Managerial Economics

The Nature & Scope of

Managerial Economics
CHAPTER 1
 The Nature & Scope of Managerial
Economics
 Here, we discuss the reason for the existence of
firms and their functions, and we define the value of
the firm, point out the constraints faced by firms,
and examine the limitations of the theory of the
firm, including the principal-agent problem.
 Then, we examine the nature of profits by
distinguishing between economic and business
profit and by analyzing their function in a free -
enterprise system.
 I define Managerial Economics as Applied
Microeconomics
 Definition of Managerial Economics
 “Managerial economics” refers to the application of
economic theory and the tools of analysis of decision
science to examine how an organization can achieve its
aims or objectives most efficiently.
 Management decisions need to be made in any
organization, be it a firm, a not-for-profit organization or a
government agency.
 A firm may seek to maximize profits. A hospital may seek
to treat as many patients as possible and the goal of a
state university may be to provide an adequate education
to as many students as possible.
 The goals and constraints may differ from case to case,
but the basic decision-making process in the same.
 The Scope of Managerial Economics
Managerial Decision Problems

Economic theory Decision Sciences

Microeconomics Mathematical Economics
Macroeconomics Econometrics

MANAGERIAL ECONOMICS
Application of economic theory
and decision science tools to solve
managerial decision problems

Optimal Solutions To
Managerial Decision Problems
Figure 1-1: The Nature Of Managerial Economics
 Relationship to Economic Theory
 The organization can solve its management
decision problems by the application of economic
theory and the tools of decision science.
 Economic theories seek to predict and explain
economic behavior. Economic theories usually
begin with a model.
 The methodology of economics (and science in
general) is to accept a theory or model if it
predicts accurately, and if the predictions flow
logically from the assumptions.
 Relationship to the Decision Sciences
 Managerial economics is also closely related to the
decision sciences.
 These use the tools of mathematical economics and
econometrics to construct and estimate decision models
in and determining the optimal behavior of the firm.
 Mathematical economics is used to formalize the
economic models postulated by economic theory.
 Econometrics then applies statistical tools (particularly
regression analysis) to real-world data to estimate the
models postulated by economic theory and for
forecasting.
 Relationship to the Decision Sciences

 For example a economic theory postulates that

Quantity Demanded, Q, of a commodity is a function
of or depends on Price of a Commodity, P, the income
of Consumers, Y, and the prices of Complementary
and Substitute Goods Pc and Ps respectively
(Q = f(P, Y, Pc, Ps)

 By collecting data on Q, P, Y, Pc, and Ps for a particular

commodity, we can then estimate the empirical
(econometric) relationship.
 Relationship to the Functional Areas of
Business Administration Studies
 The relationship between managerial economics
and the functional areas of business
administration studies includes accounting,
finance, marketing, personnel or human resource
management, and production.
 These disciplines study the business environment
in which the firm operates and provide the
background for managerial decision making.
 Relationship to the Functional Areas of
Business Administration Studies
 Managerial economics integrates economic
theory, decision sciences, and the functional areas
of business administration studies, and examines
how they interact with one another as the firm
attempts to achieve its goals most efficiently.
 Managerial economics is not the study of a
number of topics but the utilization of economic
theory and management science tools to examine
how a firm can achieve its objective most
efficiently within the business environment in
which it operates.
 The Basic Process of Decision Making

1. Define the Problem

2. Determine the objective
3. Identify Possible Solutions
4. Select the Best Possible Solution
5. Implement the Decision

Figure 1.2
The Decision-Making Process
The five basic steps of the decision-making process
 The Basic Process of Decision Making
 Regardless of the type, all decision-making
processes involve or can be subdivided into five
basic steps, as shown in figure 1.2.
 The first step involves defining the problem that
can the firm or organization faces. In 1979 the
Xerox Corporation, which invented the copying
machine in 1959 and had no competition until
1969, found itself unable to compete with
Japanese copier, which were of better quality and
cheaper.
 The second step is for the firm or organization to
determine the objective of the firm.
 The Basic Process of Decision Making
 In the case of Xerox, the company had to decide
whether to try to meet the competition or leave the
copier market to the Japanese and move on.
 The Third step is to identify the options for range of
possible solutions.
 In the case of Xerox, the range of choices included
trying to improve quality while reducing the costs of
production in it’s American plants, import from Japan
those parts and components that could be produced
better and more cheaply in Japan, or transfer its entire
production of copier to Fuji Xerox, its Japanese
subsidiary.
 The Basic Process of Decision Making

 The Fourth step is to select the best possible

solution or course of action among the choices
identified in step three.
 In the case of Xerox, this required reorganization
and integration of development and production,
and an ambitious companywide Quality Control
effort in its domestic plants with the direct
involvement of Fuji Xerox, as well as the
importation of parts or components that Fuji
Xerox could best produce in Japan.
 The Basic Process of Decision Making
 The first and final step is the implementation of
the best possible solution.
 Xerox greatly increased employee involvement,
brought suppliers into the early stages of
production design, greatly reduced inventories
and the number of suppliers, and used Fuji Xerox
to produce in Japan those parts or components
that could be better supplied from Japan.
 By taking these drastic actions Xerox was able to
reverse that tend toward loss of market share to
Japanese competitors.
 Case Study
Peter Drucker: The Man Who Invented Management
 In his 1959 book, The Practice of Management, he
asked the seeming naive but fundamental
question: “What business are we in?” “Who are
our customer?” “What does the customer
consider value?”
 In The Effective Executive (1966), Drucker says the
managers should focus on important matters in
order to avoid wasting time on nonessentials, to
focus on substance rather than style and no
institutionalized practices over charismatic or cult
leaders.
 Peter Drucker Study (contd)
 Some of the other basic management principles
introduced by Drucker are
a. The necessity of empowering workers and treating them
as resources
b. World is becoming knowledge economy and therefore
we should create knowledgeable workers
c. A corporation is a Human Community and workers
should be satisfied and continuously learn and train
d. Change should be taken as an opportunity not threat
e. Every decision is risky and risk can be minimized if
managers know how to tackle it and implement it.
 Case Study 1-2: The Management
Revolution
 Business and society are today in the midst of a
revolution comparable to the Industrial
Revolution in both scale and consequence.
 Today’s revolution has four components:-
 The globalization of markets
 The spread of information technology and
computer networks
 The dismantling of traditional manager
hierarchies, and
 The creation of a new information economy.
 The Management Revolution Study (contd)
 1st Component Globalization: It once meant simply
exporting some goods and services to other nations
and may be setting up a few production facilities
abroad.
 Today, globalization means that more and more
managerial decisions must consider the world as a
whole.
 Because of the tremendous improvement in
communication and transportation domestic
producers face ever-growing competition from
abroad.
 The Management Revolution Study (contd)
 The second component IT and Computer Networks.
 This greatly speeds up the delivery of goods and services,
cuts waste, reduces inventory, and generally increases
the productivity.
 The 3rd Component Dismantling of Traditional
Managerial Hierarchies: Dismantling of traditional
managerial hierarchies is fast resulting in virtual
elimination of the rank of middle management.
 Today, information can be transmitted from top
management directly to workers and vice versa by a
simple tap of a computer key and without any need of
middle management.
 The Management Revolution Study (contd)
 The fourth component spread of Information
Economy: The rapid spread of the information
economy involves the creation of value based on
knowledge and communication rather than as in
the past on natural resources and physical labor.
 Today’s four-pronged revolution effects drastically
not only how traditional products and services are
produced and distributed but also the entire
organization of production, consumption, and
management in ways that are not yet fully evident
or understood.
 The Management Revolution Study (contd)
 As global firms are becoming more active and as
domestic firms are becoming more active globally,
the emergence of a cosmopolitan human resource
management becomes imperative.
 It is evident from the revolution in management
that increasing global linkages and
professionalization of managerial cadre are creating
a new imperative of ethical imagination and
deepening of managerial roots.
 Linking the modern corporate component content
to traditional values and ethical roots is a blueprint
that needs further attention.
 The Theory of the Firm
 Reasons for the Existence of Firms and Their
Functions
 A firm is an organization that combines and organizes
resources for the purpose of producing goods and/or
services for sale.
 Firms produce more than 70% of all goods and services
consumed in India while the remainder is produced by
the government and not-for-profit organizations, such
as private colleges, hospitals, museums and
foundations.
 The Theory of the Firm
 Firms exist because they insulate private ownership from
management of operations.
 The firms exist in order to save on transactions costs of
entering into individual contracts with suppliers, workers
and owners of other factors of production.
 Firms, however, do not continue to grow larger and larger
indefinitely because of limitations on management’s
ability to effectively control and direct the operation of
the firms as it hugely expands.
 To some extent firms can overcome the disadvantages of
large size or diseconomies of scale by establishing a
number of semiautonomous divisions but diseconomies
of scale eventually limit the growth of the firm.
 The Theory of the Firm
 The function of firms, therefore, is to purchase resources
or inputs of labour services, capital and raw materials in
order to transform them into goods and services for sale.
 Resource owners then use the income generated from
the scale of their services or other resources to firms to
purchase the goods and services produced by firms.
 The circular flow of economic activity is thus complete.
 In the process of supplying the goods and services that
society demands, firms provide employment to workers
and pay taxes, which the government uses to provide
services that firms could not provide at all or as
efficiently.
 The Objective and Value of the Firm
 Firms often sacrifice short-term profits for the sake of
increasing future or long-term profits.
 Some examples of this are expenditures on R&D, new
capital equipment, and an enhanced promotional
campaign.
 Since both short-term as well as long-term profits are
clearly important, the theory of the firm now
postulates that the primary goal or objective of the
firm is to maximize the wealth or value of the firm.
 This is given by the present value of all expected
future profits of the firm.
 The Objective and Value of the Firm
 Future profits must be discounted to the present because
a dollar of profit in the future is worth less than a dollar
of profit today.
 Formally stated, the wealth or value of the firm is given
by

 Where PV is the present value of all expected future

profits of the firm, π1 , π2 ,…… πn represent the expected
profits in each of the n years considered, and r is the
appropriate discount rate.
 The Objective and Value of the Firm
 Since profits are equal to total revenue (TR) minus total
costs (TC), Equation 1-2a can be rewritten as

 TR depends on sales or the demand for the firm’s

output and the firm’s pricing decisions.
 The TC depends on the technology of production and
resource prices.
 The discount rate (r) depends on the perceived risk of
the firm and on the cost of borrowing funds.
 Net Present Value (NVP) Method
The net present value or discounted cash flow
method takes the time value of money into
account by
• Translating all future cash flows (benefit) into
today's money.
• Adding up today's investment and the present
values of all future (cash flows).
If the net present value of a project is positive then
it is worth pursuing as it creates value for the
company.
 Net Present Value (NPV) Calculation
What is the present value (PV) of the project?
Year 0 Year 1 Year 2 Year 3 Year 4
Project A ($1000) $400 $400 $400 $400

$400 $400 $400 $400

(1+20%)
(1+WACC)
1.2 1.2 * 1.2 1.2*1.2*1.2
(1+20%)^2 (1+20%)^3
1.728 1.2*1.2*1.2*1.2
(1.2)^4
2.736

NPV=
PV ($1000) $333
$333 $278
$278 $231 $193
$193

NPV = 35
Internal Rate of Return (IRR) Calculation
At which discount rate will the net present value
become 0?
Year 0 Year 1 Year 2 Year 3 Year 4
Project ($1000) $400 $400 $400 $400
A

NPV = 0 = ($1000) + $400 + $400 + $400 + $400

(1 + IRR) (1 + IRR)^2 (1 + IRR)^3 (1 + IRR)^4

NPV = 0 = if IRR = 22% exceeds WACC of 20%

 Comparing Projects using NPV and IRR
Net Present Value (NPV) and Internal Rate of
Return (IRR)
Year 0 Year 1 Year 2 Year 3 Year 4
Project A ($1000) $400 $400 $400 $400

Project B ($1000) $600 $500 $300 $200

Project C ($1000) $200 $300 $500 $600

NPV and IRR

Project A NPV @ 20% WACC = ($1000) + $333 + $278 + $231 + $193 = $35 / IRR 22%
Project B NPV @ 20% WACC = ($1000) + $500 + $347 + $174 + $96 = $177 / IRR 27%
Project C NPV @ 20% WACC = ($1000) + $167 + $208 + $289 + $289 = ($46) / IRR 18%
 Trail & Error Explained
• At 20% NPV = 1035.48 which is greater than 1000. So we
increase discount rate to 24%.
• At 24% Discount rate NPV = 961.72 which is less than 1000.
• So Discount rate has to be between 20% to 24%.
• To calculate exact percentage we use following formula

20% + NPV at Lower Rate Difference in

NPV at Lower Rate + NPV at Higher Rate Percentage

= 20 + 1035.48 x4 = 1035.48 x 4 = 2
1035.48 + 961.72 1997.2

= 20 + 2 = 22%
 Constraints on the Operation of the Firm
 The firm faces many constraints some of which arise from
limitations on the availability of essential inputs.
 Specifically, a firm might not be able to hire as many
skilled workers. It might not be able to acquire all the
specific raw materials it demands. There may be
limitations on factory and warehouse space and in the
quantity of capital.
 Besides resource constraints, the firm also faces many
legal constraints like minimum wage laws, health and
safety standards, pollution emission standards. Unfair
business practice etc.
 Firms now set constraints maximization as an objective.
 Limitations of the Theory of the Firm
 The postulate that the objective of a firm is to
maximize wealth is too narrow.
 In its place many broader theories of the firm
have been proposed.
 The most prominent among these are the
models that postulate that the primary objective
of a firms is
i. maximization of sales
ii. the maximization of management utility, and
iii. satisficing behavior.
 Limitations of the Theory of the Firm
 According to the sales maximization model managers of
modern corporations seek to maximize sales, after an
adequate rate of profit has been earned to satisfy
stockholders. Indeed, some early empirical studies found
a strong correlation between executives’ salaries and
sales.
 A model of management utility maximization, postulates
that, with the advent of the modern corporation and the
resulting separation of management from ownership,
managers are more interested in maximizing their utility,
measured in terms of their compensation (salaries, fringe
benefits, stock options, etc.) and extent of control over
the corporation, than on, maximizing corporate profits.
 Limitations of the Theory of the Firm
 The issues discussed in the last slide are also
referred to as the principal-agent problem.
 That is, the agent (manager) may be more
interested in maximizing his or her benefits
that maximizing the principal’s (the owner’s)
interest.
 This principal-agent problem can be resolved
by tying the managers reward to the firm’s
performance in relation to other firms in the
same industry.
 Limitations of the Theory of the Firm

 Finally, managers are not able to maximize profits but can

only strive for some satisfactory goal in terms of sales,
profits, growth, market share, and so on.
 Simon called this satisficing behavior.
 That is, the large corporation is a satisficing, rather than a
maximizing, organization
 The stiff competition prevailing in most product and
resource markets as well as in managerial and
entrepreneurial talent today forces managers to pay
close attention to profits.
 As a result, we retain our theory of the firm, in terms of
profit or value maximization.
 Case-Study: The Cigarette Industry
 Until last decade, the objective of firms in the
cigarette industry seemed to be the maximization of
long-run profits or firm value (the theory of the firm).
 The doubling of the federal excise tax on each pack of
cigarettes on January 1, 1983, as well as the rise in
other state taxes since then, resulted in a sharp
increase in cigarette prices and a reduction in
consumption.
 In order to lure customers from rivals and maintain
profit levels, the weaker three of the nation’s six
major producers introduced generic cigarettes.
 Case-Study: The Cigarette Industry
 The other three major producers, instead, followed the
more traditional marketing strategy of brand
proliferation.
 Phillip Morris, British American Tobacco, Imperial Brands,
RJR Nabisco, Japan Tobacco and China Tobacco
 On Friday April 2, 1993 (which became known as the
infamous Marlboro Friday), PMI took unusual step of
cutting the price of Marlboro cigarettes and its other
premium brands by 20%.
 RJR Nabisco Philip Morris’s main competitor, quickly
make the price cut at the same time. Both groups of
cigarettes producers greatly expanded sales abroad.
 Case-Study: The Cigarette Industry
 With a worldwide Anti-Smoking Treaty signed in February
2004 severely restricting advertising and marketing
practices. As a result international sales of American
cigarettes also slowed down.
 In January 2009 Family Smoking Prevention and Tobacco
Control Act was passed in the United States, which
granted the US FDA right to regularize tobacco products
and put restriction on tobacco marketing and advertising.
 Under the new Federal Tobacco Law, cigarette companies
will no longer be allowed to use words like “light” or
“mild” on packages to imply that some cigarettes are
safer than others.
 The Nature And Function Of Profits
 Business versus Economic Profit
 Business profit refers to the revenue of the firm minus
the explicit or accounting costs of the firm. Explicit
costs are the actual out-of-pocket expenditures of the
firm to purchase or hire the inputs.
 These expenditures include the wages to hire labor,
interest on borrowed capital, rent on land and
buildings, and the expenditures on raw materials.
 Economic profit equals the revenue of the firm minus
its explicit costs and implicit costs.
 Implicit costs refer to the value of the inputs owned
and used by the firm in its own production processes.
 Business versus Economic Profit
 Implicit costs include the salary that an
entrepreneur could earn from working for someone
else in a similar capacity and the return that the
firm could earn from investing its capital and
renting its land and other inputs to other firms.
 Implicit costs are what these same inputs could
earn in their best alternative use outside the firm
(Opportunity Cost).
 Economists include a normal return on owned
resources as part of costs, so that economic profit is
revenue minus explicit and implicit costs.
 Theories of Profit
 Profit rates usually differ among firms in a given industry.
Firms in such industries as steel, textiles, and railroads
generally earn very low profits both absolutely and in
relation to the profits of firms in pharmaceutical, office
equipment, and other high-technology industries. Several
theories attempt to explain these differences.
1. Risk-Bearing Theories of Profit According to this theory,
above-normal returns are required by firms to enter and
remain in such fields as petroleum exploration with
above-average risks.
Similarly, the expected return on stocks has to be higher
than on bonds because of the greater risk of the former.
 Theories of Profit

2. Frictional Theory of Profit This theory stresses

that profits arise as a result of friction or
disturbances from long-run equilibrium and hence
firms can earn Economic Profits in the short run.
In the long run, however, in competitive markets,
new entrants drive down the profits and firms
earn only a, normal return or zero (economic)
profit. Similarly when losses are incurred, some
firms leave the industry.
 Theories of Profit
3. Monopoly Theory of Profits: Some firms with
monopoly power can restrict output and charge
higher prices than under perfect competition,
thereby earning a profit.
Monopoly power may arise from the firm’s owning
and controlling the entire supply of a raw material
from economies of large-scale production patents, or
from government restrictions that prohibit
competition.
4. Innovation Theory of Profit The innovation theory of
profit postulates that profit is the reward for the
introduction of a successful innovation.
 Theories of Profit
 The U.S. patent system is designed to protect the profits
of a successful innovator.
Inevitably, as other firms imitate the innovation, the
profit of the innovator is reduced and, eventually,
eliminated.
5. Managerial Efficiency Theory of Profit This theory rests
on the observation that if the average firm tends to earn
only a normal return on its investment, in the long run,
firms that are more efficient than the average would earn
above-normal returns and (economic) profits.
All of the above theories of profit have some element of
truth.
 Function of Profit
 Profits often arise from a combination of factors, including
differential risk, market disequilibrium, monopoly power,
innovation, and above-average managerial efficiency.
 High profits are the signal that consumers want more of
the output of the industry.
 High profits provide the incentive for firms to expand
output and for more firms to enter the industry.
 Lower profits or losses are the signal that consumers want
less of the commodity and/or that production methods
are not efficient.
 Profits provide the incentive for firms to increase their
efficiency and/or produce less of the commodity.
 Functions of Profit
 Profits provide the crucial signals for the reallocation of
society’s resources.
 The profit system is not perfect, and governments often
step in to modify the operation of the profit system.
 For eg Governments invariably regulate the prices of
electricity by public utility companies to ensure only a fair
return on investment to shareholders.
 Minimum wage laws and pollution emission controls also
force polluting firms to internalize the social cost of the
pollution they create.
 While not perfect, the profit system is the most efficient
form of resource allocation available.
Case Study: The Personal-computer Industry
 In 1976, Steven Jobs, then 20 years old, dropped
out of college and, with a friend, developed a
prototype desktop computer.
 With financing from an independent investor, the
Apple Computer Company was born.
 Sales of Apple Computers jumped from $3 million
in 1977 to over $1.9 billion in 1986, with profits of
over $150 million.
 By 1984 more than 75 companies had jumped
into the market.
Case Study: The Personal-computer Industry
 Because of increased competition, however, many of the
early entrants had dropped out by 1986.
 Profit margin from for the 11 largest US computer
companies averaged 11.5% from 1980 to 1985 but only
6.5% from 1986 to 1990.
 In 1997 after it had suffered years of losses and several
CEO changes Jobs was back at Apple.
 He revived Apple by introducing a series of highly
successful new products such as the iPod, iPhone and
iPad which give Apple huge profits.
 This event in the newly born PC market is a classic
example of the source function and importance of profit
in an economy.
 Business Ethics
 Business Ethics seek to proscribe behavior that
businesses, firms managers, and workers should not
engage in. Ethics is a source of guidance beyond
enforceable law.
 Business and management ethics go beyond the law
to provide guidelines as to what is acceptable
behavior in business transaction.
 For eg: Should you report to your supervisor and
affair between two of your coworkers?
 What about selling a product abroad that has been
found to be harmful to health and is not allowed in
domestic markets?
 Business Ethics
 Or buying foreign products made with child labor?
Or polluting abroad in a way that is not allowed at
home?
 Established codes of ethical behavior have created
“ethics officers” or guardians of corporate
rectitude with the mission of keeping employees
conduct more upright than the law requires.
 A company with such a code is more likely to hear
of unethical behavior in the form before it comes a
legal problem.
 Business Ethics
 Nestle pushed infant formula in many countries
though mothers’ milk was definitely better.
 Nike paid poverty wages in many developing
countries.
 Employees are asked to observe code of ethics
not only domestically but also around the world.
 These code of ethics include using the
companies telephone for personal use, taking
office supplies home, lying about being sick for
missing work, not reporting illegal behavior by
other employees and giving or accepting gifts.
 Case Study: Business Ethics at Boeing
 The Boeing Ethics Challenge, complied a large
number of ethical situations that employees might
face.
 Following is an example regarding the proper use of
companies resources:
 You are a manager and one of your employees is
selling Amway product to co-workers. He shows
catalogues and takes orders during lunch.
 He leaves an order form on a table in a break and
collects money and distributes products during
lunch and after work. As the employee’s manager,
should you anything about this?
 Case Study: Business Ethics at Boeing
A. No, Place your order too !!!!!
B. No. The employee appears not to be disrupting the
workplace.
C. Yes. Employees are not permitted to use company
premises for outside business activities.
D. Yes. You should tell your employee that he may only
continue the business on the premises with your
approval.
 Preferred answer: C.
 Rationale ?
A. As a manager, you should stop this type of activity.
B. It could be difficult to restrict this activity to break and
lunch periods and will disrupt routine office work.
 Case Study: Business Ethics at Boeing
C. Sales for personal gain on company premises are strictly
prohibited. The distributor is also taking advantage of a
“captive audience”.
D. Even a manager cannot authorize for-profit sales on
company property. However, the manager can permit
nonprofit activities, such as Girl Scout cookies or candies,
as long as it doesn’t interfere with work.
 Despite its ethics program, a Boeing manager misused
Lockheed document to win a government contract and
was fired in 2003
 In 2005. Boeing’s CEO who had spearheaded the “Ethics
Drive”, after a series of scandals, was himself ousted for
having an office affair !!!!!!!
Case Study: Competition and Ethical Behavior
 The hypothetical scenario, A US based company
has entered into a trading arrangements with an
Indian company.
 An executive from the United States, who is keen
to make the project a success, is on a visit to
India. He finds that an initial shipment has been
held up in customs for want of sufficient data
required to complete information complete
import formalities.
 The information had been supplied earlier by the
US office.
Case Study: Competition and Ethical Behavior
 A clerk in the Indian joint venture partner’s office
suggest that he would work overtime, find the
information, and complete the formalities if he is
appropriately compensated.
 The question facing the student is whether the US
executive should pay.
 It is said that when competition toughens, market
pressure can drive individuals to act unethically.
 What is illegal and what is unethical is often quite
clear. But there is a vast grey area in- between. That
is where the fierce competitor can often land if
he/she is not careful.
Case Study: Competition and Ethical Behavior

 Today, profession such a medicine, law and

accounting have professional codes of ethics.
 Despite this, a number of spectacular financial
frauds were exposed; starting with the Enron on
disaster in India at the end of 2001 and spilling
over into most of 2002.
 It clearly demonstrated that firms’ officers
sometime behave not just unethically, but
downright illegally.
 Case Study: Enron Disaster in India
 The Dabhol Power Company (now called RGPPL -
Ratnagiri Gas and Power Private Limited) was a
company based in Maharashtra, India, formed in
1992 to manage and operate the controversial
Dabhol Power Plant.
 The Dabhol plant was built through the combined
effort of Enron as the majority share holder, and
GE, and Bechtel as minority share holders.
 In May 1999, the power plant began producing
energy.
 Case Study: Enron Disaster in India
 In January 2001 the state of Maharashtra stopped
paying DPC and sought to cancel the purchase
agreement.
 In May 2001, the power plant ran into further
trouble due to Enron scandal leading to the
bankruptcy of Enron and had to stop production.
 In 2005, it was taken over and revived by
converting it into the RGPPL (Ratnagiri Gas and
Power Private Limited), a company owned by the
Government of India.
 Case Study: Enron Disaster in India
 Before its collapse at the end of 2001, Enron, the
Houston-based energy-trading company, was so
good at selling itself that it led to unrealistic
expectations about its growth and profitability.
 In trying to live up to these unrealistic
expectations, Enron started to falsify its financial
reports.
 It inflated earnings by using outside partnerships
to monetize the assets and to move its debt off it
balance sheet.
 Case Study: Enron Disaster in India
 Enron was then forced to restate its earnings
sharply downward, and this caused its stock to
collapse.
 The last week of 2000 was eventful for the
financially strapped Maharashtra government.
 Having decided not to help the Maharashtra
State Electricity Board pay for Enron’s expensive
power, the consequent default led to a two-
notch downgrade in State’s credit rating.
 Case Study: Enron Disaster in India
 It also led to Enron invoking its sovereign guarantee
and asking the central government to pay the
controversial Dabhol Power Company (DPC).
 From 1992 to 2001, the construction and operation
of the plant was mired in controversies related to
corruption in Enron and at the highest political
levels in India and the US which led to complete
loss of the company and taken over plant by RGPPL.
 So the company Enron which went into bankruptcy
demanded USD 5.2 billion claim against the
government of India.
 Case Study: Enron Disaster in India
 The case was taken to International Court of Justice and
was put under arbitration in the year 2004.
 The BJP government which was in power had formed the
lawyer panel headed by the solicitor of general Harish
Salvi (the same person who represented India in
Kalbushan Jadhav case).
 After the Congress came to power in 2004 General
Elections, the government replaced all panel members
and hired Khawar Qureshi (Pakistani lawyer) to fight case
for India.
 The case was lost and Government had to pay a $4 billion
plus amount.
The International Framework of Managerial
Economics
 Domestic firms face increasing competition from
foreign firms in the US market and around the world.
 The international flow of capital, technology, and
skilled labor has also reached unprecedented
dimensions.
 There is a rapid movement toward the globalization
of production, consumption, and competition.
 Specifically, as consumers, we purchase Japanese
Toyotas and German Mercedes, Italian handbags and
French perfumes, British scotch Swiss chocolates,
Hong Kong clothes and Taiwanese hand calculators.
The International Framework of Managerial
Economics
 In view of such globalization of economic
activity, it would be unrealistic to study
managerial economics in an international
vacuum.
 This requires the training of a new type of global
executive, who requires many new skills that are
not easy to acquire.
 Nevertheless, many domestic companies which
are striving to go global have managed to
acquire some of the qualities that are expected
of a global business executive.