Managerial Economics

According to Spencer: “Managerial economics is the integration of economic theory with business practice for purpose of facilitating decision making and forward planning by management”. It means management of limited funds available in most economical way. It deals with basic problems of the economy i.e. what, how & for whom to produce.

Scope of Managerial Economics1.Demand Analysis & Forecasting: A major part of managerial decision making depends on accurate estimates of demand. By forecasting future sales manager prepares production schedules and employ resources which helps mgt. to strengthen its market position & profit.2. Cost & production Analysis: A manager prepare cost estimates of a range of output, and choose the optimum level of output at which cost is minimized. Manager is supposed to carry out the production function analysis to avoid wastage of materials & time.

3. Pricing Decisions: Success of a business firm depends upon correct pricing policy decisions taken by it. Different pricing method is used for various market structure, Cz price to a great extent determines the revenue of the firm.

4. Profit Management: Aim of business firms is to earn profits in long run. Profits are reward for uncertainty & risk bearing. A manager should be able to take calculated risk & try to avoid uncertainty for higher profits.

5. Capital Management: M.eco helps in planning & controlling of capital expenditure since it involves huge amount of money & time.

1. ALLOCATION OF RESOURCES: SINCE RESOURCES ARE SCARCE AND THEY HAVE MULTIPLE USES, ME FOCUSES ON OPTIMUM ALLOCATION OF FUNDS AVAILABLE, WHICH ALSO REDUCES THE WASTAGE LEVEL.

2. MICRO ECONOMIC NATURE: M.ECO IS MICRO ECONOMIC IN CHARACTER. IT DEALS WITH BUSINESS FIRMS. A FIRM IS THE SMALLEST DECISION MAKING UNIT OF PRODUCTION. SINCE THE STUDY IS ABOUT FIRM,THE PROBLEMS FACED BY THE FIRMS ALSO FALLS UNDER THE PURVIEW OF MICRO ECONOMICS.

3. MARKET KNOWLEDGE: A FIRM IS OPEN TO THREATS AS WELL AS OPPORTUNITIES IN MARKET PLACE. SO KNOWLEDGE OF MARKET MUST BE PERFECT. 4. MACRO-SETTING: A FIRM HAS TO OPERATE WITHIN A GIVEN ECONOMY. SO ITS ALSO GOVERNED & AFFECTED BY THE TRENDS IN INCOME, CONSUMPTION, INVESTMENT, SAVINGS LEVELS IN AN ECONOMY.

Nature of Managerial Economics

5. Positive & Normative Approach: Positive approach concerns with what is, was or will be, while normative approach concerns with what ought to be. Positive eco is of 2 types: Economics description shows state of operation of the firm at a point of time whereas economic theory explains why it happened.

Relationship with other Disciplines.

1. Statistics & Economics: Statistical techniques are very useful for collecting, processing & analyzing business data, testing & validity of economic laws before they can be applied to business. Statistical techniques like regression analysis, forecasting is used in economics.

2. Operation Research & Economics: OR is an activity carried out by specialist within the firm to help the manager to do his job of solving decision problems.OR is also concerned with model building but economic models are more general & confined to broad decision making. OR models like linear programming, queuing are widely used in managerial economics.

3. Accounting & Economics: Accounting data & statements reflect financial position, net loss or net profit earned by a company. For decision-making a manager should be familiar with generation, interpretation & use of A/c data.

4. Mathematics & Economics: Managers have to deal with quantitative concepts like demand, cost, prices & wages. So knowledge of mathematical concepts is imp to take decisions.

5. Computers & Economics: Today each person is dependent on computers. Managers depends on comp for decision making. Through comp data is presented in organized manner which facilitates decision making.

Role of Managerial Economist in Business

1. Specific Decisions: There are several specific decisions that managers might have to take like: Production scheduling, demand forecasting, market research, security management analysis, economic analysis of the industry, advice on trade, Pricing decisions.

2. General Tasks: It includes understanding external factors & suggesting the firm which policy is to be used. External factors include- economic condition of the economy, demand for the product, market conditions of raw materials, input cost of the firm affected by outside forces.

FUNDAMENTAL CONCEPTS OF ECONOMICS

1. Opportunity Cost: The benefit of the next best alternative which had been sacrificed due to the choice of the best alternative is known as opportunity cost of the best alternative. It tells us the gain from the proposed use of input.

Eg- Opportunity cost of funds employed in one’s own business is the amt of interest which cud have been earned had these funds been invested in the next best channel of investment.

2. Incremental Reasoning: It’s the most important concept in economics. Incremental principle is applied to business decisions which involves a large increase in total cost & total revenue. Incremental cost is defined as”change in total cost as a result of change in the level of output. Incremental revenue is change in total revenue resulting from change in the level of output. It tells us gain arising from the change in activity.

3. The Discounting Principle: Discounting factor determines the present value of future inflow of cash. Its based on the fundamental fact that a rupee now is worth more than a rupee earned a year after. PV= FV*PVFn,i

4. Time Perspective: Aim of the firm is to make profit in the long run. There is a difference between long & short run. In short run all of the inputs(called fixed inputs) cannot be altered, while in the long run all the inputs can be changed(i.e. there are no fixed inputs). A decision should take into account both the short run & long run effects on revenues & costs to maintain a right balance b/w short & long run perspectives.

5. Risk & Uncertainty: In real world, uncertainty influences the estimation of costs & revenues & hence the decision of the firm. Since future conditions are not perfectly predictable, there is always a sense of risk & uncertainty about outcome of decisions. When a firm is operating in a market along with other firms there is generally an element of uncertainty regarding the actions & reactions of the competitors. Other uncertain factors can be shifts in consumers choices, changes in govt policies, national international political scenario.

Concepts of Economics

1. Utility: Utility refers to the amount of satisfaction which a consumer gets by consuming the various units of commodity.

2. Marginal Utility: Addition made to the total utility by consuming 1 more unit of a commodity. MU= change in total utility/ change in quantity of good X.

3. Law of Diminishing Marginal Utility: “For any individual consumer the value that he attaches to successive units of a particular commodity will diminish slowly as his total consumption of that commodity increases, the consumption of all other goods being constant”.Assumptions of the Law:1. Various units of goods are homogeneous.2.There is no time gap b/w consumption of different units.3.Tastes, preferences & fashion remain unchanged.

4. Consumer’s Equilibrium: The quantity of good X where marginal utility of X equals price of good X. Mux=Px.

5. Income Effect: Change in consumption of the good due to the change in income of the consumer.

6. Price Effect: Change in the consumption of the good due to change in the price of the good.

7. Micro Economics: Studies the behavior of individual decision making units like consumers, firms( regulates under Company’s Act). It includes i) Product Pricing which includes Theory of Demand & Supply, ii) Factor Pricing which includes wages, rent, interest & profit.

8. Macro Economics: Studies the aggregate of all economic units. It includes theory of growth & employment, theory of Inflation & Price Level, theory of Income & theory of Distribution.Eg- Automobile industry includes firms like Maruti Suzuki India Ltd, Hindustan Motors, Hyundia Motors India Ltd, Tata Motors etc.

DEMAND ANALYSIS

Demand for a commodity refers to the quantity of the commodity which an individual consumer is willing to buy at a particular price & time. Demand for a commodity implies-a) Desire of a consumer to buy the product.b) His willingness to buy the product.c) Purchasing power to buy the product.Individual Demand: Goods demanded by an individual.Household Demand: Goods demanded by a household.Market Demand: Demand for a commodity by all individuals in the market taken together.

Determinants/ Factors Affecting Demand1. Price of the commodity: Consumers buy more of a commodity when its prices fall. A fall in the price of a normal good leads to rise in consumer’s purchasing power.

2. Income of the Consumer: With an increase in income, a consumer buys increased amount of the commodities.. Both quantity demanded of a good & income move in the same direction.

3. Price of Related Goods: When change in price of one commodity influences the demand of the other commodity, it implies that two commodities are related. Related commodities are of two types; Substitutes & Complements. When price of one commodity & demand of other commodity move in same direction, goods are called substitutes, e.g. tea & coffee, apple & pears. On the other hand when price of one commodity & demand of other commodity move in opp. Direction, goods are called complementary goods, e.g. bread & butter, pen & ink, petrol & automobiles etc.

4. Tastes & Preferences: Taste & preference of a consumer in favor of a commodity results in greater demand of a commodity, while if this change is against the commodity it results in smaller demand

DEMAND FUNCTIONA mathematical expression of the relationship b/w quantity demanded of the commodity & its determinants is known as the demand function. When this relationship relates to the market , it is called market demand function.

THE LAW OF DEMANDLaw of demand states that higher the price lower the quantity demanded & vice versa, other things remaining constant.Exceptions to the Law of Demand1) Giffen Goods: Giffen goods are also known as inferior goods and is consumed by the poor sections of the society. It’s a case where decrease in price of a good results in decrease in its quantity demanded & vice versa. E.g. bajra, barley, gram.2) Commodities which are used as status symbols: Some expensive commodities like diamond, gold, acs, cars are used as status symbols to display one’s wealth. The more expensive these commodities become , more will be their value as a status symbol and hence greater will be the demand.

3) Expectations of change in the price of the commodity: If a consumer expects the price of a commodity to increase, it may start purchasing greater amount of the commodity even at current increased price.

Why do Demand Curve Slope Downwards?1. The law of diminishing marginal utility is at the root of the law of demand. In order to get maximum satisfaction, a consumer buys a commodity in such a way that marginal utility of the commodity is equal to its price.2. A commodity tends to be put to more use when it becomes cheaper. Thus existing buyers purchase more & some new consumers enter the market. Eg. Use of electricity.3. A fall in price of a superior good will lead to a rise in the consumer’s real income. The consumer therefore buy more of it. On the contrary rise in price of superior good will result in a decline in consumers' real income. Hence they will buy less of it.

Extension & Contraction of Demand: A movement downward on the demand curve is extension of demand & a movement upward on the demand curve is contraction of demand.Shift of the demand curve: Shift in demand is brought about by change in factors other than the own price.

ELASTICITY OF DEMANDDefinition: Ed is defined as “the percentage change in quantity demanded caused by one percent change in the demand determinant, other determinants held constant.”Ed= % change in quantity demanded of good X/% change in determinant Z.

KINDS OF ELASTICITY MEASUREMENT1) Point Elasticity: It relates to the elasticity at a particular point on the demand curve.E=diff. in quantity/diff. in price*quantity/price

2) Arc Elasticity: It is the average elasticity over a segment of the demand curve. Co-ordinates of mid-point be, P1+P2/2, Q1+Q2/2…Formula: diff.in Q/diff. in P*P1+P2/Q1+Q2.

Types Of ElasticityA) Price Elasticity: Proportionate change in quantity demanded of good X/ Proportionate change in price of good X.

Types of Price Elasticity1. Perfectly Elastic Demand: Where no reduction in price is needed to cause an increase in quantity demanded.2. Absolutely Inelastic Demand: Where a change in price causes no change in quantity demanded.3. Unit Elasticity of Demand: When proportionate change in price causes an equal change in quantity demanded.B) Income Elasticity of DemandC)Cross Elasticity of DemandD)Advertising Elasticity of Demand

Significance Of Elasticity Of Demand1. Level of output & price2.Fixation of rewards for factor of production3.Demand Forecasting4.Government Policies.

SUPPLY: Supply of a commodity refers to the various quantities of the commodity which a seller is willing & able to sell at different prices in a given market, at a point of time, other things remaining the same.

Determinants Of Supply1. Price of the good: When producers get a higher price for their product, the supply of the product increases.2. Prices of other goods: Change in prices of other goods in the market also has influence on the supply of a commodity.3. Prices of factors of production: An increase in the price of a factor, say labor, may lead to a larger increase in the costs of making those commodities that use more labor.4. State of technology: A change in technology may result in lower costs & greater supply of the good.

LAW OF SUPPLYThe law of supply states that, other things remaining constant, more of a commodity is supplied at a higher price & less of it is supplied at a lower price.

Shifts in Supply: Shift in supply means increase or decrease in quantity supplied at the same priceExtension & Contraction of Supply: When more units of the goods are supplied at a higher price, it is called the extension of supply. When less units of the good are supplied at a lower price, it is called contraction of supply.

ELASTICITY OF SUPPLYElasticity of supply of a commodity is defined as responsiveness of quantity supplied to a unit change in price of that commodity. When the quantity supplied changes more than proportionately to the change in price, the supply tends to be elastic. On the other hand, if the change in price leads to less than proportionate change in quantity supplied, supply tends to be inelastic.

THEORY OF PRODUCTION

Production is an activity that transforms inputs into output, eg. Sugar mill uses inputs like labor, raw materials like sugarcane, capital invested in machinery, factory building to produce sugar.Factors Affecting Production1. Technology: A firm’s production behavior is determined

by the state of technology. Modern or high level of technology increases production of the firm irrespective of the size of the firm or kind of management.

2. Inputs: There are wide variety of inputs used by the firm like raw materials, labour services, machine tools, buildings etc. Inputs are divided into 2 main groups- fixed & variable inputs. A fixed input is the one whose quantity cannot be varied during the period, like plant & equipment. An input whose quantity can be changed during the period is known as variable input like raw materials, labor, power etc.

3. Time period of Production: The fixity or variability of an input depends on the time period. Time periods are short & long run. In short run period some of firm’s inputs are fixed. Whereas in long term all the inputs are variable i.e all inputs can be changed.

Factors of Production1. Land: It is the most basic factor that is needed for any production activity. It includes all natural resources below or above the land surface. It includes all those resources which are free gift of nature. Like hills, rivers, water etc.2. Labor: It includes any work done by body or mind for remuneration. Work done for pleasure like singing, dancing, playing etc is not labor, if it is not done for remuneration. Labor is divided into 3 categories: unskilled, semi-skilled & highly skilled.3. Capital: Capital does not mean money only. It means resources which are man made. It includes those factors which have been produced by human efforts for further use in production activity is capital. Like plant, building, machinery, road, bridges, rail lines etc.

4. Entrepreneurship: All the above factors are passive. They will not work unless there is somebody who can make them work. Producer takes decision regarding various activities like what products to produce, arranging factors of production, fixing payments to labor services, bearing risk & uncertainty etc.

Laws Of Production1. Law of Variable Proportions: It is also known as “Law of Diminishing Returns” or Returns to a Factor. This law becomes applicable when we increase one factor of production(variable factor), while keeping other factors constant, the output will increase. But after some time addition to variable factors will reduce the total output at a diminishing rate.Assumptions of the Law1. Only one factor is increased while others are kept constant.2. Various units of variable factor are homogeneous.3. Conditions of production like production methods, climatic conditions are constant. (Graph).

Production Function with 2 Variable Inputs.

Isoquant: It is a curve representing the various combinations of two inputs that produce the same amount of output. An isoquant is also known as iso-product curve or equal-product curve

Properties Of Isoquants1. An isoquant is downward-sloping to the right: It means that if

more of one factor is used, less of other factor is needed to produce the same level of output.

2. Higher Isoquant represents larger output: It means that with the same amount of one input & greater amount of second input, will result in greater output.3. No 2 isoquants touch or intersect each other.4. Isoquants are convex to the origin.

(Graphic Representation)-Outlay line or price line & Producers Equilibrium.Total outlay of Producers- Rs.1000.Price of 1 unit of Labor-Rs.50 (20 units)Price of 1 unit of Capital-Rs.100(10 units).

This means that producer can take OM units of labor & ON units of capital to produce 200 units, which is the optimum combination for him.

Production Possibility CurveMany a times firms do not produce a single product but more than one product. They utilize their productive resources to produce a given combination of products. The question is how to choose the best combination of products that can be produced with the given resources? Suppose there are 2 products X & Y. If we want to increase the output of X, it can be produced by producing lower quantity of Y. hence the curve which shows, different quantities of 2 products that can be produced with the given level of resources, it will be a negative sloped curve. This curve is known as ‘Production Possibility Curve’.(Graphic Representation) If firm produces only X then it can produce OB units & if it chooses to produce only Y then OA units it can produce. As we move from A to B, we produce more of X & less of Y. In other words Y transforms into X. This is known as Production Possibility Curve(PPC) also known as Transformation Curve.

UNIT - 2

BUSINESS CYCLESBusiness cycle or trade cycle refers to the fluctuations in economic activity. In a business cycle there are wave like fluctuations in 4 inter-linked economic variables: aggregate employment, income, output & price level. When the values of these economic variables over time are plotted on a graph, we get a wave-like figure, which is given the name of a cycle. According to Keynes, “ a trade cycle is composed of periods of good trade characterized by rising prices & low unemployment %, alternating with periods of bad trade characterized by falling prices & high unemployment %.” These fluctuations are cyclical in nature. The secular trend represents long run changes in business activity which occur slowly & are spread over a number of years. Such long run changes are the result of factors like improvement in production techniques, changes in population etc. Random fluctuations are a result of events like labor strike, power cut, war, drought, flood etc which suddenly & are unpredictable. Seasonal variations repeat themselves each year( demand for heavy woollen cloths, cotton cloths & so on depending on season each year). Cyclical fluctuations have a longer life span. The sequence of changes in business cycle( recovery, prosperity, depression & recession) recur frequently & in a similar pattern.

Phases Of Business CycleA) Recovery(revival of economic activity): 1. Economic activity as a whole increases slowly, although the general prices start rising. 2. The upward movement of business activity is slow, production picks up, construction activity is revived & there is a gradual rise in employment. 3. Industrialists & the businessmen repay the loans taken by them from the banks. 4. Investment process is increased, the result is demand orders increase & the producers get encouragement to produce more. 5. There is expansion in business activity. 6. Banks are liberal in matter of advances. 7. The prices recover & tend to reach the normal. The revival of goods & services may mainly due to 2 reasons:i) Change in business psychology in favor of optimism.Ii) Fresh public investments in development projects which create additional demand for goods & services.

B) Prosperity: 1. During this phase there is rapid movement of prices, employment, income & production. 2. Total output starts growing at a rapid pace due to higher investment & employment. 3. Prices of finished products rise faster than the increase in wage-rate, raw material prices & interest rate. 4. The sequence of general price rise generally begins with increase in security prices, which then passes on to raw material prices, wholesale prices, wages of unskilled labor, retail prices & finally the interest rates. 5. Sales increase so dealers increase the stocks to satisfy new customers, keeping existing customers satisfied. 6. Producers tend to produce more than the amount they can sell at present & wholesalers buy more than what is demanded by retailers. The peak of prosperity may lead to over-optimism in business psychology resulting in over-full employment of resources & raw material, leading to inflationary rise in prices. If it happens it signifies the end of prosperity phase & the advent of recession in the very near future.

C) Recession: When the business cycle takes a downward turn from the state of prosperity, the state of recession is said to have set in. There is a collapse of confidence. If not controlled in the beginning by timely monetary & fiscal measures by government, recession may give way to even more grave situation, called Depression. 1. Production increases with every increase in commodity prices. 2. As more & more of unemployed labor, capital, raw material are employed interest rate, wages & other costs rise. 3. Sellers upload the stocks in the market. 4. Due to uploading of stocks by many firms, the prices start declining. 5. Profit margins decline further because cost start overtaking prices. Business psychology becomes depressed & the boom bursts. 6. Some firms close down while others reduce reduction, leading to reduction in investment, employment, income & demand. 7. Soon the production falls, banks call back the loans, unemployment increases, interest rate increases & investment falls.

D) Depression: 1. General demand for goods & services falls faster than the production of goods. 2. Producers suffer losses because by the time the goods are ready for sale the prices are found to have fallen further, so producers are not able to recover their full costs. 3. The phenomenon of over production appears & workers in large numbers are thrown out of work. 4. There are accumulated reserves with banks, demand for credit is at its lowest, resulting in idle funds with the banks. Depression is thus characterized by low prices, idle funds with banks, mass unemployment & slack trade.

Factors Causing Swings In Business Activity1. Banking operations plays a vital role. By expanding & contracting credit creation, changing discount rates & the ratio between deposits & cash reserves, the bank can change the volume of money supply in the economy. Thus contribute to cyclical fluctuations.2. Changes in the proportion between capital goods & consumer goods production in the economy can also lead to shortages & surpluses in commodity supply in the short run. This results in business cycle.3. If purchasing power does not correspond to the expansion or contraction of production, the market suffers from cyclical fluctuations.

4. The profit mania of the producer is also a contributory cause of the business cycles. This makes the producer too optimistic. This behavior tends to intensify the process of rise or fall in prices.5. The cyclical changes in weather also contribute to the emergence of trade cycle. Agriculture production & prices of basic goods is affected. This in turn affects the wage rate, cost of raw material leading to fluctuations in the economic activity.

Measures To Control Business Cycles1. Balance between demand & supply is possible if appropriate information is available at the right time.2. Taking care that inventories do not increase or decrease excessively, financial commitments do not exceed financial resources & plant & equipment increase at a steady rate.3. The overhead cost per unit of output(indirect cost eg advertising, rent, repairs, research & development) should not be allowed to go up.4. Soundness in judgment in placing the order must be ascertained before accepting the offer.

5. Controlling costs & their reduction can help in overcoming the problem of recession.6. Firms can also change their sale methods & strategies so as to adjust to new situations.7. In the time of depression firms can utilize a part of its retained profits.