Ch 1 Introduction

Ch 1 INTRODUCTION •Economics is concerned with the best possible use of limited resources. •But it is now considered that economics is much more than merely a theory of value OR of resource allocation. •“Economics is the study of the factors affecting the size, distribution and stability of a country’s National Income.”

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INTRODUCTION Cont…. o Economics Macroeconomics Money, finance, banking

Microeconomics “Sector” economics Labour economics Economics of IT and EC Managerial economics

Regional Economics International Economics Economic Development

DIFFERENCE  How

does managerial economics differ from “regular” economics?

 There

is no difference in the theory; standard economic theory provides the basis for managerial economics.

 The

difference is in the way the economic theory is applied.

Managerial Economics Defined  The

application of economic theory and the tools of decision science to examine how an organization can achieve its aims or objectives most efficiently.    

applications of economic theory quantitative methods statistical methods computational methods

Relationship between Managerial Economics and Related Disciplines

Economic Theory  Microeconomics 



Study of the economic behavior of individual decision-making units. Relevance to Managerial Economics

 Macroeconomics 

Study of the total or aggregate level of output, income, employment, consumption, investment, and prices for the economy viewed as a whole.

Decision Sciences  Mathematical 

Economics

Expresses and analyzes economic models using the tools of mathematics.

 Econometrics 

Employs statistical methods to estimate and test economic models using empirical data.

The Process of decisionmaking

Nature & Characteristics M.E.  M.E.

is perspective rather than descriptive.  M.E. belongs to Normative Economics rather than Positive Economics.  M.E. is pragmatic i.e. it avoids difficult abstracts.  M.E. is the combination of theory of firm & theory of profits.

Scope Of M.E.  Pricing

Problems

 Resource

Allocation

 Investment

 Inventory

Problems

& Queuing Problems

Role & Responsibility of Managerial Economist

Optimal Decision: Given the goal(s) that the firm is pursuing, the optimal decision in managerial economics is one that brings the firm closest to this goal.

Role & Responsibility of Managerial Economist Cont…. Making decisions and processing information are the two primary tasks of managers. Examples: •

Whether or not to close down a branch of the firm?

•

Whether or not a store or restaurant should stay open more hours a day?

Role & Responsibility of Managerial Economist Cont…. •

How a government agency can be reorganized to be more efficient?

•

Whether to install an in-house computer rather than pay for outside computing services?

•

How a hospital can treat more patients without a decrease in patient care?

Role & Responsibility of Managerial Economist Cont…. All these, as well as many other managerial decisions require the use of basic economics. Economic theory helps decision makers to know what information is necessary in order to make the decision and how to process and use that information.

Questions that managers must answer: ♦ ♦ ♦

Should our firm be in this business? If so, what price and output levels achieve our goals? How can we maintain a competitive advantage over our competitors?  Cost-leader?  Product Differentiation?  Market Niche?  Outsourcing, alliances, mergers, acquisitions?  International Dimensions?

Questions that managers must answer: ♦

What are the economic conditions in a particular market?       

Market Structure? Supply and Demand Conditions? Technology? Government Regulations? International Dimensions? Future Conditions? Macroeconomic Factors?

Role & Responsibility of Managerial Economist Cont…. The manager attempts either to maximize or minimize some objective function, frequently subject to some constraint(s). And, for all goals that involve an optimization problem, the same general economic principles apply!

Theory of the Firm WHAT: A firm is an organization that combines and organizes resources for the purpose of producing goods and services for sale. Firms produce more than 70%of all goods and services consumed in India. The remainder is produced by Govt. & NGO.

Theory of the Firm Cont… WHY? Firms exists because it would be very inefficient & costly for entrepreneurs to enter into & enforce contracts with workers and owners of capital, land and other resources for each separate step of production and distribution process. The firms exists in order to save on such TRANSACTION COSTS.

Theory of the Firm Cont… Firms Function Resulting in circular flow The function of firms, therefore, is to purchase resources or inputs of labor 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 sale of their service or other resources to firms to purchase the goods& services produced by firms. The circular flow of economic activity is thus complete.

Partners of Firm in Circular Flow of Economic Activity

Theory of the Firm Cont… Both Short term as well as Long term profits are clearly important. The theory of the firm now postulates that the primary goal or objectives of the firm is to maximize the wealth or VALUE OF THE FIRM.

Value of the Firm PV =

π1 (1 + r )

1

+

π2 (1 + r )

2

+L +

πn

n

(1 + r )

n

=∑ t =1

πt (1 + r )t

PV=The present value of all expected future profits = Expected Profits in each of the ‘n’ years r = Appropriate discount rate

πt

TRt −TCt Value of Firm =∑ =∑ t (1 +r )t t =1 (1 +r ) t =1 n

n

Value of the Firm Cont…

Environment of the Firm

Theory of the Firm Cont…  Combines

and organizes resources for the purpose of producing goods and/or services for sale.  Internalizes transactions, reducing transactions costs.  Economic theory assumes that the primary goal of managers is to maximize the value of the firm.

Constraints on the Operations of Firm       

Legal Constraints Limited resourses Labour Capital Finance Raw materials Environment

Constraints on the Operations of Firm Cont…. 

Limited capacity of market



Demand



Societal Constraints



Choice & Opportunity Cost

Economic Tools Applied Under Managerial Economics  Opportunity

Cost  Discounting Principle  Equi-Marginal Principle  Marginal Analysis  Incremental Cost Principle