Managerial Economics

Managerial Economics

Dr. Kishor Bhanushali Faculty Member – Economics & Quantitative Methods IBS - Ahmedabad

Introduction: Fundamental Problems of An Economic System: Scarcity and Efficiency The Three Problems of Economic Organization Market command and mixed economies The market mechanism How markets solve three economic problems? The invisible hands and perfect competition The economic role of government General and partial equilibrium Nature and scope of managerial economics

Economics Economics is the study of how economic agents or society choose to use scarce resources that have alternative uses to satisfy wants which are unlimited and of varying degrees of importance Scarcity: the root of all economic problems Problem of choice Social Science Decision making by the manager Economics is Positive Sciences (what is ?) Rational behavior Economic activity (consumption, productions and exchange)

The central themes of managerial economics 1. Identifying problems and opportunities 2. Analyzing alternatives from which choices can be made 3. Making choices that are best from the standpoint of the firm or organization

It is certainly not true that all managers must be managerial economists, any more than it is true that all managers should have degree in management. However, managers who understand the economic dimensions of business problems and apply economic analysis to the specific problem they encounter often choose more wisely than those who do not

Rationality? Firm: maximize profit or sales revenue (Productive capacity and size of the market) Consumer: Maximize profit (Size of his budget) Investor: maximize returns over investment (level of acceptable risk)

Rational decision making process 1. Knowledge of all possible course of action 2. Separate the course of action into feasible and infeasible 3. Consequences of alternative feasible courses of action 4. Rank alternatives in terms of priorities 5. Choose the course of action that occupies the highest position in the order of priority

Three fundamental questions What goods and services to be produced in what quantity? How to produce those goods and services? How the scarce resources and optimally allocated? How the goods and services so produced are distributed among the households?

Alternative economic systems Market economy Command economy Mixed economy

Market Economy Demand decides the nature and quantity of goods and services to be produced Consumers are assumed to act in a rational manner Given the demand, firms decide the production methods to maximize their profits Optimum allocation of scarce resources Factor prices are determined by the market Invisible hands – Adam Smith

Command Economy Hierarchical organizational structure Command decision making process People carry out instruction given to them Central planning authority to determine resource allocation, production goal and prices State ownership of factors of production Authoritarian methods to determine resource use and prices

Mixed Economy Use of both market and command to coordinate economic activities Government control many resources and criteria other than personal gains and business profit are used to decide how resources will be employed Government as well as private business provide goods and services Government intervene in the market to control prices and correct the shortcomings of a system in which prices and the pursuit of personal gains influence resource use and income

Role of Government  Purchasing of labor services and other productive resources  Borrow funds from credit market  Purchase output of business firms  Contracts with business firms  Tax on households and firms  Provides national and social services  Free public goods  Social security measures  Influence the market demand and prices  Supply of goods and services

MARGINALISM Marginal output of labor Marginal revenue Marginal cost Change in independent variable by single unit Chunk changes rather than unit changes – Concept of instrumentalism (incremental output, cost, benefits) All marginal concepts are incremental but all incremental concepts may not be confined to marginal concepts alone.

Opportunity Cost The cost of particular alternative chose is the cost of next best alternative forgone Opportunity cost is the highest valued benefit that must be sacrificed as a result of choosing alternative

Partial Equilibrium Analysis  Determination of prices and quantity of a commodity or a factor and working of its market viewed in isolation of what happens to other commodities and factors is called partial equilibrium analysis  Partial equilibrium analysis do not take in to consideration the interrelationships or interdependence between the prices of goods and factors of production  Each product and factor market is considered as independent and self-contained for proper explanation of the determination of price and quantity of a commodity or factor  Not useful when commodities and factor markets are interrelated and interdependent

General Equilibrium Analysis Used when markets for various commodities and factors are interrelated and interdependent General equilibrium analysis considers simultaneous equilibrium of all the markets taking into account all effects of changes in the price of one market over the others

Managerial Economics  Managerial economics is an application of the principles of economic for the solution of business problems  Bridge between economics and business practice

What is Managerial Economics? Douglas - “Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization.” Pappas & Hirschey - “Managerial economics applies economic theory and methods to business and administrative decisionmaking.” Salvatore - “Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.”

Managerial Economics Managerial economics is the science of directing scarce resources to manage cost effectively. Wherever resources are scarce, a manager can make more effective decisions by applying the discipline of managerial economics. These may be decisions with regard to customers, suppliers, competitors, or the internal workings of the organization.

How it differ from….. Microeconomics is the study of individual economic

behavior where resources are costly. It addresses issues such as how consumers respond to changes in prices and income and how businesses decide on employment and sales. Microeconomics also extends to such issues as how voters choose between political parties and how governments should set taxes. Managerial economics has a more limited scope – it is the application of microeconomics to managerial issues. By contrast with microeconomics, the field of macroeconomics focuses on aggregate economic variables. Macroeconomics addresses such issues as how a cut in interest rates will affect the inflation rate and how a depreciation of the U.S. dollar will affect unemployment, exports, and imports. While it is certainly true that the whole economy is made up of individual consumers and businesses, the study of macroeconomics often considers economic aggregates directly rather than as the aggregation of individual consumers and businesses. This is the key distinction between the fields of macroeconomics and microeconomics.

Nature of Managerial Economics Is essentially microeconomic in nature Is pragmatic (practical) Belong to normative economics (what ought to be) Is conceptual in nature Utilize some theories of macroeconomics Is problem solving in nature

Scope of Managerial Economics Estimation of product demand Analysis of product demand Planning of production schedule Deciding input combinations Estimation of cost of production Analysis of cost of product Achieving economies of scale Determination of price of product Analysis of price of product Analysis of market structure Profit estimation and planning Planning and control of capital structure

Managerial economics is applied economics; it is the use of economics theory and methodology to solve practical decision problems. A primary emphasis of managerial economics is the application of economic theory and methodology to the practice of business decision making. Secondary emphasis in managerial economics is the study of how managerial decisions are affected by the economic environment.