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resource constraints.
legal constraints.
Role of Managerial Economics
1. Demand forecasting
2. Production scheduling
3. Industrial Market Research
4. Economic analysis of the competing companies
5. Investment appraisal
6. Security management analysis and forecasts
7. Foreign exchange management
8. Advice on trade
9. Environmental forecasting
10. Pricing and the related decisions
Profit Maximization
Profit is defined as revenue minus cost. Economists recognize the
other costs defined as implicit costs. These costs are not reflected in
cash outlays by the firm and includes managers time and talent.
Goodwill in society .
Behavioral Theories
Managerial and Behavioral theories of firm,
assume owners and managers to be
separate entities in large corporations with
different goals and motivation.
There is a dichotomy.
1 Berle and Means and later developed by Gal braith ( B-M-G) Hypothesis.
States 1) That owner controlled firms have higher profit than manager controlled
firms AND
2) That managers have no incentive for profit Maximization.
f) Growing sales strengthen competitive spirit of the firm in the market and
vice versa.
3) Robin Marries Hypothesis of Maximization of firms growth rate :
U= F (s , m , I )
d
Where s is additional expenditure on staff
m is Managerial emoluments
I Is discretionary investments
d
Incremental cost
Discounting principle
Concept of time
Equi-marginal principle
(cdeio)
Demand analysis
Demand means the quantity of the commodity which an
individual consumer or a household willing to purchase at
a particular price.
Dx = f ( Px , Py , Pz ……Pn, I, T.A)
where
Dx = Amount demanded per unit of commodity x
Reasons:
Substitution effect
Income effect
Consumption by marginal
Consumers
Types of Demand
Direct demand and Derived demand.
Relatively elastic
Quantity demanded changes by a larger percentage than does
price. e >1.
Unitary elastic
Quantity demanded changes by exactly the same percentage as
does price. e=1.
Relatively inelastic
Quantity demanded changes by a smaller percentage than does
price. e < 1.
Graphical Presentation of Types of Elasticity
Delphi method.
Naive model.
Time-series analysis.
Regression method.
Smoothing techniques.
Survey of buyers intentions or consumer sample survey method.
a) customers are asked to communicate their buying intentions in
coming period.
b) Identify potential buyers – industrial demand forecasting.
Merit: Useful for products with a history of stable demand than for
products with erratic sales patterns.
Demerit: Cannot be used to forecast sales of a new product because past
sales data are absent.
End use method:
a) Sales are projected through survey of its end users.
b) Commodity is used for final consumption or intermediary
consumption.
c) Domestic market or international market.
Statistical Methods
Time series analysis:
Smoothing Techniques:
Moving averages and Exponential smoothing. Exponential smoothing is a
short run forecasting technique. It uses a weighted average of past
data as the basis for a forecast. The procedure gives heaviest weight
to more recent information and smaller weights to observations in the
more distinct past.
Evolutionary approach
Substitution approach
Vicarious approach
Criteria of a Good Forecasting Method
Accuracy
Simplicity
Economy
Quickness
Flexibility
Plausibility
Production Function
Production function refers to the functional relationship, under the
given technology between the physical rates of input and output of a
firm per unit of time.
Q = f ( m, l, k )
Production Function with one Variable Input
or Law of Variable Proportions
This law states that as more and more of one factor input is employed,
all other input quantities constant a point will eventually be reached
where additional quantities of varying input will yield diminishing
marginal contribution to the total product.
Assumptions:
1. Applicable only for short run decisions.
2. Constant technology.
3. Homogeneous factors.
The firm increases its output by using more of two inputs that are
substitutes for each other. Ex: Labour and Capital
Cobb-Douglas Production Function
This is a multiplicative form of production function because it accurately characterizes many
production processes.
Q=a[ Lb K l -b ]
Importance
and ∆F = Proportionate.
F
Marshall explains increasing returns in terms of ‘increased efficiency’ of labour and capital in the
improved organisation with the expanding scale of output and employment of factor input. It
is referred to as ‘the economy of organisation’ in the earlier stages of expansion.
Increasing returns may be attributed to improvements in large scale operation, division of labour,
use of sophisticated machinery, better technology, etc. Increasing returns to scale are due to
indivisibilities and economics of scale and technological advancement.
The Law of Constant Returns:
The process of increasing returns to scale cannot go on
forever. It may be followed by constant returns to scale.
As the firm continues to expand its scale of operations, it
gradually exhausts the economies responsible for the
increasing returns. Then, the constant returns may occur.
There are constant returns to scale when a given
percentage increase in inputs leads to the same
percentage increase in output.
Internal Economies of Scale are those which arise from the firm
.
increasing its plant size External Economies arise outside the firm
from improvement or deterioration of the environment in which the firm
operates.
Internal Economies:
Real Economies
Pecuniary Economies
Labour Economies
Technical Economies:
1. Specialization
2. Indivisibilities
Managerial Economies
Diseconomies:
Management
Co-ordination
Decision making
Increase investment, Increase in risks
Labor diseconomies
Scarcity of factor supplies
Financial difficulties
Marketing Diseconomies
Short run - Long run costs
Short run costs are those that can vary with the degree of utilisation of
plant and other factors fixed. These include fixed costs and variable
cost.
Short run costs include the following :
in the long run ,the firm is not tied to a particular plant capacity.
The long run average cost curve is the envelop of the various short run
average cost curves. It is drawn as tangent to SAC.
Cost function
The relationship between cost and its determinants is known as cost
function.
Productivities of factors of production,
Learning effect,
Geographical location,
Institutional factors,
SAC 3
SAC 1 SAC 2
LAC
Features
Tangent curve
Envelope curve
Planning curve
Flatter U-shape
Supply Function
Supply of commodity means that amount of that commodity
which produces are able and willing to offer for sale at a
given price.
Limitations:
1. Future prices
2. Agricultural output
3. Subsistence farmers
4. Factors other than price not remaining constant
Market Structure
The term ‘Market’ refers to an arrangement whereby the buyers and
sellers come in close contact with each other directly or indirectly to
sell and buy goods.
Features:
Features:
1. Only one seller in the market of a particular good or service
2. There exists factors that prevent the entry of other firms
3. Product is highly differentiated from other goods
4. Entry is prohibited or difficult
5. There are no rivals or direct competition of the firm
6. Firm is the price maker
Monopolistic Competition
A market with a blending of monopoly and competition is described
as monopolistic competition.
Features:
Features:
We would get such a curve when it is assumed that the rivals will lower
their prices, when the oligopolist lowers his own price but that rivals
will not raise their price when the oligopolist raises his own price.
KDC
DC
P K
DC
Quantity
Drawbacks:
Objectives of pricing:
Administrative Pricing:
The prices are fixed and enforced by the government. The major
characteristics are the following:
They are fixed by the govt.
They are statutory
They are regulatory in nature
They are meant as corrective measures
They are the outcome of the price policy of the govt.
Price Discrimination
Means charging different prices and it takes various forms.
On the basis of customer
On the basis of product version
On the basis of place
On the basis of time
Product-mix:
Many times the management has to take a decision whether to produce one
product or another instead. Generally decision is made on the basis of
contribution of each product. If there is a shortage, say, raw materials and
or time ,then, the respective constraints will become key factors.
The following factors are to be considered as an optimal product-mix.
An objective function
The constraints within which the objective function is to be achieved.
Decision Making
Ex: two products a and b. Find the most profitable product when the plant
capacity is limited.
Selling price (Rs.) a and b are Rs.2 and Rs. 2.50
Variable cost (Rs.) 1 and 1.5 respectively
Machine hours 2 and 1 respectively.
Shut Down:
If the products are making a contribution towards fixed expenses or if
selling price is above the marginal cost, it is preferable to continue
because the losses are minimized.
Decision Making
In making shut down decisions non-cost factors are also to be taken into
consideration, namely, interest of the workers, competitors, nature of plant
and machinery.
C V P equation :
Sales = variable expenses + fixed expenses + profit
Break-Even Analysis
Break-even analysis is a study of revenues and costs of a firm in relation to its volume of
sales, determination of that volume at which the firm costs and revenues will be equal.
Assumptions:
It is static in character
Costs cannot be classified accurately
Applicable only in short run
Variable cost line need not necessarily be a straight line because of
possibility of operation of law of increase or decrease in returns
Selling price will not be a constant factor
Ignores capital employed in business
It is based on accounting data
Break-Even Analysis
Managerial Uses:
Margin of safety – extent to which the firm can afford a decline in sales before it
starts incurring losses
Target profit – volume of sales necessary to achieve a target profit
Change in prices
Change in costs
Expand or contract
Drop and or add decisions
Make or buy decisions
Choosing promotional mix
Equipment selection
Improving profit performance
Break-Even Chart
It is graphical representation of cost volume profit relationship.
Angle of incidence:
Angle at which total sales line cuts total cost line.
sales
aoi cost
bep
fe
output
Break-Even Chart
Assumptions:
Costs are either classified as fixed or variable, at least they can be so
classified for the purposes of this analysis.
Fixed and variable costs are clearly separated.
Selling price is constant, regardless of the level of output
There is one product, or a constant sales-mix if more than one product
is involved
Production and sales are equal, and as a result all fixed costs incurred
in the period covered by the analysis will be deducted from the
revenue realised in the same period.