MANAGERIAL ECONOMICS

MANB403

Prof. Tanuja Dubey

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 COURSE OUTCOME

At the end of course you will be able to understand:

• Basic concepts of economics
• Apply the knowledge of economics while dealing with
business.
• Understand the various tools to measure national
income
• Analyse economic data
• Interpret demand and supply mechanism

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Suggested Readings:

John Sloman, Economics, 7th ed., Pearson Education

Case, Fair, Oster., Principle of Economics, 10th ed.,

Pearson Education

Robert Hall, Marc Lieberman, Economics-Principles

and Applications, 2nd ed.

Yogesh Maheshwari, Managerial Economics, 2nd ed.,

Prentice Hall India, 2008

R. Pindyck, D. Rubinfeld, Microeconomics, 5th ed.,

Prentice Hall India

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 Some Questions…
• Should I buy branded jeans or non-branded one?

• Should I save for a summer holiday, or spend more on day-to-day

living?

• Should I go to university, or should I try to find a job now?

• If I go to university, should I work part time?

• Should Govt. spend on infrastructure or on defence?

 Some Questions…
• Should water be used for drinking or industrial purpose?

• Land should be used for farming or for setting factory?

• Should you rent the house or buy?

• Do business or do job?

ANY QUESTION INVOLVING CHOICE COMES UNDER ECONOMICS

Why there is need of choice?

SCARCITY
Human wants are unlimited
 Definitions
“An inquiry into the nature and causes of the wealth of nations“ -
Adam Smith – Father of Economics (1779)

A social science that studies how individuals, governments, firms

and nations make choices on allocating scarce resources to
satisfy their unlimited wants. – Investopedia

Economics is the study of the production and consumption of

goods and the transfer of wealth to produce and obtain those
goods.
 Content of Economics

Economics

Traditional

Modern

Distribution
Consumption Rent
Production Exchange
Human wants Wages
Input Producer
Satisfaction Interest
Output cosumer
Demand Profit

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 3 Questions
Economics answers following 3 questions:

1. What to produce?

2. How to produce?

3. For whom to produced?

 Goals and Objectives of economics

• Cost Allocation :
– Opportunity cost, fixed cost and variable cost

• Understanding of Human Behavior :

– Emotional aspect behind decision making
– How humans react to change in circumstances

• Government policies and decisions:

– Make policies
 Managerial Economics
Basic Concepts of Economics:

Introduction:
Economics is a social science. Its basic function is to study how people that is
individual, households, firms, and nations maximize their gains from their limited
resources and opportunities. In economic terminology, this is called as optimizing behavior.
Optimizing behavior is, selecting the best out of available options with the objective of
maximizing gains from the given resources. Economics is thus a social science, which
studies human behavior in relation to optimizing allocation of available resources.
Economics is sometimes called the science of choice.
Example : Economics studies the behavior of households allocate their limited resources.

Thus economics is a social science which relates to:

1) The study of scare resources
2) The allocation of scare resources to different uses, involving the problem of
choice.
3) The maximization of welfare at the individual level as well as at the level of
society as a whole.
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 Nature of Economics:
The objective of the study of nature of economics is to know whether economics
is a science or an art or both science as well as art. According to Samuelson, “Economics is
the oldest form of arts, the newest form of sciences – indeed the queen of all the social
sciences.”

Economics as a Science:

The term science has its origin in term “Scientia” of latin language. It means “to
know.” By knowing a subject we mean understanding it and being able to describe its
causes and effects. “Science is a systematic body of knowledge concerning the
relationship between causes and effects of a particular phenomenon”

Factors to Decide:

1) Collection of Facts: In science, initially facts concerning a subject are collected. In

economics also facts relating to economic activities are collected.
Example: An economist observes that when prices rises, ordinarily demand contracts.
Similarly, when consumer buys more of a commodity then the utility of that commodity
diminishes.
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2) Measurement: In science efforts are made to measure the facts. To do so facts are
classified and properly presented. In economics also facts are measured. An economist try
to measures as to how much demand has contracted due to rise in the price. If there is
unemployment then what is the number of unemployed people?

3) Explanation: After collecting and measuring the facts, the same are sought to be
explained and put for testing. In other words, the same are put to systematic study. By
establishing the relationship between cause and effects of a fact, economic laws are
framed.
Example: on the basis of study of mutual relationship between change in price and
consequent change in demand, Law of demand is formulated.

4) Verification or Validity of laws: Final feature of science is to verify the validity of

scientific laws by applying the same to real life situation. In other words, whether the same
confirms to facts or not. In economics also the Laws of demand are treated as valid because
same apply to real life situation.

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Scope of Economics:
Human wants are unlimited but means to satisfy them are limited. Not only means
are scare but also have alternate uses. It is this dilemma which gives rise to economic
problem. Economic activities are conducted in order to solve this dilemma. Production is
the outcome of economic activity. Therefore the scope of economics covers the
following:
A) Economic Activities : Economic activities are those which concerned with production,
consumption, and investment of resources used for satisfying human wants:
1) Production – It refers to the creation of utility or addition of value in goods or services.
2) Consumption – This activity is concerned with use of utility goods and services for direct
satisfaction of wants. Wearing of clothes, eating of bread, drinking of tea etc. are
consumption activities.
3) Investment – It refers to the activity as a result of which there is an increase in physical
and human capital. In other words there is capital formation.
4) Exchange - This refers to the activity concerned with sale and purchase of goods and
services of the factors of production.
B) Economic System -
1) Market Economy
2) Command Economy
3) Mixed Economy

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C) Economic Policies – Several economic problems arise as a result of
operation of economic system, such as unemployment, inflation, poverty etc.
And policies which are formed to solve these problems are-
1) Monetary Policy
2) Fiscal Policy
3) Price Policy
4) Economic Planning

D) Econometrics – It is a branch of economics wherein mathematics and

statistics are used to measure and analyze economic activities is called
Econometrics.

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 Positive and Normative Economics approach:
Positive economics is objective and fact based, while normative
economics is subjective and value based. Positive economic statements do not have
to be correct, but they must be able to be tested and proved or disproved. Normative
economic statements are opinion based, so they cannot be proved or disproved.
For example, the statement, "government should provide basic healthcare to all
citizens" is a normative economic statement. There is no way to prove whether
government "should" provide healthcare; this statement is based on opinions about the
role of government in individuals' lives, the importance of healthcare, and who should
pay for it.

The statement, government-provided healthcare increases public expenditures

is a positive economic statement, as it can be proved or disproved by examining
healthcare spending data in country, where the government provides health care.

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 Branches of Economics
a) Micro Economics - Micro means small. Thus micro economics analyzes
individual behavior. It studies an Individual consumer, producer, price of a
particular commodity, households etc.

b) Macro Economics – It is the study of aggregate of individuals or aggregate

covering entire economy, such as total unemployment, national income, total
investment etc.

Difference between Micro and Macro Economics:

The micro economics is the study of an economic behaviour of a particular

individual, firm, or household, i.e. it studies a particular unit. On the other hand, macro
economics is the study of the economy as a whole i.e., not a single unit but the
combination of all, firms, households, nation, etc.

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 Managerial Economics
According to Jeal Dean, ”The purpose of managerial economics is to how
economic analysis can be used in formulating company policies. ”

Managerial economics bridges the gap between traditional

economic theory and real business practices in two ways.

Firstly, it provides number of tools and techniques to enable the

manager to become more competent to take decisions in real and
practical situation.

Secondly, it serves as an integrating course to show the interaction

between various areas in which the firm operates.
In the words of Michael Baye,”Managerial Economics is the
study of how to direct scares resources in a way that mostly
effectively achieves a managerial goal”.
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 Objectives of Managerial Economics:
• The basic objective of managerial economics is to analyze
the economic problems faced by the business. The other
objectives are:
• To integrate economic theory with business practice.
• To apply economic concepts and principles to solve
business problems.
• To allocate the scares resources in the optimal manner.
• To make all-round development of a firm.
• To minimize risk and uncertainty
• To helps in demand and sales forecasting.
• To help in profit maximization.
• To help to achieve the other objectives of the firm like
industry leadership, expansion implementation of policies
etc...

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Importance: In order to solve the problems of decision
making, data are to be collected and analyzed in the
light of business objectives. Managerial economics
provides help in this area. The importance of
managerial economics maybe relies in the following
points:
• It provides tool and techniques for managerial decision making.
• It gives answers to the basic problems of business management.
• It supplies data for analysis and forecasting.
• It provides tools for demand forecasting and profit planning.
• It guides the managerial economist.
• It helps in formulating business policies.
• It assists the management to know internal and external factors
influence the business
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 Following are the important areas of decision making
• Selection of product.
• Selection of suitable product mix.
• Selection of method of production.
• Product line decision.
• Determination of price and quantity.
• Decision on promotional strategy.
• Optimum input combination.
• Allocation of resources.
• Replacement decision.
• Make or buy decision.
• Shut down decision.
• Decision on export and import.
• Location decision.
• Capital budgeting
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 Scope of Managerial / Business
Economics
The scope covers two areas of decision making
(A) operational or internal issues:(arise within the
business organization and are under the control of
the management & what to produce, when to
produce, how much to produce and for which
category of consumers .
(B) Environmental or external issues:(general business
environment in which the firm operates )

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 Operational/internal issues

• Demand analysis and Forecasting: -.

• Cost analysis:
• Pricing Decisions: -
• Profit Analysis: -
• Capital budgeting: -
• Production and supply analysis:

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 Environmental or external issues

• The types of economic system in the country.

• The general trend in production, employment, income,
prices, savings and investments
• Trends in the working of financial institutions like
banks, financial corporations, insurance companies etc.
• Trends in foreign trade.
• Trends in labour and capital market.
• Government economic policies viz., industrial policy,
monitory policies, fiscal policy, price policy etc…

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Reasons behind Economic Problem:
1) Unlimited Wants
2) Limited Resources
3) Alternate uses of resources.

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Basic Economics Problems:
Micro Economic Problems –
1) What to produce and how much to produce
2) How to produce
3) For whom to produce

Macro economic problems –

1) How to achieve optimum utilization of resources
2) How to attain efficiency in production and distribution
3) How to accelerate economic growth

Market forces in solving economic problem –

1) Adam Smiths Invisible Hand Theory : The unobservable market force that
helps the demand and supply of goods in a free market to reach
equilibrium automatically is the invisible hand.
2) Government
3) Central Bank
4) EXIM policy

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Circular Flow of Income and Expenditure:
An economy is an integrated system of production, exchange and
consumption. In carrying out these activities, people buy and sell goods and
services. Income generated in the production process flows in a circular
manner. It is called as circular flow of income.

• Circular flow of income and expenditure in two sector economy –

The business sector employs the factors of production and produces
the final output for sale, whereas the household sector which is assumed to
own the factors of production, supplies the factor services and consumer
consumes the output produced by the business sector.

Money payments to firm

Factor services
Households Firms

Goods and Services

Payment of Factor income

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• Real flows of resources, goods and services have been
shown in Fig.
• In the upper loop of this figure, the resources such as land,
capital and entrepreneurial ability flow from households to
business firms as indicated by the arrow mark.
• In opposite direction to this, money flows from business
firms to the households as factor payments such as wages,
rent, interest and profits.
• In the lower part of the figure, money flows from
households to firms as consumption expenditure made by
the households on the goods and services produced by the
firms,
• while the flow of goods and services is in opposite direction
from business firms to households.

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Circular Income Flow in a Three Sector Economy with
Government:

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• In our above analysis of money flow, we have
ignored the existence of government for the
sake of making our circular flow model simple.
• This is quite unrealistic because government
absorbs a good part of the incomes earned by
households.
• Government affects the economy in a number
of ways.

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• Government purchases goods and services just as
households and firms do.
• Government expenditure takes many forms including
spending on capital goods and infrastructure
(highways, power, communication), on defence goods,
and on education and public health and so on.
• These add to the money flows which are shown in Fig.
where a box representing Government has been
drawn.
• It will be seen that government purchases of goods
and services from firms and households are shown as
flow of money spending on goods and services.

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• The money flow from households and
business firms to the government is labelled
as tax payments
• Another method of financing Government
expenditure is borrowing from the financial
market.

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Circular Income Flow in a four Sector Economy Adding
Foreign Sector

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• Circular flow of income and expenditure in four sector economy
No economy in world functions in isolation. It is linked with the other
economies through trade. This brings us to an analysis of a four sector economy
where besides the households, firms and the government the fourth sector is the
foreign market.

• Withdrawals and Injections in an Economy

The circular flow of income and money would remain constant as long as
what is spent on goods and services by the households is all distributed by the
firms as a factor of payments. However reality presents a different picture where
there exist withdrawals and injection of income, which prevents the circular flow
of income and money from remaining constant

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Importance of circular Flow of Income and Expenditure
 Study of Problems – It is with the help of circular flow that the problems of
disequilibrium and restoration of equilibrium can be studied.

 Effects of Leakage and Inflows – The role of leakage enables us to study their
effects on the national economy. For example, imports are a leakage out of
circular flow of income for the reason that they are payments made to the
foreign country. To stop this leakage, government adopts measures like to
promote exports or to decrease imports.

 Link Between Producer and Consumer – The circular flow establishes a link
between producers and consumers. It is through income that producers buy
the services of the factors of production with which the latter in turn
purchase goods and services from the producers.

 Inflationary and Deflationary Tendencies – Leakage or Injection in circular

flow disturb the smooth functioning of the economy. Example – Saving is a
leakage out of expenditure stream. If saving increases this decreases the
circular flow of income. This tends to unemployment, deflation in economy.
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 Conversely, consumption tends to increase employment, income,
productivity, and prices that leads to inflationary tendencies.

 Basis of Multiplier – If leakages exceeds injections in the circular flow, the total
income becomes less than the total output. This leads to a cumulative decline
in employment, income and productivity over time.
Conversely, if injections in to the circular flow exceed leakages the
income is increased in economy. This leads to cumulative rise in employment,
income, output over time.

 Importance of Monetary Policy – The study of circular flow highlights the

importance monetary policy to bring about the equality of saving and
investment in economy.

 Importance of Fiscal Policy :Tell about importance of compensatory fiscal

policy

 Importance of Trade policies: importance of adopting export promotion and

Import control policy.

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Nature of Firm
A firm is an organization that combines and organizes resources for the
purpose of producing goods and/ or services for sale.

A firm is an organization which changes hired inputs in to saleable. The inputs or

the factors of production are divisible in to two broad categories – human
resources and capital resources.

According to S.E. Landsbury, “Firm is an organization that produces and sells

goods with the goal of maximising its profits. ”

Firms can be classified as follows:

1) Small, medium and large
2) Proprietorships, Partnerships, Corporations
3) Public Sector, Private Sector and Joint Sector

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 How do you qualify as an MSME in India?

• The Micro, Small and Medium Enterprises

Development (MSMED) Act, 2006, governs the
coverage and investment ceiling of MSMEs in
India.
• According to the Act, there are two categories
of MSMEs in the country – manufacturing and
services.

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 Manufacturing sector
• An MSME is based on a company’s capital
investment
• Micro: when investment does not exceed Rs 2.5
million (US$34,040);
• Small: when investment is more than Rs 2.5
million (US$34,040) but does not exceed Rs 50
million (US$680,875); and
• Medium: when investment is more than Rs 50
million (US$680,875) but does not exceed Rs 100
million (US$1.3 million).
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 Services Sector
• An MSME is based on a company’s investments in
equipment. The threshold limits are:
• Micro: When investment does not exceed Rs 1
million (US$13,617);
• Small: When investment is more than Rs 1 million
(US$13,617) but limited to Rs 20 million
(US$272,350); and
• Medium: When investment is more than Rs 20
million (US$272,350) but less than Rs 50 million
(US$680,875).
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 The new classification of MSMEs
Enforced by amendment.
• Micro: a unit where the annual turnover does not
exceed Rs 50 million (US$680,875);
• Small: a unit where the annual turnover is more
than Rs 50 million (US$680,875) but does not
exceed Rs 750 million (US$10.1 million); and
• Medium: a unit where the annual turnover is
more than Rs 750 million (US$10.1 million);
rupees but does not exceed Rs 2.5 billion
(US$33.8 million).
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Objectives of the Firm
1) Profit Maximization

Criticism of Profit maximization –

a) It is narrow minded
b) It is unclear weather short term or long term
c) Profits are uncertain
d) No perfect knowledge – This objective is based on the assumption that all firms have
perfect knowledge not only about their costs and revenues but also of other firms.
e) Not Applicable to Oligopoly firm

2) Wealth Maximizations –

Criticism of wealth maximization –

a) The market price of share of a firm does not necessarily depends on firm related
factors alone.
b) The entire focus is on the shareholders value maximization alone this may prove
costly to other stake holders like suppliers, and community.
c) The managers may not always act in the best interest of shareholders to maximize
the value of firm. They may guided by their personal considerations like rewards,
incentives, stock options.
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Other Objectives of the firm :
Economic Objectives:
a) Maximum growth rate
b) Desire for liquidity

Non-Economic Objectives:
1) Survival
2) Building up Public Confidence for the product
3) Welfare
4) Sound business practice

Principal Agent Problem

Profit-
Accounting Profit and Economic Profit :
Economic Profit = Total Revenue – Total Economic Cost
= Total Revenue – Explicit Costs – Implicit Costs

Accounting Profit = Total Revenue – Explicit Costs

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Role / Scope of Profit in the Economy:
Following are the important roles of profit in the economy are :
1) Measure of Performance
2) Premium to cover costs of staying in business
3) Ensuring supply of future capital
4) Motivating entrepreneur
5) Provide resources
6) Sources of Revenue

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 Practice Questions

Which of the following are macroeconomic issues, and which are microeconomic
ones?
1. Inflation.
2. Gross Domestic Product
3. Low wages in banking industry.
4. Per capita income
5. Price of medical care
6. The rate of exchange between the pound and the euro
7. Why the price of cabbages fluctuates more than that of cars
8. The decline of traditional manufacturing industries

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