UNIT-I Basic Concepts and Principles

Lecture plan

Objectives What is Economics? Basic Assumptions Types of Economic Analysis Managerial Economics Managerial Decisions Economic Principles Relevant to Managerial Decisions Managerial Economics and Functions of Management

Relationship with Other Disciplines Summary

Objectives

To introduce key economic concepts like scarcity, rationality, equilibrium, time perspective and opportunity cost. To explain the basic difference between microeconomics and macroeconomics. To help the reader analyze how decisions are made about what, how and for whom to produce. To define managerial economics and demonstrate its importance in managerial decision making. To discuss the scope of managerial economics and its relationship with various other disciplines and functional areas.

What is Economics?

Discusses how a society tries to solve the human problems of unlimited wants and scarce resources. Scientific study of the choices made by individuals and societies with regard to the alternative uses of scarce resources employed to satisfy wants. Theoretical aspect and an applied science in its practical aspects. Not an exact science; An art as well A social science Deals with the society as a whole and human behaviour in particular Studies the production, distribution, and consumption of goods and services. A science in its methodology, and art in its application.

Basic Assumptions

Rationality
Consumers

maximize utility subject to given money

income. Producers maximize profit subject to given resources or minimize cost subject to target return.

Types of Economic Analysis

Micro and Macro

Microeconomics (micro meaning small): study of the behaviour of small economic units An individual consumer, a seller/ a producer/ a firm, or a product. Focus on basic theories of supply and demand in individual markets Macroeconomics (macro meaning large):

study of aggregates.

Industry as a unit, and not the firm. Focus on aggregate demand and aggregate supply, national income, employment, inflation, etc.

Types of Economic Analysis

Positive and Normative Positive economics: what is in economic matters

Establishes a cause and effect relationship between variables. Analyzes problems on the basis of facts. For example:The distribution of income in india is equal

Normative economics: what ought to be in economic matters.

Concerned with questions involving value judgments. Incorporates value judgments about what the economy should be like. For example: The distribution of income in India is un equal

Types of Economic Analysis

contd..

Short Run and Long Run Short run: Time period not enough for consumers and producers to adjust completely to any new situation. Some inputs are fixed and others are variable Long run: Time period long enough for consumers and producers to adjust to any new situation. All inputs are variable Decisions to adjust capacity, to introduce a larger plant or continue with the existing one, to change product lines.

Types of Economic Analysis

Partial and General Equilibrium Partial equilibrium analysis: Related to micro analysis Studies the outcome of any policy action in a single market only. Equilibrium of one firm or few firms and not necessarily the industry or economy. General equilibrium: explains economic phenomena in an economy as a whole. State in which all the industries in an economy are in equilibrium. State of full employment

Managerial Economics

Application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively Study of allocation of the limited resources available to a firm or other unit of management among the various possible activities of that unit Applies economic theory and methods to business and administrative decision-making Application of economic principles and methodologies to the decision-making process within the firm or organization

Managerial Economics

Contd

Micro as well as Macro Applied microeconomics: demand analysis, cost and production analysis, pricing and output decisions Macroeconomic: national income, inflation and stages of recession and expansion Normative Bias Prescriptive: States what firms should do in order to reach certain objectives. Decides on whether or not the probable outcome of a managerial decision is desirable. Decisions Resulting in Partial Equilibrium Decisions taken by any firm would relate to the equilibrium of that particular firm. Deals with partial equilibrium analysis

Economic Principles Relevant to Managerial Decisions

Concept of scarcity
Unlimited human wants Limited resources available to satisfy such wants Best possible use of resources to get:
maximum satisfaction (from the point of view of consumers) or maximum output (from the point of view of producers or firms)

Concept of opportunity cost

Opportunity cost is the benefit forgone from the alternative that is not selected. Highlights the capacity of one resource to satisfy multitude of wants Helps in making rational choices in all aspects of business, since resources are scarce and wants are unlimited

Economic Principles Relevant to Managerial Decisions Contd

Concept of margin or increment

Marginality:

a unit increase in cost or revenue or

utility.

Marginal cost: change in Total Cost due to a unit change in output. Marginal revenue: change in Total Revenue due to a unit change in sales. Marginal utility: change in Total Utility due to a unit change in consumption.

Incremental:

applied when the changes are in bulk, say 10% increase in sales.

Economic Principles Relevant to Managerial Decisions

Discounting Principle
Time

value of money : Value of money depreciates with time

A rupee in hand today is worth more than a rupee received tomorrow.

Outflow

and inflow of money and resources at different points of time

1 (1 r ) n

PVF =

where PVF = Present Value of Fund, n = period (year, etc.) R = rate of discount

Managerial Economics and Functions of Management

All functional areas have to find the most efficient way of allocating scarce organizational resources Managerial economics:

Facilitates the process of evaluating relationships between functional areas Helps in making rational decisions across managerial functions.

Managerial Economics and Functions of Management

Contd

Financial Management
From where to collect resources Equity Debt How to allocate resources How much profit to be retained/distributed

Human Resource Management

Recruitment Wage and Salary Training and development Retirement

Managerial Economics and Functions of Management

Marketing Management
Which product For whom What price

How

to sell
technology

Operations Management
Which Inputs

Processing

Information System Management

Communication channels Use of information Technology

Relationship Other Disciplines

Economic Theory
Microeconomics Theory of firm Theory of consumer behaviour (demand) Production and cost theory (supply) Market structure and competition Price theory Macroeconomics National income and output Business cycle Inflation

Numeric and algebraic analysis Optimization Discounting and time value of money techniques Statistical estimation and forecasting Game theory

Quantitative Analysis

Managerial Economics

Solutions to Managerial Decision Making

Quantity and quality of product Price of product Marketing Management Financial Management Human Resource Management Research and Development

Summary
Economics

studies the choices made by individuals and societies in regard to the alternative uses of scarce resources which are employed to satisfy unlimited wants. Microeconomics is the study of the behaviour of individual economic units, such as an individual consumer, a seller, a producer, a firm, or a product. Macroeconomics deals with the study of aggregates, the economy as a whole. The assumption of rationality means that consumers and firms measure and compare the costs and benefits of a decision before going ahead for that decision. Partial equilibrium analysis studies the outcome of any policy action in a single market only, while general equilibrium analysis seeks to explain economic phenomena in an economy as a whole. Opportunity cost is the benefit forgone from the alternative that is not selected.

Summary

Concept of Time value of money tells that Value of money depreciates with time. Concept of Marginal/increment tells about impact of unit/proportionate change in cost/revenue on decision making. Managerial economics is a means to finding the most efficient way of allocating scarce organizational resources and reaching stated objectives. It is micro as well as macro in nature; it has a normative bias, and deals with partial equilibrium. The knowledge of managerial economics helps to understand the interrelationships among the various functional units of any firm (namely production, marketing, HR, finance, IT and legal) Decision sciences provide the tools and techniques of analysis used in managerial economics, in particular numerical and algebraic analysis, optimization, statistical estimation and forecasting.