Managerical Economics

(KNB 102)
UNIT-I
Meaning-

Managerial Economics is integration of economics therory and analytical tools for rational business decesion
making. The science of Managerial Economics has emerged only recently. With the growing variability and
unpredictability of the business environment, business managers have become increasingly concerned
with finding rational and ways of adjusting to an exploiting environmental change.

Definitions-

Economics

According to Marshall, “Economics is a study of mankind in the ordinary business of life; it examines that
part of individual and social action which is most closely connected with the attainment and with the use
of the material requisites of well-being.”

Managerial Economics

Joel Dean declares: "The purpose of managerial economics is to show how economic analysis can be used
in formulating business policies".

Managerial Decision

Issues

Economic Theory and Quantitative Approach

concepts (Demand, Supply, (Mathematical economics)
Cost, Market)

Managerial Economics

Dr. SWATI TIWARI

 Economics

Micro Economics Macro Economics

 Demand  National
 Supply Income
 Production
 Market

The Nature of Managerial Economics:

1. It analyses towards solving business problems, constitutes the subject-matter of Managerial

Economics.
2. It helps in decision making and forward planning.
3. The problem of choice arises because resources are limited and the firm has to make the most
profitable use of these resources.
4. As future is unpredictable, a business manager’s task is to prepare the best possible plans for
the future depending on past experience and future outlook.
5. It assists the managers of a firm in a rational solution of obstacles faced in the firm’s activities.
6. It helps in formulating logical managerial decisions.
7. It lessens the gap between economics in theory and economics in practice.
8. It guides the managers in taking decisions relating to the firm’s customers, competitors,
suppliers as well as relating to the internal functioning of a firm.
9. It makes use of statistical and analytical tools to assess economic theories in solving practical
business problems.
10. It helps in enhancement of analytical skills, assists in rational configuration as well as solution
of problems.
11. It can also be used to help in decision-making process of non-profit organizations (hospitals,
educational institutions, etc).
12. It enables optimum utilization of scarce resources in such organizations as well as helps in
achieving the goals in most efficient manner.

Scope of Managerial Economics

1. Demand Analysis and Forecasting.

2. Cost and Production Analysis.
3. Pricing Decisions, Policies and Practices.
4. Profit Management.
5. Capital Management.

Dr. SWATI TIWARI

Difference between Microeconomics and Macroeconomics
Microeconomics:
1. It is the study of individual economic units of an economy.
2. It deals with Individual Income, Individual prices, Individual output, etc.
3. Its central problem is price determination and allocation of resources.
4. Its main tools are demand and supply of a particular commodity/factor.
5. It helps to solve the central problem of ‘what, how and for whom’ to produce in the economy.
6. It discusses how equilibrium of a consumer, a producer or an Industry Is attained.
7. Price is the main determinant of micro- economic problems.
8. Examples are: Individual Income, Individual savings, price determination of a commodity, individual
firm’s output, consumer’s equilibrium.

Macroeconomics:
1. It is the study of economy as a whole and its aggregates.
2. It deals with aggregates like national Income, general price level, national output, etc.
3. Its central problem is determination of level of Income and employment.
4. Its main tools are aggregate demand and aggregate supply of the economy as a whole.
5. It helps to solve the central problem of full employment of resources in the economy.
6. It is concerned with the determination of equilibrium level of Income and employment of the economy.
7. Income is the major determinant of macroeconomic problems.
8. Examples are: National Income, national savings, general price level, aggregate demand, aggregate
supply, poverty, unemployment, etc.

Relevance of Managerial Economics in decision making

1. Useful in Business Organization

2. Helpful in Chalking Out Business Policies
3. Help in Business Planning
4. Helpful in Cost Control
5. Useful in Coordination of Business Activities
6. Useful In Demand for Casting
7. Helpful in Profit Planning and Control
8. Helpful for Business Prediction
9. Helpful in Price Determination
10. Helpful in Solutions of Business Taxation Problems
11. Useful in Understanding the Mechanism of Economic System
12. Helpful in Analysis of Effects of Government Policies

Dr. SWATI TIWARI

Fundamental Principles of Managerial Economics

1. Incremental principle

The main objective of this principle is maximization of profits. Or In other words to raise the profits in
the business

General rule: By increasing in the production, the total cost of the product raises and simultaneously
profit also rises.

Practicality in the business:

How much we extra we should produce to get the best profits and how much extra cost is incurring for the
extra production.

It is related to the marginal cost and marginal revenue concepts in economic theory. 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 else may be at stake in the decisions. The two basic components of incremental reasoning are:

1. Incremental cost
2. Incremental revenue.

Incremental cost may be defined as the change in total cost resulting from a particular decision.
Incremental revenue is the change in total revenue resulting from a particular decision.

The incremental principle may be stated as follows: A decision is a profitable one if—
a) it increases revenue more than cost
b) it decreases some costs to a greater extent than it increases others
c) it increases some revenues more than it decreases others and
d) it reduces cost more than revenues.

2. Marginal Principle

Marginal Analysis The examination of the additional benefits of an activity compared to the
additional costs incurred by that same activity

Marginal Benefit
The additional satisfaction one gains from an additional unit of an activity
Marginal Cost
The additional costs from an additional unit of an activity
Marginal Net Benefit
The difference between the marginal benefits and marginal costs of an action

3. Equi-marginal Principle

Marginal Utility is the utility derived from the additional unit of a commodity consumed. The
laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the
marginal utilities of various commodities he consumes are equal. According to the modern
economists, this law has been formulated in form of law of proportional marginal utility. It states
that the consumer will spend his money-income on different goods in such a way that the
marginal utility of each good is proportional to its price, i.e,

Dr. SWATI TIWARI

 MUx / Px = MUy / Py = MUz / Pz

Where, MU represents marginal utility and P is the price of good.

Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique
of production which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources in a manner which
equalizes the ratio of marginal returns and marginal costs of various uses of resources in a specific
use.

4. Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of alternatives required by that decision.
If there are no sacrifices, there is no cost. According to Opportunity cost principle, a firm can hire
a factor of production if and only if that factor earns a reward in that occupation/job equal or
greater than it’s opportunity cost. Opportunity cost is the minimum price that would be necessary
to retain a factor-service in it’s given use. It is also defined as the cost of sacrificed alternatives.
For instance, a person chooses to forgo his present lucrative job which offers him Rs.50000 per
month, and organizes his own business. The opportunity lost (earning Rs. 50,000) will be the
opportunity cost of running his own business.
5. Time Perspective Principle

According to this principle, a manger/decision maker should give due emphasis, both to short-term
and long-term impact of his decisions, giving apt significance to the different time periods before reaching
any decision. Short-run refers to a time period in which some factors are fixed while others are variable.
The production can be increased by increasing the quantity of variable factors. While long-run is a time
period in which all factors of production can become variable. Entry and exit of seller firms can take place
easily. From consumers point of view, short-run refers to a period in which they respond to the changes in
price, given the taste and preferences of the consumers, while long-run is a time period in which the
consumers have enough time to respond to price changes by varying their tastes and preferences.

6. Discounting Principle

According to this principle, if a decision affects costs and revenues in long-run, all those costs and
revenues must be discounted to present values before valid comparison of alternatives is possible.
This is essential because a rupee worth of money at a future date is not worth a rupee today.
Money actually has time value. Discounting can be defined as a process used to transform future
dollars into an equivalent number of present dollars. For instance, Rs.1 invested today at 10%
interest is equivalent to Rs.1.10 next year.

FV = PV*(1+r)t

Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is
the discount (interest) rate, and t is the time between the future value and present value.

7. Utility Analysis- Cardinal Utility & Ordinal Utility

The utility is a psychological phenomenon; that implies the satisfying power of a good or service. It differs
from person to person, as it depends on a person’s mental attitude. The measurability of utility is always a
matter of contention. The two principal theories for the utility are cardinal utility and ordinal utility.
Many traditional economists hold the view that utility is measured quantitatively, like length, height,
weight, temperature, etc. This concept is known as cardinal utility concept.On the other hand, ordinal
utility concept expresses the utility of a commodity in terms of ‘less than’ or ‘more than’. Take a read of
the article to know the important differences between cardinal and ordinal utility.

Dr. SWATI TIWARI