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BASIC TRAINING

DIAGRAMMATICAL REPRESENTATION OF
RELATIONSHIP BETWEEN ECONOMICS,
MANAGEMENT & MANAGERIAL ECONOMICS
SCARCITY- COUNTRY & FIRM PERSPECTIVE

• COUNTRY
– What to produce- products
– How to produce- choice of technology
– For whom to produce- distribution of goods & services

• FIRM
– What- product decision
– How- hiring, staffing, procurement, capital budgeting
decisions
– For whom- market segmentation decisions
PRODUCTION POSSIBILITIES CURVE
GUNS BUTTER
GUNS 0 210
20 207
40 198
60 186
80 168
100 144
120 119
140 82
O
BUTTER
160 42
175 0
BASIC PRINCIPLES

• Opportunity cost principle


• Principle of time perspective
• Discounting & Compounding principle
• Marginal & Incremental principle
• Equi-marginal principle
(I) OPPORTUNITY COST PRINCIPLE

• To get something it costs the opportunity to do


something else. The foregone alternative is opportunity
cost

• Next alternative that could be produced instead by the


same factors, costing the same amount of money

• Amount or subjective value that must be sacrificed in


choosing one activity over the next-best alternative
(I) OPPORTUNITY COST: SELF EXERCISE

• Opportunity cost of attending this lecture……..


• OC of living in own house……..
• OC of investing your money in business…..
• OC of producing a product…….
• OC of doing PGDM from here………
• OC of lending money to your friend……..
(II) PRINCIPLE OF TIME PERSPECTIVE

• Temporary run analysis: constraints are rigidly


fixed & pegged

• Short run analysis: some constraints are variable &


some are fixed

• Long run analysis: all constraints are variable &


adjustable
FACTORS LEVEL OF O/P NATURE OF I/P
TIME
PRSPCTV

TEMPORARY RUN Χ Χ

SHORT RUN  Χ

LONG RUN  
(III) DISCOUNTING PRINCIPLE (1)

• A rupee now is worth more than a rupee a year


after.

Example: One may ask how much money today would


be equivalent to Rs 100 a year from now if the rate
of interest is 5%.

The present value of Rs 100 to be received after one


year is:
PV = Rs 100/1+i = Rs 100/1.05 = Rs 95.24
(III) DISCOUNTING PRINCIPLE (1)

Money has time value: earning power (earn at least an


interest rate), changing prices (demanded due to its
purchasing power which is inversely related to price) &
uncertainty (certainty of today’s money)
TIME VALUE OF MONEY
Present value (PV) of an amount (FV) to be received at
the end of “n” periods when the per-period interest rate
is “i”:

FV
PV =
(1 + i ) n
PRESENT VALUE OF A SERIES
Present value of a stream of future amounts (FVt)
received at the end of each period for “n” periods:

FV1 FV2 FVn


PV = 1 + 2 + . . .+
(1 + i ) (1 + i ) (1 + i ) n
NET PRESENT VALUE
• Suppose a manager can purchase a stream of future receipts
(FVt ) by spending “C0” rupees today. The NPV of such a
decision is:

FV1 FV2 FVn


NPV = −C 0 + 1 + 2 + . . .+
(1 + i ) (1 + i ) (1 + i ) n

NPV < 0: Reject


NPV > 0: Accept
EXAMPLE
An investment costs Rs 100 lakhs this year and is
expected to yield net returns of Rs 30 lakhs, 40 lakhs &
60 lakhs in the next three years respectively. Assuming
that the interest cost of money is 10%, calculate the Net
Present Value.
30 + 40 + 60 – 100
(1 + .1) (1 + .1)2 (1 + .1)3

= Rs 6.51 lakhs
Investment is desirable
COMPOUNDING PRINCIPLE

Future/ compound values of cash flows are


calculated at a given rate of return at the end of
a given period of time

=
FV PV (1 + i) n
EXAMPLE
What will be the FV of Rs 7500 deposited today at 10%
interest for 20 years

FV = 7500 (1.10)20
= 50456
(IV) MARGINAL PRINCIPLE
• Marginal refers to change (increase/ decrease) in
total of any quantity due to a one unit change in its
determinant

• Example: marginal output of labour, marginal


output of machine, marginal cost of production
INCREMENTAL PRINCIPLE (1)
• In actual business conditions, concept of marginalism
replaced by incrementalism
• Concerned with “chunk changes” & not “unit change”

Example: in a construction project, the labour which a


contractor may change is not by one

• Incremental cost (IC): change in cost with change in


output
• Incremental revenue (IR): change in revenue with
change in output
INCREMENTAL PRINCIPLE (2)

Decision would be profitable if:


 It increases revenue more than cost
 Decreases cost to a greater extent than the decline
in revenue
(V) EQUI-MARGINAL PRINCIPLE (1)

• Deals with allocation of available resources among


alternative activities

• An I/P should be so allocated that the value added by


last unit is same in all cases
(V) EQUI-MARGINAL PRINCIPLE (2)

It states that a rational decision maker would allocate or


hire his resources in such a way that the ratio of
marginal returns and marginal costs of various uses of a
given resource or of various resources in a given use is
the same, e.g., a consumer seeking maximum utility
(satisfaction) from his consumption basket will allow his
consumption budget on goods and services such that

MU1/MC1=MU2/MC2=......=MUn/MCn;
Where, MU1 = marginal utility from product 1
MC1 = marginal cost of product 1, and so on.
(V) EQUI-MARGINAL PRINCIPLE (3)

• To maximize net benefits, managerial control variable


should be increased up to the point where MB = MC

• MB > MC means the last unit of the control variable


increased benefits more than it increased costs

• MB < MC means the last unit of the control variable


increased costs more than it increased benefits
EXERCISE: FIND THE OPTIMUM COMBINATION OF
GOODS WHEN 6 UNITS HAVE TO BE PURCHASED

UNITS MARGINAL UTILITY


ITEM A ITEM B ITEM C
1 10 9 8
2 9 8 7
3 8 7 6
4 7 6 5
5 6 5 4
6 5 4 3
EXERCISE: FIND THE OPTIMUM COMBINATION OF
GOODS WHEN INCOME = Rs. 19, Px= Rs 2, Py = Rs 3

Units MUx MUy


1 20 24
2 18 21
3 16 18
4 14 15
5 12 9
6 10 3
RELATIONSHIP B/W TOTAL, AVERAGE &
MARGINAL
• Total Product - total number of goods produced during
a specified period of time using a particular input

• Average product - the average output per unit of input


used
AP = TP / L
• Marginal product - is the change in the TP
corresponding to one unit change in the input.
MP = ∆ TP / ∆ L
Number of Total Average Marginal
Workers Product Product Product
(L) (Q) (AP) (MP)
0 0 0 0
1 2 2.0 2
2 5 2.5 3
3 9 3.0 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 6
9 64 7.1 1
10 63 6.3 -1
Number of Total Average Marginal
Workers Product Product Product
(L) (Q) (AP) (MP)
0 0 0 0
1 2 2.0 2
2 5 2.5 3
3 9 3.0 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 6
9 64 7.1 1
10 63 6.3 -1
Number of Total Average Marginal
Workers Product Product Product
(L) (Q) (AP) (MP)
0 0 0 0
1 2 2.0 2
2 5 2.5 3
3 9 3.0 4
4 14 3.5 5
5 22 4.4 8
6 40 6.7 18
7 57 8.1 17
8 63 7.9 6
9 64 7.1 1
10 63 6.3 -1
EXCERCISE
Given TR function:
TR = 50 Q – 0.5 Q2
& TC function:
TC = 2000 + 200Q – 0.2 Q2 + 0.001 Q3
Find MR & MC functions
RULES
MAXIMISATION:
• I Differentiation: 0
• II Differentiation: negative
MINIMISATION:
• I Differentiation: 0
• II Differentiation: Positive
EXCERCISE
Given the following demand and cost functions for
Apollo Cycles:
Q = 20 – P
C = Q2 + 8Q + 2
Find out:
• Revenue maximizing level of output and prices
• Profit maximizing level of output and prices
• Maximum Revenue
• Maximum Profit