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UNIT I : NATURE AND SCOPE OF MANAGERIAL ECONOMICS IMPORTANT

means. Managerial Economics: Relates to managerial decision making in achieving a business goal by using the given business resources in the most effective manner. Managerial economics is essentially applied economics in the field of business management. It is the economics of business or managerial decisions. It pertains to all economic aspects of managerial decision making. Managerial economics is an evolutionary science, it is a journey with continuing understanding and application of economic knowledge theories, models, concepts and categories in dealing with the emerging business/ managerial situations and problems in a dynamic economy. Decision making is the crucial aspect of dealing with business problems, Decision becomes essential since business problems would usually imply a basic question: What is the alternative course of action? For instance, business/managerial decisions: Should an electronic goods manufacturer cut the price of its best selling television set in response to a rival companys launching of a new model? Should a commercial bank go for Internet banking? Should a publisher offer more trade discount in response to a new competitors entry into the market of educational books? Should a Pharmaceutical firm undertake a promising but costly R&D programme? What tender should a construction company submit to get a road construction contract from the municipal corporation in a city? These are all economic decisions making issues in essence. A sensible economic analysis in each case is required in determining alternative course of action and making the best choice. In business decision making, however, the real situation tends to be quite different from theoretical assumptions actually, There are multiple goals in running a business There is lack of certainty due dynamic changes The element of uncertainty may create disappointment in the realization of business expectations Decision making is an art as well as science. Many managerial decisions are addressed in a routine manner. Rules of thumb or the tried-and-true decision rules are, however, invalidated
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NOTES

Economics: Economics studies division making in view of many want against scarcity

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by the changes in routine situations. Dynamic changes in business situations need that decisions are to be addressed in a proactive manner. In proactive decision-making, many alternatives have to be explored; conditions and assumptions have to be reviewed and structured in a perspective manner. Managerial economics offers an understanding of business and economic perspectives, jargons, tools, technique and tactics that will facilitate managers development as a proactive decision-maker a decision maker who addresses dynamic business situations in a critical, comprehensive and careful manner, right in time, using formal analytical tools and skills that are guided by the knowledge, judgment, experience and intuition. Managerial Insight: Managers have to acquire the insight of both micro-economics and macro-economics as the former analyses the behavior of individual economic entities such as consumer and producers, while the later exposes issues pertaining to their behavior in the economy as a whole. Business / Managerial Economics: Economics applied to business decision making. There is a little difference between the manager and a business/managerial economist; the former is a decision maker, while the latter acts as an adviser. Nonetheless, in these days of dynamism of knowledge there is a thin line of demarcation between the two categories of experts before the top management or entrepreneurial leadership. A business economist may gradually move into decision making and play the managerial role in the business from a mere advisory role. A manager, at a time, also has to play an advisory role before the Board of Directors. A manager, for all practical purpose in a business, is increasingly responsible for team work, since he has to coordinate the functioning and process of allied business activity and also to make right economic decisions to achieve the pre-determined business goals. Positive Economics explains the economic phenomenon as: What is, what was and what will be. Normative Economics prescribes what it ought to be. Managerial economics is a blending of pure or positive science with applies or normative science. It is positive when it is confined to statements about causes and effects and to functional relations of economic variables. It is normative when it involves norms and standards, mixing them with cause-effect analysis. Management Function: A business or managerial function is to allocate given business resources possessed by the firm for achieving predetermined business goals.

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Managerial economists tend to rely on the scientific research method in building and empirically testing business oriented economic models. The scientific approach consists of the following steps: Defining the problem Formulation of the hypothesis Abstraction for the model building Data collection Testing the hypothesis Deduction based on data analysis Evaluating the test results Conclusion for decisions The significance of economic models and micro macro analysis lies in the logical framework created by them for the decision making process in business management. Managerial economics, thu8s, becomes useful as it makes the task of successful business management easier through characterization of business behavior with a scientific blending of economic theory and business experience in practice. Opportunity Cost: The cost of sacrificing some thing else(y) from the use of a given resources when a decision is made in favour of one thing (x) Time series Data: Data collected with time variations at different points in time, daily, weekly, mo0nthly, quarterly or annually. Cross sectional Data: Data collected for different characteristics of items at a given / specific point of time. Panel / Pooled Data: Cross sectional data collected at several points in time referred to as panel data or pooled data. IMPORTANT STRUCTURES

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UNIT I
NATURE AND SCOPE OF MANAGERIAL ECONOMICS
Meaning: Managerial Economics or Business Economics is a branch of Economic Theory and its application to business problems and to take right decisions in right time. The nature of Managerial Economics is normative science like Psychology, Sociology, Human Behavior etc. This subject deals with all aspects of profit optimization. However, there are different views about the scope of the subject matter and its applications. Positive Science: Positive Science only explains, What is. It deals with things as they are and explains causes and effects without making value judgments whether it is right or wrong. In other words, positive science only describes things as they actually are. These may called Pure Science. Normative Science: Normative Science is concerned with What ought to be. It is concerned with the ideal. It discusses whether a thing is good or bad and lays down policies or rules to achieve what is considered to be good. Normative science may be called applied science. Thus, managerial economics is normative science.
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Managerial Economics Concept: Managerial Economics is a discipline that deals with the application of economic concep0ts, theories, tools and methodologies to the practical problems in a business. It facilitates the manager in decision-making and acts as a link between theory and practice. Managerial economics is a combination of management and economics. As management is the process of planning, organizing, leading and controlling the efforts of the organizational members and of using all the available organizational resources to reach the stated organizational goals. Whereas, economics is mainly concerned with analyzing and providing solutions to the various economic problems. As a combination of these two, managerial economics is viewed as economics applied to the problems of choice and allocation of scarce resources among the alternative uses by the firm. Managerial economics by nature is goal-oriented and aims at maximum achievement of objectives. In particular managerial economics is concerned with the allocation of the resources available to a business firm or an organization.

Definitions: Managerial economics is the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management. Spencer and Siegelman Managerial economics is the use of economic models of thought to analyze business situations - Mc Nair and Meriam Managerial economics is the application of economic theory and methodology to business administration practice economics is
1. Demand Analysis: Demand is a desire, ability and willingness to purchase a product.

Brigham and Pappas

Scope and Subject Matter: An aggregate view of scope and subject matter of managerial

This subject deals with analysis of demand, factors influencing it and the relative responsiveness with respect to change in price is the primary topic of the managerial economics.

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MANAGERIAL ECONOMICS 2. Demand Forecasting: Estimating demand for the existing and new products is the

need of every businessman which is mostly dependent on consumer behavior. Opinion Survey and Statistical Methods are useful ways of estimating demand for the product. Primary data collection is essential for analysis of opinions of consumers and secondary data sources are enough for statistical analysis for demand forecasting.
3. Cost Analysis: The total expenditure incurred for the manufacturing of a product is

called Cost of a particular product. By studying Managerial Economics one can easily estimate cost of product as this subject deals with analysis of cost based on its nature, i.e., Fixed, Semi-Fixed, Variable Cost and Determination of Cost and Price. Decision making with the help of Cost-Volume-Profit analysis can be made at the managerial level.
4. Production Analysis: Land, Labour, Capital and Organization are four major

contributors of factors of production. Rent, Wages, Interest and Profit are returns to the factors of production. Hence, Economies of Scale can be achieved by applying theories of Production and a clear understanding of factors influencing production function and location of industry.
5. Pricing Decision: Price of product depends on the cost of manufacturing and

expected profit on it. At the same time there are several other factors like Government policy, trend in the market, objective of the firm, accordingly the price fixation policy will be practiced by a firm. Thus, the study of price determination and analysis of pricing policies and practices prevailing in India is another important area of this subject.
6. Profit Management: The fundamental objective of business is to make profit,

Managerial Economics deals with theories of profit, and how to achieve expected profit, and how to balance the social responsibilities and profit motive. The objectives like profit maximization and wealth maximization will be key variables to the managerial economist.
7. Capital Budgeting: Long term investment decisions need a careful analysis of

expected returns, risk and uncertainty. Budgeting techniques can be classified in to traditional and modern methods. This subject deals with application of these techniques to business. Nature of Managerial Economics:

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Managerial economics is concerned with the business firm and the economic problems that every business management need to solve. Spencer and Siegelmen point to the feet that Managerial Economics., is the integration of economic theory and business practice for the purpose of facilitating decision-making and forward planning by management. The nature of managerial economics is as follows: 1. M.E. is of micro economic in character 2. ME is concerned with normative micro economics 3. ME makes economic theory more application oriented 4. ME takes help of macro economic concepts Macro Economic Conditions: The decisions of the firm are made almost always within the broad framework of economic environment within which the firm operates, know as macro economic conditions. These conditions, stress three points. i. ii. iii. The economy in which the business operates is predominantly a free enterprise economy asking prices and market. The present-day economy is the one undergoing rapid technological and economic changes. The intervention of government in economic affairs has increased in recent times. Micro Economic Analysis: The micro-economic analysis deals with the problems of an individual firm, industry, consumer etc. In the case of managerial economics, microeconomics helps in studying what is going on within the firm; how best to use the available scarce resources between various activities of the firm; how to be technically as well as economically efficient etc.
A. Managerial economics is concerned with normative micro-economics and not with

positive micro-economics. In normative micro-economics tells us what objectives a business should pursue and how they should be set. B. Managerial economics concentrates on making economic theory more applicationoriented. While economic theory tries to solve; die complicated theoretical issues, managerial economics tries to solve complicated business problem. Hence managerial economics is more pragmatic. C. Managerial economics takes the help of macro-economics also so as to understand the external conditions which are relevant to the business. Chief Characteristics of Managerial Economics:

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Understanding of the chief characteristics of managerial economics helps in appreciating the subject in its true perspective. These characteristic features are as follows:
1. Managerial economics is micro-economics in character as it concentrates only on the

study of the firm and not on the working of the economy. 2. Managerial economics takes the helps of macro-economics to understand and adjust to the environment in which the firm operates.
3. Managerial economics is normative rattier than positive in character. It is prescriptive

rattier than descriptive. 4. It is both conceptual and metrical. It takes the help of conceptual framework to understand and analyse the decision problems and takes the help of quantitative techniques to measure the impact of different factors and policies. 5. The contents of managerial economics are based mainly on the theory of firm. It is only for the analysis of profit. 6. Managerial economics, being the study of the allocation of the scarce resources available to a firm among the activities of that unit, to maximize the benefit. Significance Importance of Managerial Economics: Major aspects of management is decision-making. Decision-making needs a balance between various factors and objectives. It also needs common sense and good judgment. Managerial economics helps the decision-making process in die following ways: 1. Managerial economics provides a number of tools and techniques to build models and with the help of these models, the manager can handle real situation. 2. Managerial economics provides most of the concepts that are needed for the analysis of business problems and also to solve various kinds of managerial problems. Concept of elasticity of demand, fixed and variable costs, short and long-run costs, corporeity costs, net present value etc. all help in understanding and solving decision problems. 3. Managerial economics is helpful in making decisions such as What should be the product mix? Which is the production technique and the input-mix that is least costly? What should be level of output and price for the product? How to take investment decisions? How much should the firm advertise and how to allocate an advertisement fund between different media? The concepts of managerial economics helps to analyse problem logically. Scope of Managerial Economics: No uniform opinion as to the scope of managerial economics, but the following aspects may be said to generally fell under the scope of Managerial Economics.
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1. Demand analysis and forecasting: A business firm which take necessary steps to transform productive resources into goods that are to be sold in a marketer Mostly decisionmaking depends on accurate estimates of demand. Before preparing production in schedules sales forecast is essential. This forecast can also serve as a guide to management for maintaining or strengthening market position and enlarging demand for a firms product and thus provides guidelines to manipulating demand. Demand analysis and forecasting is essential for business planning and occupies a strategic place in Managerial Economics. It mainly consists of discovering the forces determining sales and their measurement. The main topics covered under demand analysis and forecasting are: Demand Determinants, Demand Distinctions Law of demand Exception to rules Demand forecasting Methods of forecasting Forecasting of new and existing product. 2. Cost and Production Analysis: A study of economic costs, and their estimates are useful for management decisions. The factors causing variations in costs must be recognized and allowed for if management is to arrive at cost estimates which are significant for planning purposes. An element of cost uncertainty exists because all the factors determining costs are not always known or controllable. Discovering economic costs and being able to measure them, are necessary steps for more effective profit plaguing, cost control and often for sound pricing practices. Production analysis is narrower in scope than cost analysis. Production analysis frequently proceeds in physical tense while cost analysis proceeds in monetary terms. The main topics covered under cost and production analysis are: cost concepts and classifications, cost-output relationships. Economic and diseconomies of scale, production functions and cost function cost control etc. 3. Pricing decisions, policies and practices: Another important area of Managerial Economics is pricing and the success of a business firm largely depends on the correctness of
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the pricing decisions taken by it. The important aspects dealt with under this area are : Price Determination in various market forms, perfect monopoly, monopolistic, oligopoly etc., pricing methods, differential pricing, product-line pricing and price forecasting. 4. Profit Management: Business firms are established with an objective of making profits and it is the chief measure of success. There is an element of uncertainty existing about profits because, of difference in costs and revenues which, in turn, are caused by internal and external factors to the firm. If we know the future, profit analysis would be an easy task. However, in a world of uncertainty, expectations are not always realized so that profit planning and measurement constitute the difficult area of Managerial Economics. The important aspect5s covered under this are : Nature and Measurement of Profit, Profit Policies and Techniques of Profit Planning like Break-Even Analysis, cast volume profit analysis etc. 5. Capital Management: The, most complex and troublesome for the business manager is the firms capital investments. Greater the investment more complex the problem and their disposal not only requires considerable time and labor but is a matter for top-level decision. Capital management implies planning, acquisition disposition and control of capital. The main topics covered under this area are: Costs of Capital, Rate of Return and Selection of Projects etc. 6. Competitions: Study of markets and understanding is one of the important aspect of managerial economist. The manager should have a clear knowledge of different markets existing in the environment. These environment are not constant and go on changing thereby markets are also changing. Thus manager should know clearly about perfect and imperfect markets so as to introduce the product in such markets where lie can increase the sales revenue. Under this the main aspects are perfect market monopoly market, monopolistic market, oligopoly market, price fixation under different market conditions. 7. Product policy, sales promotion and market strategies: Product policy, sales production and market strategy also become as part of managerial economist responsibility to assist the concerned person to enable to take decision. Product mix, Sales production strategies market strategies etc., are the important areas. Relation ship of M.E. with other Disciplines:
1. Managerial Economics and Statistics: Statistics is widely used by

managerial economics. Managerial economics aims at quantifying the past

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economic activity to predict its future. Probability, correlation, interpolation are the concepts which are also used by managerial economist to solve certain problems.
2. Managerial Economics and Operations Research: Both operational

research and managerial economics are concerned with taking effective decisions. Both economics and operations research resort to model building, economic models are more general and broad, while operation models draw from various disciplines and are more job oriented. The O.R. models like transportation, linear programming, assignment etc., are routinely useful in business.
3. Managerial economics and Mathematics: Mathematics provides us with a

set of tools which helps in the derivation and exposition of economic analysis. Mathematics is closely linked to managerial economics. This is because managerial economics being both conceptual and material. It tires to estimate and predict the relevant economic factors for decision making and forward planning. The main branches of mathematics which are generally used by a managerial economist are geometry, algebra, and calculus.
4. Managerial Economics and Accounting: Managerial economics also closely

linked to accounting which is concerned with, regarding the financial operations of a business firm. Accounting information is one of the principal sources of data required by managerial economist for his decision purpose. Especially, there is close link between management accounting and managerial economics.
5. Managerial Economics and Organizational Behavior: Organizational

behavior facilitates a manager to study and develop the behavioral models of the firm by integrating the managers behavior with that of the owner. It further analyses the economic rationality of the firm in a goal-oriented way.
6. Managerial economics and Traditional Economics: In general the relation

between managerial economics and economic theory is very ranch like the relation of engineering to physics and of medicine to biology. It is in tact the relation of an applied field to its more fundamental and conceptual counterpart. Economics provides certain basic concepts and analytical tools which are applied suitably to a business situation.
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Economics and Managerial economics both deal with identical problems they are concerned with problems of scarcity and resource allocation. Thus the two main contributions of economics to managerial economics are: 1. It helps in understanding the market conditions and the general economic environment within which the firm operates. 2. It provide a philosophy for understanding and analyzing resource-allocation problems.
7. Managerial economics and the theory of decision making: The theory of

decision-making is relatively a new subject that has significance for managerial economics. Much of economic theory is based on the assumption of a single goal-maximization of profit. It also usually resets on the assumption of certainty. It contrast the theory of decision-making recognizes the multiplicity of goals and the pervasiveness of uncertainty in the real world of management. The theory of decision-making often replaces the notion of a single optimum solution with the view of finding solutions that balance conflicting objectives.
8. Managerial economics and Computer Science: Development of technology

improved the use of computers in business undertakings. Today computers are used for maintaining data and accounts, inventory control, demand and supply predictions etc. Computerization of various business activities has limited their execution time and work load on managerial personnel. So, it is quite essential for a manager to be well acquainted with computers.
9. Managerial economics and Psychology: Psychology is the basis upon which

managerial economics is built. Psychology helps in understanding the behavioral implications, attitudes and motivations of macroeconomic variables such as consumers, suppliers, investors, worker or and employee which are very vital in managerial economics. Uses of Managerial Economics: There are so many uses of managerial economics: They are: 1. Managerial economics accomplishes the objective of building a suitable tool kit from traditional economics. 2. Managerial economics taken the aid of other academic disciplines having a bearing upon the business decisions of a manager.

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3. Managerial economics helps in reaching variety of business decision in a complicated environment such as i. What products and services to be produced ii. What inputs and production techniques to be used iii. How much to be produced and to be sold at what price
iv. What are best sizes of plant and where to locate the plant

v. When equipment should be replaced vi. How the capital to be allocated 4. Managerial economics makes a manager a more competent model builder. 5. Managerial economics serves as an integrating agent by coordinating different functional areas to take effective decision. 6. Lastly managerial economics takes into consideration the integration between firm and society. Conclusion: The usefulness of managerial economics lis in borrowing and adopting the toolkit from economic theory, incorporating relevant ideas from other disciplines to achieve better business decisions, serving as a catalytic agent in the course of decision-making by different functional departments/specialists at the firms level and finally accomplishing a social purpose through orienting business decisions towards social obligations. Limitations of Managerial Economics: The theory of firm which is a fundamental to managerial economics is based upon certain assumption. The basic assumption are, the decision maker has 1. Perfect knowledge 2. Rational in approach Most of the economic theory also based on those assumptions and also firm has single goal of profit maximizations. But in real life neither the firm has perfect knowledge nor a single goal to pursue. Economic theory assumes that every firm is a one man firm, run by its owner. The limitations are: 1. firm do not continuously seek maximum profit. 2. large firm run by salaried managers 3. different groups working in a firm, each group has different objectives to pursue. 4. profit maximization is not only die sole objective of a firm, other objectives are also important for the firm.
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MANAGERIAL ECONOMICS 5. Economic theory states the equilibrium point, where marginal cost equals marginal

revenue but hi real world firm cannot reach this point of equilibrium due to shortage of sources.
6. Economic theory is unable to provide satisfactory answers for output, price, cost and

revenue policies when the firm produces many products simultaneously. MANAGERIAL ECONOMICS AND TRADITIONAL ECNOMICS: Managerial is usually described as the economics applied in managerial decision making. It is that branch of economics which bridges the gap between pure economics theory and managerial practice. But there are certain differences between managerial economics and traditional economics. The following table gives the differences between managerial economics and traditional economics. Comparison between Managerial Economics and Traditional Economics Traditional Economics
1. Traditional

Managerial Economics both 1. Managerial economics is only

economics

is

microecomics and macroeconomics in nature

microeconomic in nature
2. Managerial economics has a limited

2. Traditional economic as a wide scope. It deals with each and every aspect of the firm.

scope. It is concerned with decision making and economic theories that guide the managerial decision-making. 3. Managerial economics is a normative science. 4. Managerial economics deals with

3. Traditional economics is both normative and positive sciences

4. Traditional economics is concerned with

theoretical aspects of the firm. 5. Traditional economics consider only the economic aspects of a problem while decision making.

practical aspects of the firm. 5. Managerial economics considers both economic and non economic aspects of a problem while decision-making.

6. Traditional economics deals with both 6. Managerial economics is concerned with micro and macro of a firm decision making of a firm.

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ECONOMICS OF RISK AND UNCERTAINITY Risk and uncertainty go hand in hand, risk and uncertainty coexists. Risk : From decision making point of view is defined as a situation in which there is more than one possible outcome to a business decision and the probability of each outcome is known to the decision- maters or can be reliably estimated. For example introducing a new product can lead to one of a set of possible outcomes i.e., each has an equal chance (product will be successful of product will not succeed). Probability of each possible outcome can be estimated from past experiences or previously conducted market studies. Greater the number and range of possible outcomes, greater is the risk associated with the decision or action. Two approaches to probable outcomes of a business decision. (a) Priori approach based on deductive thinking (b) Posteriori approach based on probability statistically past data. Uncertainty : Arises from changes and refers to a situation in which there is more than one possible outcome of a business decision and where the probability of each specific outcome occurring is not known or can be meaningful estimated. This uncertainty may due to inadequate data of past records. Example: Insurance companies cannot predict fairly accurately the probability of death rate of people insured. Uncertainty for decision making is classified into (a) Complete Ignorance Investors investing without any rational criteria, investor can be risk overture, neurtral or risk inviter or lover

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(b) Partial Ignorance Some Knowledge can be gained from expert regarding future market condition and so probability estimates can be made.

ASYMMETRIC INFORMATION Asymmetric information is the situation in which one party to a transaction has more information than one other party on the quality of the product or service offered for sale. Risk is due to inadequate data. The parties to a transaction may be buyers or sellers of a product or service. Possible Outcomes of Asymmetric Information 1. Firms strategy may fail in market leading to regulation by the government 2. Difficulty in contracting.
3. Possibility of a fraud.

4. Fall in demand of a good due to consumers fear as seller knows more of quality of goods leading to a bad scenario in the market. 5. Seller using more information to his advantage in negotiations. To counteract the effect of asymmetric information firms must acquire and be aware of any information advantage or disadvantage and what courses of action they can avail to help their position. Two Problems causes in market with Asymmetric information
(a) Adverse Selection

(b) Moral Hazard

Adverse Selection: Adverse selection can be defined as a situations resulting from asymmetric information in which parties during a transaction may not come to an agreement, because of distrust on the part of the party with less information of market about the quality or reliability that is being offered in the market.
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Example: Market of used cars selection by providing more information can overcome adverse. Moral Hazard: Moral hazard can be defined as a situation resulting from asymmetric information where the behavior of one party may change to the determine of another after the transactions has taken place. Example: insurance companies can overcome Moral hazard by co insurance where only part of the possible loss/ value of property is insured. MARKET SIGNALING Market Signaling is used in markets where asymmetric information exist and it is a way of passing information to other parties when success of one activity is closely related with success of another activity it is said to be a good signal. Example: Warranties and guarantees act as a signal. A product with a longer duration of warranty signals that it is of high quality warranty can be used as strategy. MANAGERIAL ECONMICS AND ECONOMETRIC MODELS Economics models aim to predict the future behavior of the economic variables encompassed by the model. By explaining the relationship being forecast there models help the manager the decide the firms policies. Economics forecasting models may be 1. Single equation model of the demand that the firm faces for its product
2. Multiple equation models describes hundreds of sectors and industries of the

economy.
1. Single Equation Model: Used by firms to forecast demand or sales. The simplest form of

econometric forecasting is with a single equation model where the relationship is expressed in terms of one equation only.

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The first step would be to identify the determinants of the variable to be forecasted Demand for the product = Q Price of the product = P Consumer disposable income = Y Size of the population = N Advertising expenditure of product = A Assuming relationships to be linear the demand equation can be written as, Q=a0+a1Pt+ a2Yt+ a3Nt+ a4A+ a5Pst+ 62Pct+ a7Zt+e Where, a0 to a7 are parameters to be estimated. Parameter a1 is hypothesized to be negative and a2 to a7 to be positive Ps = Price of the substitute. Pc= Price of the complement Z= any other determinant variable The last term e is an error term means that all variations of demand may not be fully explained. The subscript t refers to time (t=1, 2,,n years)

Once the model has been estimated (values of a determined) and evaluated, the forecasted values of the independent or explanatory variables of the model for the time period for which the dependent variable (Qt), is to be forecasted must be obtained by the firm.

Forecasted values of the macroeconomics variables (Yt,Nt)

are obtained from the

necessary departments i.e.., those who specialize in making such forecasts. The micro variables in the model not under the control of the firm (Pst,Pct) can be forecasted with the help of time series analysis.

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MANAGERIAL ECONOMICS 2. Multiple Equation Model: Multiple equation model is more advanced than a single

equation model which is used when relationships are simple but when these economic relationships become very complex then this model is used. Multiple equation models involve estimating several simultaneous equations. These equations may be
1. Mathematical identifiers ( Definitial equations) 2. Behavioral structural equations. 1. Mathematical Identifier : Express relationships in a definition 2. Behavioral Equation : Relationship between a particular endogenous variable and

other variables on the system is expressed by means of such an equation Behavioral equation have parameter which are not known, they are must to know the economic behavior of consumers and producers (economic groups) There are 2 type of variable in multiple equation models they are i. ii. Endogenous variable Exogenous variables

1. Endogenous variables: Are those dependent variables which a model explanistran its solution. Number of equations in a model must be equal to the number of endogenous variables. Example: Production of commodity depends on inputs like capital employed. 2. Exogenous Variables: Are those uncontrollable variables which are not determined from the solution but from outside the model. Example: Production of commodity can be influenced by external forces like government policy, international competition.

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Illustration Let us consider a national economy model. Zt=Ct+It+Gt.(1) Where Zt= Gross national product Ct=Consumption expenditure It=Investment Gt= Government expenditure Equation (1) can be explained with the help of following simultaneous equations. Ct = a1+b1Zt+u1t It=a2+b2Pt-1+u2t (2) (3)

Where a1,b1,a2,b2 are parameters of the equation u Disturbance term (random error) t current year in order to find out fore cast the values of the endogenous model we assume parameters (a,b) have been correctly estimated. So equations (2) and (3) have been substituted into equation (1) Zt=Ct+It+Gt [: Equation (1) ] Now

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NEW TOOLS FOR OPTIMIZATION Firms managed currently are quite different from firms managed in the previous years as there are new management tools There are 2 new tools for optimization 1. Bench Marking 2. Total Quality Management 1. Bench Marking Bench Marking is also known as fast cycle or rapid bench marking tool. Bench marking is an investigation by a firm into another firms quick, cheap and efficient functioning techniques so that these methods could be adopted and incorporated by the investigating firm. Requirements for Bench Marking
1. Selection of a Specific Process : The Investigating firm should first select a process that

it feels is inefficient ,expensive and needs to be updated as regards its functioning. To update means to improve its efficiency.
2. Identification of Firms : The investigating firm after selecting a process should then

demarcate a few firms having similar processes but which are much cheaper , efficient and productive than its own process.
3. Sending of a Bench Marking Mission Team : The investigating firm should send a

bench marking team to the firms so that they can study and make a detailed report about the technique followed by the firm.
4. Marketing Adjustment and Incorporating the findings into the firms specific process

by copying or improving the technique.

Advantages of Bench Marking 1. Investigation can be done in an open manner

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MANAGERIAL ECONOMICS 2. Technique can be copied or improved by studying another firms specific process. 3. Bench marking improves production and quality thereby improving performance.

4. Results in considerable reduction of costs by cutting of processing cost 5. It is a quick and efficient tool for diagnosis not complicated cumbersome Bench marking used by international firms like IBM , Ford , Xerox to improve productivity. Total Quality Management (TQM) One movement that swept U.S. corporations in the 1980s involved maximizing quality and minimizing costs through total quality management (TQM). This refers to constantly improving the quality of products and the firms processes so as to consistently deliver increasing value to customers. TQM constantly asks, How can we do this cheaper, faster, or better?. It involves worker teams and benchmarking. In its broader form, TQM applies quality-improvement methods to all firm processes from production to customer service, sales and marketing, and even finance. By improving quality and reducing costs in all these areas, Hewlett-Packard achieved spectacular results. Other companies that have successfully used TQM are Xerox, Motorola, General Electric, Marriott, Harley-Davidson, and Ford. The core principles of TQM: Genuine management commitment towards quality and customer satisfaction. Create value for customer. Process improvement Collect and analyse data Cooperation and team work in all business operations
SPDAS (Study, Plan, Do, Act, System) for innovations and improvements

Continuous efforts for improvement Zero defect prevention Clear documentation for execution
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Change in organizational culture Fundamental paradigm shift Top management leadership with positive thinking and relationship building. Elimination of management by fear and control by unemos.
Planning and programming for infrastructure building and human resource

development. Thus, to improve the quality level of both hardware and software of the organization. Customise the TQM programme specifically for particular firm. These can not be a standardization of the TQM process applicable to all. TQM entails several principles such as follows: Quality Planning Quality Control Quality Audit Quality Surveillance Quality Assurance Quality Circle Change in Organizational Structure The failure TQM is attributed to : Weak leadership at variable levels of operations Redesigning Lack of proper incentives Poor planning and management Inconclusive mindset

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Absence of best practices Irresponsibility Absence of corrective measures No statistical thinking Improper learning Lack of attitude Inconsistency and Imperfections

Rules determine the success of a TQM programme: 1. The corporate executive officer (CEO) must strongly and visibly support in with words and actions. 2. The TQM program must clearly show how it benefits customers and creates value for the firm. 3. The TQM program must have a few clear strategic goals; that is, it must ask, What is the firm trying to accomplish
4. The TQM program must provide quick financial returns and compensation

people need to see early and concrete results to continue to support the program.
5. The TQM program should be tailored to a particular firm; that is, one firm

cannot simply copy another firms TQM program. Success TQM program increased quality of products , reduction in cost and increase in competitiveness Failure of a TQM programme is due to lack of one or more determinants of a TQM success programme.
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Advanced TQM model is called six sigma developed by Motorola. It is defined as a model where non-defective products or procedures fall are encompasses within six standard deviations of the mean. Despite some glaring successes from using TQM programs only about a third of American corporations polled indicated that their TQM programs significantly increased the quality of their products, reduced costs, and increased their competitiveness. The most frequent reason for lack of success in TQM programs is the failure of upper management to show a strong personal involvement and commitment to the program. The other reasons for failure were that TQM programs often were not strongly linked to the overall business strategy of the firm or aimed at delivering increasing value to customers. Optimization Analysis: Optimization analysis can best be explained by examining the process by which a firm determines the output level at which it maximizes total profits. We will start by using the total revenue and total-cost curves of the previous sections in order to set the stage for the subsequent marginal analysis, with which we are primarily concerned. 1. In optimization analyzing the relation between total average and marginal concepts and measures is very importance. 2. Objectives of a firm is to make profit. 3. Even, if a firm is maturing profit it tries to maximized profit by minimizing the costs.

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