First Lecture - Managerial Economics

MANAGERIAL ECONOMICS

Prof. Swaha Shome

Managerial Economics Objectives

Understand usefulness of economics in describing managerial behavior. – Understand how economics can be used to improve managerial decisions. – Appreciate vital role of business in society. –

What is Managerial Economics? Howard Davies “It is the application of economic analysis to business problems; it has its origin in theoretical microeconomics.”

Why Managerial Economics?

 

A powerful “analytical engine”. A broader perspective on the firm.  what

is a firm?  what are the firm’s overall objectives?  what pressures drive the firm towards profit and away from profit 

The basis for some of the more rigorous analysis of issues in Marketing and Strategic Management.

Contents  Introduction

to economics- scarcity, choice and Efficiency. Role of Government  Demand and Supply analysis  Consumer behaviour  Production and costs  Markets

TEN PRINCIPLES OF ECONOMICS  How  

 

people make decisions: People face trade offs The cost of something is what you have to give up. Rational people think at the margin People respond to incentives

 How  



people interact? Trade can make everybody better off Markets are usually a good way to organize economic activity Government can sometimes improve market outcomes

 How 

 

the economy as a whole works? A country’s standard of living depends on the its ability to produce goods and services Prices rise when Govt prints too much money Society faces a short run trade off between inflation and trade off

Market Structures  Perfect

competition  Monopoly  Oligopoly  Monopolistic Competition

 Pricing

practices- transfer pricing  Current developments

Scarcity and Economic System

1. 2.

3.

What are the opportunity costs of the choices you make? How does a production possibility frontier (PPF) illustrate opportunity cost, specialization of resources, inefficiency, and economic growth? What are the differences between command economies, free market economies, and mixed economies in terms of the ways they address the 3 basic economic questions?

Opportunity Cost - Components Direct money cost of a choice may only be a part of opportunity cost of that choice  Opportunity cost of a choice = explicit costs + implicit costs – Explicit cost—dollars actually paid out for a choice Accounting cost – Implicit cost—value of something sacrificed when no direct payment is made 

Opportunity Cost and Society  Resources

in whole society are limited.  All production carries an opportunity cost – To produce more of one thing Must

shift resources away from producing something else

 No

free lunch!

Increasing Opportunity Cost  According

to law of increasing opportunity cost –

The more of something we produce The

greater the opportunity cost of producing even more of it

 This

principle applies to all of society’s production choices

Production Possibilities Frontiers  Production

Possibilities Frontiers (PPF) shows the combinations of two goods that can be produced with resources and technology available

Opportunity cost Opp. cost of X = Amount of Y to be compensated for one more unit of X

•

Opp. cost of X increases as you produce more of X

•

Situation

X

Y

1

0

20

2

1

18

3

2

15

4

3

11

5

4

6

6

5

0

Opportunity Cost - Illustrated  Sacrifice

of alternatives in production/consumption of a good

 Eg.

Let a farm produce 1000 tonnes of wheat or 2000 tonnes of sugar Opportunity Cost of producing 1 ton wheat = 2 tonnes of sugar foregone.

Production Possibility Curve



Enclosed region – unemployment Outside graph – not feasible

Various combinations of 2 classes of goods produced provided resources in the economy are fully employed

6

5

4

3

Y



2

1

0 0

1

2

3

X

4

5

6

Production Possibility Frontier  Curve

shows all possible 2-goods combination that an economy can produce - Specified time period - Resources fully & efficiently employed - Issues of choice & opportunity cost  Concave to origin – increasing opportunity cost  Region interior to PPF – economy has not attained Productive Efficiency - unemployment

PPF Shift 8

Economic Growth Improvement in skills Improved Technology Increase in factors of production

7

6

Y

5

4

3

2

1

0 0

1

2

3

4

X

5

6

7

8

 Economic

Activity is transformation of inputs into output

 What

to produce?  How to produce?  For whom to produce?  Economics

is concerned with identification, explanation and solution of these problems

Resource Allocation 

Problem of resource allocation –

–

–

Which goods and services should be produced with society’s resources?  Where on the PPF should economy operate? How should they be produced?  No capital at all  Small amount of capital  More capital Who should get them?  How do we distribute these products among the different groups and individuals in our society?

The Three Methods of Resources Allocation 

Market Economy – –



Resources are allocated through individual decision making Dominant method

Command Economy (Centrally-Planned) –

Resources are allocated according to explicit instructions from a central authority.

Mixed economy- a combination of markets and state

The Nature of Markets A

market is a group of buyers and sellers with the potential to trade with each other –

Global markets Buyers

–

and sellers spread across the globe

Local markets Buyers

and sellers within a narrowly defined area

INVISIBLE HAND  In

trying to maximize his own welfare an individual is led by an invisible hand to achieve the best for all.  A competitive market economy will provide an efficient allocation of resources through the price mechanism

The Importance of Prices A

price is the amount of money that must be paid to a seller to obtain a good or service  When people pay for resources allocated by the market –

They must consider opportunity cost to society of their individual actions

 Markets

can create a sensible allocation of resources

 Objective

– maximum possible ends by sacrificing the minimum possible resources

 Ends

are unlimited but can be graded in priority  Means are limited and they have alternative uses  This leads to the twin issues of efficiency and choice

Types of Economic Systems  An

economic system is composed of two features –

Mechanism for allocating resources Market Command

–

Mode of resource ownership Private State

Figure 4: Types of Economic Systems Resource Allocation

Private

Market

Command

Market Capitalism

Centrally Planned Capitalism

Market Socialism

Centrally Planned Socialism

Resource Ownership State

Role of Government 





Increasing efficiency by: a. Increasing competition b. control of externalities c. public goods Equity: redistribution of income by taxes and public expenditure Macro-stability : control inflation, ensure growth, reduce unemployment and stabilize exchange rates

Externalities  Externalities

can occur in production or consumption.  External costs : pollution due to industries, traffic congestion etc  External benefits: research, ancilliary industries, reducing pollution  External costs in consumption – passive smoking

Public Goods  Private

goods are depletable and excludable.  Hence there is no extra cost for serving an additional user. This makes pricing of such goods difficult.  It is difficult to collect fees for public goods thus discouraging private enterprise.

Mixed economy  The

government and the private sector interact in solving economic problems.  Government controls a significant share of the output through taxation, transfers, provision of public goods and also regulates the extent to which individuals pursue their self interest.