual and social action which ismost closely connected with the

attainment and with the use of thematerial requisites of well being.AlfredMarshall


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Economics is the science which studieshuman behaviour as a relationshipbetween ends and scarce means which

have altrernate uses-----Lionel Robbins


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BASIC FUNCTION

Observe

Explain

Predict

Usage of resources to maximize the

income/utility


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RESOURCES

NATURAL RESOURCES

HUMAN RESOURCE

MAN MADE RESOURCE ENTRPRENEURSHIP ---ability and

willingness to take risk


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PROBLEM OF CHOICEMAKING

Human aspirations are limitless

Resources are scarce

Gain maximization


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WHO IS MANAGER?

Manager organizes the work and directs itscompletion through the service of others

Managers

PLAN

ORGANISE

LEADCONTROL


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MANAGEMENT FUNCTIONS

PLANING

ORGANISING

LEADINGCONTROLLING


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MANAGEMENT SKILL

TECHNICAL SKILL

HUMAN SKILL

CONCEPTUAL SKILL


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LEADER

Influence a group towards achievement of avision or set of goals .


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Managementis...

Coping with complexityPlanning & Budgeting

Organising & Staffing

Controlling & ProblemSolving

Effective Action

Leadership is .

Coping with &

promoting change

Setting Direction

Aligning People

Motivating & InspiringPeople

Meaningful Action


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MANAGER VS LEADER

Managers

Administer and copy

Maintain

Focus on systems & structure

Rely on control Short-range view - bottom line

Ask how and when

Accept the status quo

Classic good soldier

Do things right

Leaders

Innovation and originality

Develop

Focus on people

Inspire trust Long-range view - the horizon

Ask what and why

Challenge the status quo

Own person Do the right things


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MANAGER VS LEADER

MANAGERS

administer

are a copy

maintain

systems/structure focus

control

short-term

how/when

bottom line

imitateaccept

good soldier

do things right

LEADERS

innovate

are an original

develop

people focus

trust

long-range

what/why

horizon

originatechallenge

own person

do the right thing


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Managerialeconomics is the

application of

economic theory

& tools tomanagement

decision making

What is managerial economics?

EFFECTIVE UTILISATION OF RESOURCESRESPOND TO ECONOMIC SIGNALS


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FIRM


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MARKET

EXHANGE OF GOODS & SERRVICES FORSOME CONSIDERATION

DEMAND

SUPPLY

PRICE


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HOUSEHOLD

All people who live under the same roof &jointly make financial decisions.


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HIERARCHY OF ECONOMIC

UNITS

INDIVIDUAL

HOUSEHOLD

FIRM

MARKETSTOCK MARKET

GOVERNMENT

WORLD MARKET


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ECONOMIC ACTIVITIES

CONSUMER

PRODUCER

LABOUR ECONOMIC MANAGER


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The Circular-Flow Diagram

Market forFactors

of Production

Market forGoods

and Services

SpendingRevenue

Wages, rent,and profit

Income

Goods &Services sold

Goods &Servicesbought

Labor, land,and capital

Inputs forproduction

Firms Households


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MICRO VS MACRO ECONOMICS

Micro Economics : Study of economic behaviour ofindividual decision making units ( Producer /Consumer/Entrepreneur) Managerialeconomics

Macro Economics : Study of economic behaviourof total economy as a whole ( level of

income,GDP,Employement , Govt expenditure,inflation etc)


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MANAGERIAL ECONOMICS

Micro in nature

Pragmatic(Practical)

Normative and Prescriptive Conceptual in nature

Utilises some principles of

macroeconomics Problem solving in nature


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BUSINESS DECISIONS

Financial Decisions

Production Decisions

Marketing Decisions Misc. Decisions like

purchasing,inventory,IT,PR etc


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BUSINESS DECISIONS

Scientific & Intuitive Decisions

Strategic & Tactical Decisions

Certain & Uncertain Decisions Major & Minor Decisions

Hard & Soft Decisions


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MAJOR ECONOMICPROBLEMS

Microeconomics

What to produce & how much to produceHow to Produce

For whom to produce

How to distribute the social output


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Macroeconomic problems

How to increase the production capacity ofthe economy

How to stabilize the economy

How to solve the problems ofunemployment / inflation etc


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MICROECONOMICS

Demand theory

Production theory

Pricing theory Profit management/analysis

Theory of capital & investment decision


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TECHNIQUES OFMICROECONOMICS

RISK ANALYSIS

PRODUCTION ANALYSIS

PRICING ANALYSIS CAPITAL BUDGETING


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ADAM SMITH

It is not from the benevolence of the butcher,the brewer, or the baker, that we can expect ourdinner, but from their regard to their owninterest. We address ourselves, not to their

humanity but to their self-love, and never talk tothem of our own necessities but of theiradvantages.[

Theory of moral sentiments

Wealth of nation-Invisible Hand SelfRegulating Nature of Market


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Smith saw the main cause of prosperity asincreasing division of labor. Using thefamous example of pins, Smith asserted

that ten workers could produce 48,000pins per day if each of eighteenspecialized tasks was assigned toparticular workers. Average productivity:

4,800 pins per worker per day. But absentthe division of labor, a worker would belucky to produce even one pin per day.
http://www.econlib.org/library/Enc/Productivity.htmlhttp://www.econlib.org/library/Enc/Productivity.html


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PROFIT

A reward which goes to the

organisation as a factor of

production for its participation in theprocess of production ./Return to

the risk when making aninvestment


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PROFIT

PROFIT = TR TC

= P*Q C*FWhere P=Selling Price

Q=Quantity SoldC= Avg factor CostF= Vol. of factors

Employed


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PROFIT

TOTAL PROFIT

MARGINAL PROFIT

AVG. PROFIT


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Average Profit:

a business's total profit per unit of output

AP= Total Profit (TP)/ Quantity of Output (q)

Marginal Profit:

The extra total profit earned from anadditional unit of output

Marginal Profit (MP) = TP/ q


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OUTPUT TOTAL MARGINAL AVERAGE

PER DAY PROFIT PROFIT PROFIT

0 0

1 100 100 100.0

2 250 150 125.03 600 350 200.0

4 1000 400 250.0

5 1350 350 270.0

6 1500 150 250.0

7 1550 50 221.4

8 1500 -50 187.5

9 1400 -100 155.6

10 1200 -200 120.0


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-500

0

500

1000

1500

2000

0 5 10 15

OUTPUT PER DAY

PROFIT

TOTAL

PROFIT

MARGINAL

PROFIT

AVERAGE

PROFIT


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ACCOUNTING VS ECONOMIC

PROFIT Economic profit = Total revenue Total economic cost

= Total revenue Explicit costs Implicit costs

=Accounting Profit Implicit Cost

Accounting profit = Total revenue Explicit costs

Accounting profit does not subtract implicitcosts from total revenue

Firm owners must cover all costs of allresources used by the firm Objective is to maximize economic profit


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TYPE OF IMPLICITE COST

Opportunity cost of cash provided byowners

Equity capital

Opportunity cost of using land or capitalowned by the firm

Opportunity cost of owners time spent

managing or working for the firm


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Opportunity cost of using any resource is:

What firm owners must give up to use theresource

Market-supplied resources Owned by others & hired, rented, or leased

Owner-supplied resources

Owned & used by the firm


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EXAMPLE OF ECON. PROFIT

Subrat runs a small pizzeria in hishometown.

He owns the building.

Annual revenues are Rs100000 .

Annual costs are Rs 20000.

Annual profit is 80000 euros. This is not the economic profit!


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Subrat could have a job earning Rs30000.

Subrat could have rented the space forRs100000.

The economic profit is just

P = 80000 - 30000 -100000 = -50000

CONCLUSION: Subrat should close the pizzeria, rent the

space and get the alternative job.


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ROLE OF PROFIT

To provide businessman with an incentiveto produce what the consumer wants ,when & where they want and with the

lowest feasible cost.


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PROFIT SERVES

Measure of performane

Reward for Risk taking ability

Helps in R & D Rewards share holders

Attracts new firms

Tax collection


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PROFIT

As an accounting surplus

As a cost

As rent of ability

As a dynamic surplus

As a reward for risk bearing/uncertaintybearing

As a Reward for innovationAs a Return for monopoly


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Total Cost -the sum of all costs incurredin production

TC = FC + VC

Average Cost the cost per unitof output

AC = TC/Output

Marginal Cost the cost of one more orone fewer units of production

MC= TCn TCn-1 units


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Normal Profit the minimum amount requiredto keep a firm in its current line ofproduction(TR=TC)

Abnormal or Supernormal profit profitmade over and above normal profit ( TR>TC) Abnormal profit may exist in situations where firms

have market power

Abnormal profits may indicate the existence of

welfare losses Could be taxed away without altering resource

allocation


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Sub-normal Profit profit below normalprofit (TR


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DO FIRMS ALWAYS GO FOR

PROFIT ?

NO.

WHY ?


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Attainment of Industry Leadership

Forestalling potential competition

Preventing Govt Intervention

Maintaining Consumer goodwill

Restraining wage hike

Liquidity of firmAvoiding Risk


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BREAK EVEN ANALYSYS

It involves study of revenues & costs of afirm in relation to its volume of sales anddetermination of that volume at which the

firms cost & revenue is equal .


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BREAK EVEN POINT

BEP may be defined as that level of sales atwhich total revenue equals total cost andthe net income is zero .

It is also known as no profit no loss point.

Helps in understanding of relationship b/ncost, price & volume.


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This is a planning and control technique.

PLANNING: make informed decisions about pricing your product

or service and the cost to produce it.

CONTROL: compare your actual results with those that you have

forecast. (For example, your restaurant may requireyou to sell 10,000 meals at Rs 50.00 per meal =

500,000 in order to break even annually. This worksout to 192 meals a week or 28 per day. If on the firstday of operation you sell 30 mealsyou are on trackto break even!)


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Profit = Selling Price* Qty-Qty*AVC-FC

Qty=FC + Profit

--------------------

Selling Price-AVC

Selling Price AVC = Profit ContributionMargin

DETERMINATION OF BREAK


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EVEN POINT

BREAK EVEN POINT IN TERMS OFPHYSICAL UNITS

B.E. Point = Fixed CostsContribution Margin

= Fixed CostsSelling price/unit - Variable Cost/unit



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EVEN POINT

EXAMPLE

FIXED COST =Rs 10000 per year

Variable cost = Rs 2.00 Per unit

Selling Price = Rs 4.00 Per unit

BEP = 10000/(4-2) = 5000 units

Usually convenient for single product firm


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FIXED COST =Rs 10000 per year

Variable cost = Rs 2.00 Per unit


What is BEP ?



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EVEN POINT


Rent = Rs 200.00 Per month

Salaries = Rs 450.00 Per Month

Depreciation = Rs 30.00 Per Month

Raw material = Rs 7.00 Per Unit

What is BEP ?


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Break-Even Analysis

Costs/Revenue

Output/Sales

Initially a firmwill incur fixed

costs, these do

not depend on

output or sales.

FC

As output is

generated, thefirm will incur

variable costs

these vary

directly with the

amount produced

VC

The total costs

therefore

(assuming

accurate

forecasts!) is the

sum of FC+VC

TCTotal revenue is

determined by the

price charged and

the quantity sold

again this will be

determined by

expected forecast

sales initially.

TRThe lower the

price, the less

steep the total

revenue curve.

TR

Q1

The Break-even point

occurs where totalrevenue equals total

coststhe firm, in

this example would

have to sell Q1 to

generate sufficient

revenue to cover its

costs.


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Break-Even AnalysisCosts/Revenue

Output/Sales

FC

VCTCTR (p = Rs2)

Q1

If the firm chose

to set price higher

than Rs2 (say

Rs3) the TR curve

would be steeper

they would not

have to sell as

many units to

break even

TR (p = Rs3)

Q2


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Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VCTCTR (p = 2)

Q1

If the firm chose

to set prices lower

(say Rs1) it would

need to sell more

units before

covering its costs

TR (p = 1)

Q3


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Break-Even Analysis

Costs/Revenue

Output/Sales

FC

VC

TCTR (p = Rs 2)

Q1

Loss

Profit


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Break-Even Analysis

Remember:A higher price or lower price does not

mean that break even will never be

reached! The BE point depends on the number of

sales needed to generate revenue to covercosts the BE chart is NOT time related!


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Break-Even Analysis

Importance ofPrice Elasticity of Demand: Higher prices might mean fewer sales to

break-even but those sales may take a longertime to achieve.

Lower prices might encourage more customersbut higher volume needed before sufficientrevenue generated to break-even


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Break-Even Analysis

Links of BE to pricing strategies andelasticity

Penetration pricinghigh volume, low price more sales to break even

Market Skimminghigh price low volumes fewer sales to break even

Elasticity what is likely to happen to sales

when prices are increased or decreased?


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All costs are perfectly variable or fixedover the entire vol.of production

All revenues are perfectly variable with

vol.of production.

Vol.of prod & vol. of sales are equal.

Product mix should be stable .


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ASSIGNMENT

ADAM SMITH

SAMUELSON

P.DRUCKER

STIGLITZ

BAUMOL

LIONEL ROBBINS


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THANK YOU

managerial economics class1

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