Unit I ME&A

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MANAGERIAL ECONOMICS& ACCOUNTANCY

Unit :I

III

rd

Semester IT

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Syllabus

UNIT : I

Meaning, Nature and Scope of managerial economics.Concepts used in managerial economics such as

incremental concepts, Time perspective Discounting fortime, Opportunity cost equimarginalism.Law ofdiminishing marginal utility,' Methodology of managerialeconomics, Simulation.

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Learning Objectives

After the successful completion of this unit,students will:

- be acquainted with major topics in managerial

economics, - be more confident while participating in firm

decision making process,

- have developed skills, that are need forstrategic decision making and decision makingunder uncertainty,


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Introduction

What is Economics ? Economics is a social science ,which studies economic phenomena &

related behaviour of the people. Economic behaviour is a conscious effort toderive maximum gains from the use of scarce resources & opportunitiesavailable.

It is fundamentally the study of how people allocate their limited resources,

which have alternative uses ,to produce & consume goods & services tosatisfy their endless wants or to maximize their gains. Economics as a branch of knowledge is concerned with the study of the

allocation of scarce resources among competing ends as problems ofresource allocation are constantly faced by individuals ,enterprises &nations.

As a subject ,it is most closely associated with everyday life at all levels. As

a voter you will make decisions on issueson government deficit ,on taxes,on free trade, on inflation & unemployment- that cannot be understood untilyou have mastered the rudiments of this subject.

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Contd..

Economics is the study of how societies use scarce resources to producevaluable commodities & distribute them among different people.

If infinite quantities of every good could be produced or if human desireswere fully satisfied ,what could be the consequences?

People would not worry about stretching out their limited incomes,because they could have everything they wanted

Businesses would not need to worry over the cost of labour &healthcare

Governments would not need to struggle over taxes or spending because nobody would care. Moreover ,since all of us could have asmuch as we pleased ,no one would be concerned about the distributionof incomes among different people or classes.

In such a situation there would be no economic goods, that is that arescarce or limited in supply. All goods would be free, like sand in thedesert or seawater.

Prices & markets would be irrelevant .& Economics would no longer bea useful subject ,but goods are limited ,while wants seem limitless.

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Contd..

Economics can be studied under two heads:

1) Micro Economics :

It has been defined as that branch where the unit of study is an

individual, firm or household. It studies how individual make their choices about what to produce,

how to produce, and for whom to produce, and what price tocharge.

Various micro-economic concepts such as demand, supply,

elasticity of demand and supply, marginal cost, various marketforms, etc. are of great significance to managerial economics.

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Contd..

2) Macro Economics : The study of aggregate or total level ofeconomics activity in a country is called macroeconomics.

It studies the flow of economic resources or factors of production(such as land, labour, capital, organisation and technology) from

the resource owner to the business firms and then from thebusiness firms to the households.

It deals with total aggregates, for instance, total national incometotal employment, output and total investment.

It is aggregative in character and takes the entire economy as a

unit of study. Macro economics helps in the area of forecasting. Itincludes National Income, aggregate consumption, investments,employment etc.

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DECISION-MAKING ANDFORWARD PLANNING

The chief function of a management executive in a business firm isdecision-making and forward planning.

Decision-making refers to the process of selecting one action fromtwo or more alternative courses of action.

Forward planning on the other hand is arranging plans for the future.

In the functioning of a firm the question of choice arises because theavailable resources such as capital, land, labour and management,are limited and can be employed in alternative uses

The decision-making function thus involves making choices ordecisions that will provide the most efficient means of attaining an

organisational objectives, for example profit maximization. Once a decision is made about the particular goal to be achieved,

plans for the future regarding production, pricing, capital, rawmaterials and labour are prepared. Forward planning thus goeshand in hand with decision-making.

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Contd..

The conditions in which firms work and take decisions, ischaracterised with uncertainty.

If the knowledge of the future were perfect, plans could beformulated without error and hence without any need for subsequentrevision.

In the real world, however, the business manager rarely hascomplete information about the future sales, costs, profits, capitalconditions. etc.

To execute the function of decision-making in an uncertain frame-work, economic theory can be applied with considerable advantage.

Economic theory deals with a number of concepts and principlesrelating to profit, demand, cost, pricing, production, competition,business cycles and national income.

The way economic analysis can be used towards solving businessproblems constitutes the subject matter of Managerial Economics.

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Definitions of Managerial

EconomicsDouglas :

Managerial economics is concerned with the application of economic

principles and methodologies to the decision making process within the firm or

organization. It seeks to establish rules and principles to facilitate the

attainment of the desired economic goals of the management.

Mansfield :

He defines that managerial economics is concerned with the application of

economic concepts and economic tools to the problems of formulating rational

decision making.

Spencer and Seigleman :

It is the integration of economic theory with business practice for the purpose of

facilitating decision making and forward planning by management.

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Economics Theory &

Methodology

Business Management

Decision Problems

Optimal Solution toBusiness Problems

ME

Application ofEconomics

To solve BusinessProblems

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APPLICATION OF ECONOMICSTO BUSINESS MANAGEMENT

The application of economics to business management or theintegration of economic theory with business practice, as Spencerand Siegelman have put it, has the following aspects :

Estimating economic relationships: This involves themeasurement of various types of elasticities of demand such as

price elasticity, income elasticity, cross-elasticity, promotionalelasticity and cost-output relationships.

Predicting relevant economic quantities: Economic quantitiessuch as profit, demand, production, costs, pricing and capital arepredicated in numerical terms together with their probabilities.

As the business manager has to work in an environment ofuncertainty, the future needs to be foreseen so that in the light of thepredicted estimates, decision-making and forward planning may bepossible.

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Contd..

Using economic quantities in decision-making and forwardplanning: This involves formulating business policies for establishingfuture business plans. This nature of economic forecasting indicates thedegree of probability of various possible outcomes, i.e., losses or gainsthat will occur as a result of following each one of the available

strategies. Understanding significant external forces: Applying economic theory

to business management also involves understanding the importantexternal forces that constitute the business environment and with whicha business must adjust. Business cycles, fluctuations in national income

and government policies pertaining to taxation, foreign trade, labourrelations, antimonopoly measures, industrial licensing and pricecontrols are typical examples. The business manager has to appraisethe relevance and impact of these external forces in relation to theparticular business unit and its business policies.

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CHARACTERISTICS OF

MANAGERIAL ECONOMICSThere are certain chief characteristics of managerialeconomics, which can help to understand the nature of thesubject.

M E is micro-economic in character. This is because the unit ofstudy is a firm and its problems. Managerial economics does notdeal with the entire economy as a unit of study.

M E largely uses that body of economic concepts and principles,which is known as Theory of the Firm or Economics of the Firm.

M E is concrete and realistic. It avoids difficult abstract issues of

economic theory. Macroeconomics is also useful to M E since it provides an intelligent

understanding of the business environment.

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DIFFFFERENCE BETWEEN MANAGERIAL

ECONOMICS AND ECONOMICS

M E involves application of economic principles to theproblems of a business firm whereas; economics deals withthe study of these principles only. Economics ignores the

application of economic principles to the problems of abusiness firm.

M E is micro-economic in character, however, Economics isboth macro-economic and micro-economic.

M E, though micro in character, deals only with a firm and hasnothing to do with an individuals economic problems. Butmicroeconomics as a branch of economics deals with botheconomics of the individual as well as economics of a firm.

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SCOPE OF MANAGERIAL

ECONOMICS

Demand analysis and forecasting.

Cost and production analysis.

Pricing decisions, policies and practices. Profit management.

Capital management.

Inventory Management. Advertising.

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Demand Analysis andForecasting

A business firm is an economic Organization, which transformsproductive resources into goods that are to be sold in a market.

A major part of managerial decision-making depends on accurateestimates of demand. because before production schedules can be

prepared and resources are employed, a forecast of future sales isessential.

This forecast can also guide the management in maintaining orstrengthening the market position and enlarging profits.

The demand analysis helps to identify the various factors influencing

demand for a firms product and thus provides guidelines tomanipulate demand.

Demand analysis and forecasting, thus, is essential for businessplanning and occupies a strategic place in managerial economics.

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Cost and Production Analysis

A study of economic costs, combined with the data drawn from thefirms accounting records, can yield significant cost estimates.

The factors causing variations in costs must be recognized and

thereby should be used for taking management decisions.

The chief topics covered under cost and production analysis are:

Cost concepts and classifications

Cost-output relationships

Economics of scale

Production functions

Cost control.

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Contd..

Pricing Decisions, Policies and Practices Pricing is a very important area of managerial economics. In fact

price is the origin of the revenue of a firm.

As such the success of a business firm largely depends on theaccuracy of price decisions of that firm. The important aspects thatare dealt under this area, are as follows:

Price determination in various market forms Pricing methods

Differential pricing ,product-line pricing and price forecasting.

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Profit Management

Business firms are generally founded with the purpose of makingprofits.

In the long run, profits provide the chief measure of success.Animportant point worth considering is the element of uncertainty existingabout profits.

This uncertainty occurs because of variations in costs and revenues.These are caused by factors such as internal and external.

If knowledge about the future were perfect, profit analysis would havebeen a very easy task.

Thus profit planning and measurement make up the difficult area ofmanagerial economics.

The important aspects covered under this area are:

Nature and measurement of profit.

Profit policies and techniques of profit planning.

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Capital Management Among the various types and classes of business problems, the most

complex and troublesome for the business manager are those relating tothe firms capital investments.

Capital management implies planning and control and capital expenditure. The main elements dealt with cost management are: Cost of capital Rate of return and selection of projects.

Inventory Management What do you mean by the term inventory? inventory is stock. It refers to stock of raw materials which a firm keeps. Now here the

question arises how much of the inventory is ideal stock. Both the high inventory and low inventory is not good for the firm. Managerial economics uses methods such as ABC Analysis, simple

simulation exercises, and some mathematical models, to minimizeinventory cost. It also helps in inventory controlling.

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Advertising

Advertising is a promotional activity.

In advertising while the copy, illustrations, etc., are the responsibilityof those who get it ready for the press.

The problem of cost, the methods of determining the total

advertisement costs and budget, the measuring of the economiceffects of advertising ---- are the problems of the manager.

Theres a vast difference between producing a product andmarketing it.

It is through advertising only that the message about the product

should reach the consumer before he thinks to buy it.

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THE ROLE OF MANAGERIAL

ECONOMIST

Making decisions and processing information are the twoprimary tasks of the managers.

Managerial economists have gained importance in recent

years with the emergence of an organizational culture inproduction and sales activities.

A managerial economist is nearer to the policy-making

Equipped with specialized skills and modern techniques he

analyses the internal and external operations of the firm. He evaluates and helps in decision making regarding sales,

Pricing financial issues, labour relations and profitability.

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Basic Economic Tools inManagerial Economics

The most significant contribution of economics to managerialeconomics lies in certain principles, which are basic to the entire rangeof managerial economics.

Opportunity Cost Principle

Incremental Principle

Principle of Time Perspective

Discounting Principle

Law of Diminishing Marginal Utility

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Opportunity Cost Principle

Opportunity Cost : The opportunity cost is the opportunity lost. Anopportunity to make income is lost because of scarcity ofresources.

Income maximizing resource owners put their scarce resources to

their most productive use and thus they forego the incomeexpected from the second best use of the resources.

opportunity cost is the expected returns from the second best useof the resources that are foregone due to the scarcity ofresources. It is also called alternative cost.

By the opportunity cost of a decision is meant the sacrifice ofalternatives required by that decision.

This cost arises because most economic resources have morethan one use.

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Contd...

a) The opportunity cost of the funds employed in ones own business isthe interest that could be earned on those funds if they have beenemployed in other ventures.

b) The opportunity cost of using a machine to produce one product is

the earnings forgone which would have been possible from otherproducts.

c) The opportunity cost of holding Rs. 1000 as cash in hand for oneyear is the 10% rate of interest, which would have been earned hadthe money been kept as fixed deposit in bank.

Its clear now that opportunity cost requires ascertainment ofsacrifices.

If a decision involves no sacrifices, its opportunity cost is nil. Fordecision making opportunity costs are the only relevant costs.

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Incremental Principle

It is related to the marginal cost and marginal revenues

Incremental concept involves estimating the impact of decision alternativeson costs and revenue,

The two basic components of incremental reasoning are

1) Incremental cost

2) Incremental Revenue

The incremental principle may be stated as under:

A decision is obviously a profitable one if

a) it increases revenue more than costs

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

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Principle of Time Perspective

Managerial economists are also concerned with the short runand the long run effects of decisions on revenues as well ascosts.

Important problem in decision making is to maintain the rightbalance between the long run and short run considerations.

A decision may be made on the basis of short-runconsiderations, but may in the course of time offer long-runrepercussions, which make it more or less profitable than itappeared at first. An illustration will make this point clear.

The principle of time perspective may be stated as under: Adecision should take into account both the short-run and long-run effects on revenues and costs and maintain the rightbalance between the long-run and short-run perspectives.

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Discounting Principle

One of the fundamental ideas in Economics is that a rupeetomorrow is worth less than a rupee today. Suppose a person isoffered a choice to make between a gift of Rs.100/- today orRs.100/- next year. Naturally he will chose Rs.100/- today. This istrue for two reasons-

i) The future is uncertain and there may be uncertainty in getting Rs.

100/- if the present opportunity is not availed of ii) Even if he is sure to receive the gift in future, todays Rs.100/- can

be invested so as to earn interest say as 8% so that one year afterRs.100/- will become 108 .

whereas if he does not accept Rs. 100 today, he will get Rs. 100

only in the next year. Naturally, he would prefer the first alternativebecause he is likely to gain by Rs. 8 in future.

Another way of saying the same thing is that the value of Rs. 100after one year is not equal to the value of Rs. 100 of today but lessthan that.

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Law of Diminishing Marginal Utility

Definition and Statement of the Law: Thelaw of diminishing marginal utilitydescribes a familiar and

fundamental tendency of human behavior. The law of diminishingmarginal utility states that:

As a consumer consumes more and more units of a specificcommodity, the utility from the successive units goes on diminishing.

Law is Based Upon Three Facts: The law of diminishing marginal utility is based upon three facts. First, total wants of a man are unlimited but each single want can be

satisfied. As a man gets more and more units of a commodity, thedesire of his for that good goes on falling. A point is reached when theconsumer no longer wants any more units of that good.

Secondly, different goods are not perfect substitutes for each other inthe satisfaction of various particular wants. As such the marginal utilitywill decline as the consumer gets additional units of a specific good.

Thirdly, the marginal utility of money is constant given the consumerswealth.

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Summary

Managerial economics is the science of directing scarce resources to managecost effectively.

It consists of three branches: competitive markets, market power, and imperfectmarkets.

A market consists of buyers and sellers that communicate with each other forvoluntary exchange. Whether a market is local or global, the same managerial

economics apply. A seller with market power will have freedom to choose suppliers, set prices,

and use advertising to influence demand.

A market is imperfect when one party directly conveys a benefit or cost toothers, or when one party has better information than others.

An organization must decide its vertical and horizontal boundaries. For effective

management, it is important to distinguish marginal from average values andstocks from flows.

Managerial economics applies models that are necessarily less than completelyrealistic. Typically, a model focuses on one issue, holding other things equal.


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THANK YOU

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Documents

Unit I ME&A