Managerial economics

Managerial Economics: Means to

an end to managers in any
business, in terms of finding the
most efficient way of allocating
scare organizational resources
and reaching stated objectives

 Economics is defined as a body of

knowledge or study that discuses
how a society tries to solve the
human problems of unlimited wants
and scare resources.

 It is based on the economic analysis

for identifying problems, organizing
information and evaluating
alternatives.

DEFINITIONS OF MANAGERIAL ECONOMICS

Managerial economics is the

economic modes of thought to
analyse business situation

-Mc.Nair and Meriam

 Nature and Scope of Economics:

Some six main scope of

economics are:
Demand Analysis and Forecasting
Cost Analysis
Production and Supply Analysis
Pricing decisions, Policies and procedures
Profit management
Capital Management

SIGNIFICANCE OF MANAGERIAL ECONOMICS

It helps in decision making

Decision making means a
balance between simplification of
analysis to be manageable and
complication of factors in hand

 It helps the manager to become an more

competent builder
It helps in providing most of the concepts
that are needed for the analysis of
business problems,the concepts such as
elasticity of demand ,fixed, variable cost,
SR and LR costs (short run and long run
cost), opportunity costs,NPV etc.,
It helps in making decisions.

ROLE OF MANAGERIAL ECONOMIST IN BUSINESS

Task of making Specific decisions

Task of making General decisions

Specific decisions include

Production scheduling
Demand forecasting
Market research
Economic analysis of the industry
Investment appraisal

 Security management appraisal

Advice on trade
Advice on foreign exchange
management
Pricing and related decisions

 General decisions include

Analysing the general economic
condition of the economy
Analyzing the demand for the
product
Analysing the general market
condition of the economy

 Goods:
Goods and services have to be produced
with the help of factors of production. So
production is another important branch of
economics.
Goods produced by one are exchanged
for the goods produced by the other. So
exchange forms another important branch
of economics. Goods and services are
produced with efforts

Utility:
It is the want satisfying power of a
Commodity or a service, which
determines the demand for
commodity. Jevons called this as
Utility

Two main types of utility are

Cardinal and Ordinal utility and Total
and Marginal Utility.

Concepts of Total and Marginal Utility:

Marginal utility is defined as the
change in total utility resulting from
one unit change in the consumption
of the goods in question per unit of
time. To put it shortly, total utility is
the total satisfaction derived in
consuming all the quantities of a
commodity in possession or
purchased. et

 Ex: Suppose consumer purchases a

packet of biscuits. Total utility or
satisfaction derived refers to the
utilities of all biscuits in the packet. If
all biscuits in the packet are alike,
the marginal utility may be
represented as follows, assuming
there are m units of biscuits in the
pack

 Marginal utility = Total Utility of M

units of biscuits minus total utility of
(m-1) units of biscuits. Suppose
consumer n units of oranges, the
marginal utility are the difference
between total utility of n units and
(n-1) units. In general, we can say
that marginal utility is the difference
between total utilities of n units of a
commodity and (n-1) units or (n+1)

 Marginal utility is the rate of change

of total utility caused by a small
given change in the quantity of a
commodity.

This can be expressed by

using formula mathematically

MUx = Dux

Dqx

 Where MUx is the marginal utility of a

commodity X. Dux is the change in
the total utility of X, Dqx stands for
the change in the total quantity of X.

 Marginal Utility Analysis

(Cardinal):

The principle behind the law of

diminishing marginal utility is that as
wet more of a thing, the intensity of
our desire for that thing diminishes
or tends to diminish.

 Marginal Utility Analysis

(Cardinal):

The principle behind the law of

diminishing marginal utility is that as
wet more of a thing, the intensity of
our desire for that thing diminishes
or tends to diminish.

 According to this law, as a person

purchases more and more units of a
commodity, its marginal utility
decreases. Prof. Boulding defines the
law if diminishing marginal utility in
the following words: As a consumer
increases the consumption of any
one of the commodity keeping
constant the consumption of all other
commodities.

 Illustration of the Law:

Suppose a man is hungry, a loaf of bread will give
him immense pleasure as it has great utility for
him. The second loaf though agreeable to him
would not give him as much as the satisfaction as
the first one. This means utility of the second loaf
would be less than first loaf. If he consumes the
third loaf, it would give him some satisfaction or
but not extent of the previous loaf. So with the
fourth, fifth, and sixth loves of bread goes on
diminishing. This can well illustrated by using
utility table.

Number of Products

Marginal Utility

Total Utility

20

20

16

36

12

48

56

60

60

-4

56

 From the utility table, it is clear that the total utility

(sum of the utilities of all the units consumed) goes on
increasing and after a certain state begins to decline.
The marginal utility (addition made to the total utility)
on the other hand goes on diminishing till it reaches
zero and then it becomes negative. So long as the
marginal utility is tending towards zero, the total utility
is increasing and it is at the maximum when the
marginal utility is zero and afterwards it declines.

The relationship between total

utility and marginal utility can be illustrated by means
of a graph based on the utility table given.

 The successive units of the commodity consumed

are represented in X axis and utility in units are
represented in Y axis. With the help of the data
available in the utility table, the total utility and
marginal utility at various levels of consumption
are pointed and then the total utility and marginal
utility curve are drawn. As the figure shows, total
utility curve ascends, reaches the maximum point
at the fifth and sixth units of consumption and
then begins to decline. Marginal utility declines
and it comes to zero at the consumption of sixth
unit and afterwards it becomes negative.

 Demand ;

Defined as a desire for a commodity

backed by willingness and ability to pay a
price. And is always relates to price. The
desire for the commodity should be backed by
necessary purchasing power. (Money). 3 types
of demand are Recurring and Replacement
demand, Direct and Derived demand,
Complementary and Competing Demand

 Demand Schedule and Demand Curve:

Demand schedule is the table for statement

showing how much of a commodity is demanded
(Purchased) in a particular market at different prices.

A demand schedule is one of the Alfred Marshalls

contributions to the techniques of price theory.

A demand schedule that states relationship

between Price and the quantity demanded.

Statement showing the quantity demanded of a

commodity is called demand schedule of a
commodity

Point on Demand Curve

Price (Per Cup)

Demand (1000 Cups)

15

50

20

40

25

30

30

15

35

10

 Demand Curve:

The demand curve shows the

relationship between price of a good and
the quantity demanded by consumers.

It is the graphical presentation of the

demand schedule of any commodity. It is
customary to plot the quantity demanded
on the horizontal axis and the price on
the vertical axis

 Elasticity of Demand:

States as direction of change. The

relationship between the small
changes in price and consequent
changes in amount demanded is
known as elasticity of demand.

States as the rate of change. The

elasticity of demand shows the
extent of response in demand to
change in price.

 Price Elasticity of Demand:

Defines elasticity as the ratio of

relative change in quantity to a
relative change in price. If E stands
for elasticity, then

E = Relative change in
quantity

Relative change in
price

 Price elasticity of demand is the ratio of proportionate

change in quantity demanded of a commodity to a
given proportionate change in its price. This means

E = Proportionate change in quantity

demanded

Proportionate change in price

E = Change in the quantity demanded /

Quantity Demanded /Change in Price/

Price

Divided in to five main types:

Perfectly or Infinity elasticity Demand
Perfectly Inelastic Demand
Relatively Elasticity Demand
Relatively Inelasticity Demand
Unit elasticity Demand

 Perfectly or Infinite Elasticity of Demand:

This is a condition in which a very small

change in price will result in infinitely
large response in the demand. A small rise
in price may result in the contraction of
demand even to zero and a small drop in
price may result in extension of demand
of unimaginable quantity. Hence the type
of elasticity is called perfectly elastic or
infinite demand. Where E =

 Perfectly Inelastic Demand:

This is a case in which the

response in demand to change in
price is almost nil. Even a large fall in
price will not induce the quantity of
demand to be more, nor will a large
rise in price prevent the consumers
from buying less. The demand is
inert (Static) to the changes in price.
In this case E = 0.

 The demand curve DD2 shows that a

fixed quantity will be purchased
whatever changes take place in
price. The curve is vertical showing
no change in quantity demanded.

 3 Relatively elastic Demand:

This refers to a condition when a small

change in price will lead to very big change in
the quantity demanded. In this case E > 1.
Hence it is called elastic demand. And to be
more precise, it is relatively a elastic demand.
A small fall in price of luxury or comfort
commodity will expand for that commodity
largely. Similarly rise in price will contract the
demand. The figure depicts the relative elastic
nature of demand curve.

 M
M1

The demand curve DD3 is

rather flatter where the slope is not steep,
but gentle, showing that the quantities
demanded are larger to a change in price.
The drop in the from P to P1 has resulted
in extension of demand from M to M1
which is comparatively larger than the fall
in price. Hence the demand is said to be
relatively elastic.

 4. Relatively Inelastic Demand:

- This is with reference to situations where a

larger change in the quantity demanded. In this case
E < 1. Hence it is called inelastic demand. Many
commodities which are necessaries of life will have
inelastic demand as they are essential requirements.
In the case of inelastic demand, the demand curve
will be steeper as shown in figure. The demand curve
DD4 is steeper showing that in spite of steep fall in
price the quantity demanded has gone up only very
little. For a price change of P1P2 the quantity has
changed from X1X2 which is smaller than P1P2.

 5. Unit Elasticity Demand:

- This is a case in which the

change in price will result in exactly
equal change in the quantity
demanded. If both are equal then E
= 1 and the elasticity is said to be
unitary. The figure indicates the unit
elasticity

 Factors Determining Elasticity and its Measurement and

Significance:

- Some 8 main factors influencing demand are

1. Nature of Commodity

2. Uses of Commodity

3. Existence of Substitutes

4. Postponement of Demand

5. Amount of Money Spent

6. Habits

7. Range of Prices of Commodity 8. Time

Factor in Elasticity

17

 Supply:

Prof: Mac Connel defines supply as

Supply is the schedule which shows the
various amounts of products which a
producer is willing to and able produce and
make available for safe in the market at
each specific price in the set of possible
prices during some given period.
Supply depends on scarcity, just as
demand depends on usefulness.

 Supply Schedule and Supply Curve:

Supply of different quantities

placed on the market at different
prices mentioned with the help of a
schedule called supply schedule.
Supply is also related to time, place
and price like demand. The supply
schedule represents the functional
relationship between he quantity
supplied and the prices.

Price in Rs.

Quantity supplied in Units

40

50

60

70

90

 2. Supply Curve:

- On the basis of schedule

given, we can draw the supply curve
taking quantities supplied on the X
axis and price on the Y axis as shown
in the figure.

 The supply curve SS slopes upwards

from left to right showing larger
supplies at a higher price.

 Perfect Competition:

Prof. Frank Knight defines as Perfect

competition as a condition of market in which
there will be fluidly and mobility of factors of
production so that the number of firms and the
size of firms can freely increase or decrease.

According to him perfect competition

entails rational conduct on the part of buyers
and sellers, full factors of production and
completely static conditions

 Features: 7 Main Features of perfect

competition are
Large no of Buyers and Sellers 2.
Homogeneous Product 3. Free entry and
exit barriers 4. Perfect Knowledge on the
part of buyers and Sellers 5. Perfect
mobility of Factors of Production 6.
Absence of transport Cost 7. Absence of
Governmental or Artificial Restriction.

24

 Monopoly:

Monopoly means absence of competition. It

is an extreme situation in imperfect
competition. It denotes a single seller or
producer having the control over the market.

A monopoly can be defined as the condition

of production in which a single person or a
number of people acting in combination have
the power to fix the price of the commodity or
the output of the commodity.

 Should have some 4 main features:

1. It should have only single control
2. The commodity produced should
not have any close substitutes. If it is
so, then the monopoly power is lost
as the people can choose the
substitutes commodity produced

 Relation Between Economic Decision and

Technical Decision:
Economical Decision:

Economic Decision means financing

the project within approved design and
environmental framework.

Has an economic impact on Investment

in excess, Opportunity cost of unused
commodity, Cost of power capacity.

 Technical Decision:

Done by rural development by

increasing the opportunity and
improving the quality.

Project Eligibility

Technical Requirements

Energy Audit

Types of Financing
The three types of financial
management decisions are capital
budgeting, capital structure, and
working capital.

Short Term and Long Term Borrowing:

Short-term loans can be for periods
as short as 90 days
Long-term loans of greater than
three years require a more detailed
analysis the lending institution

 External Commercial Borrowings:

External Commercial Borrowings
(ECB) refer to commercial loans [in
the form of bank loans, buyers
credit, suppliers credit, securitised
instruments (e.g. floating rate notes
and fixed rate bonds)] availed from
non-resident lenders with minimum
average maturity of 3 years.

 Foreign Currency Convertible bonds

(FCCBs) mean a bond issued by an
Indian company expressed in foreign
currency, and the principal and
interest in respect of which is
payable in foreign currency

 Assistance from government budgeting

support and international finance
corporations:
Promotes sustainable private sector
investment in developing countries.
IFC is a member of the World Bank Group and
is headquartered in Washington, DC. It shares
the primary objective of all World Bank Group
institutions: to improve the quality of the lives
of people in its developing member countries.

Analysis of Financial
Statement
Financial statement analysis is
defined as the process of identifying
financial strengths and weaknesses
of the firm by properly establishing
relationship between the items of the
balance sheet and the profit and loss
account.

 There are various methods or

techniques that are used in analyzing
financial statements, such as
comparative statements, schedule of
changes in working capital, common
size percentages, funds analysis,
trend analysis, and ratios analysis.

 Balance Sheet, Profit and Loss

Account and Funds Flow Statement:

 In financial accounting, a balance

sheet or statement of financial
position is a summary of the financial
balances of a sole proprietorship, a
business partnership or a company.
Assets, liabilities and
ownership equity are listed as of a
specific date, such as the end of its
financial year

Profit and Loss Account:

The purpose of the profit and loss
account is to:
Show whether a business has made a
PROFIT or LOSS over a financial
year.
Describe how the profit or loss arose
e.g. categorizing costs between
cost of sales and operating
costs.

 A profit and loss account starts with

the TRADING ACCOUNT and then
takes into account all the other
expenses associated with the
business.

 Funds Flow Statements: (FFS):

It is the statement of changes in
financial position prepared to
determine only
the sources and
uses of working capital between
dates of 2 balance sheets.

Types of Costing:
Some 8 types of costing 1. Real cost
of Production 2. Opportunity Cost or
Production Cost 3. Past Cost or Future
Cost 4. Pocket Cost or Book Cost 5.
Incremental Cost and Sunk Cost 6.
Shut Down Cost and Abandonment
Cost 7. Replacement Cost and
Historical Cost 8. Private and Social
Cost 9. Short run and Long run cost.

Traditional Costing Approach:

The traditional method of cost
accounting refers to the allocation of
manufacturing overhead costs to the
products manufactured

Activity Base Costing

Activity-based costing (ABC) is a
costing model that identifies
activities in an organization and
assigns the cost of each activity
resource to all products and services
according to the actual consumption
by each: it assigns more
indirect costs (overhead) into
direct costs.

Fixed Cost:
A cost that remains constant,
regardless of any change in a
company's activity.
A good example is a lease payment.
If you are leasing a building at
$2,000 per month, then you will pay
that amount each month, no matter
howwell orhow poorlythe business
is doing.

 Variable Cost:
Marginal Cost:
Cost output relationship in short and
long run:
Pricing Practice;
Full Cost pricing and Marginal Cost
Pricing;

 Total cost of all recourse used or consumed in

production, including direct, indirect, and
investing cost.
Going Rate pricing:
All firms do have the power to fix a price ,but
instead of doing so, in a competitive market
situation firms fix a price which is equal to
the average price charged by all firms in an
industry,ie,it collects all the prices firms with
same product and compute the average

 Bid Pricing:
A bid price is the highest price that a
buyer (i.e., bidder) is willing to pay
for a good. It is usually referred to
simply as the "bid."

 Pricing for a Rate of return:

Target rate of return pricing is a
pricing method used almost
exclusively by market leaders or
monopolists. You start with a rate of
return objective, like 5% of invested
capital, or 10% of sales revenue

 Apprising Project Profitability

Assessment of project in terms of
economic, social and financial feasibility.
Economic Aspects
Technical Aspects
Organization Aspects
Financial Aspects
Market Aspects

Capital Budgeting

Non Discounted Technique Methods

Payback Period:
Accounting Rate of return
Discounted Cash Flow Technique
Methods
NPV- Net Present Value Method
PI Profitability Index
IRR-Internal Rate of Return

Cost Benefit Analysis:

Cost benefit analysis is a term that
refers both to:
Helping to appraise, or assess, the
case for a project, programme or
policy proposal;
An approach to making economic
decisions of any kind

 Under both definitions the process

involves, whether explicitly or
implicitly, weighing the total
expected costs against the total
expected benefits of one or more
actions in order to choose the best or
most profitable option. The formal
process is often referred to as either
CBA (Cost-Benefit Analysis) or BCA
(Benefit-Cost Analysis).

 Benefits and costs are often

expressed in money terms, and are
adjusted for the time value of money
, so that all flows of benefits and
flows of project costs over time
(which tend to occur at different
points in time) are expressed on a
common basis in terms of their
present value

 Closely related, but slightly different,

formal techniques include
cost-effectiveness analysis,
economic impact analysis, fiscal
impact analysis and
Social Return on Investment (SROI)
analysis

 A cost benefit analysis is done to

determine how well, or how poorly, a
planned action will turn out. Although
a cost benefit analysis can be used
for almost anything, it is most
commonly done on financial
questions

 Example Cost Benefit Analysis

As the Production Manager, you are
proposing the purchase of a $1 Million
stamping machine to increase output.
Before you can present the proposal to the
Vice President, you know you need some
facts to support your suggestion, so you
decide to run the numbers and do a cost
benefit analysis.

Feasibility Reports:(conveniently/perfectly)

This is formal document for

management use, briefly enough and
sufficiently non technical to be
understandable by high level
management. There is no standard
or formal format for the preparation
of feasibility report. Analyst usually
decides on a format that suits
particular user and system.

Appraisal Process:
The first step in the process of
performance appraisal is the setting
up of the standards which will be
used to as the base to compare the
actual performance of the
employees.

 Technical, Economical, and Financial Feasibility:

A series of indicators of economic or financial
worth are then derived, including net present
values, benefit-cost ratios, net present
value/capital cost ratios, internal rates of
return, discounted payback periods and costeffectiveness ratios, which allow the
comparison of alternative proposals over their
economic life.

 In finding out financial feasibility, the

following facts should be taken into
account:
1 Cost of Project.
2 Means of Financing.
3 Costs of Production and
Profitability.
4 Cash Flow Estimates.
5) Proforma Balance Sheets.