Scribd
Upload
15 views2 pages

Module 1 Basic Principles of ME

The document outlines the basic principles of Managerial Economics, including key concepts such as marginal analysis, incremental analysis, and opportunity cost. It emphasizes the importance of time perspective, equi-marginal principle, discounting, and the management of risk and uncertainty in decision-making. Each concept is explained in relation to its significance in optimizing firm performance and resource allocation.

Uploaded by

sajiniossajini0
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
15 views2 pages

Module 1 Basic Principles of ME

The document outlines the basic principles of Managerial Economics, including key concepts such as marginal analysis, incremental analysis, and opportunity cost. It emphasizes the importance of time perspective, equi-marginal principle, discounting, and the management of risk and uncertainty in decision-making. Each concept is explained in relation to its significance in optimizing firm performance and resource allocation.

Uploaded by

sajiniossajini0
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

Managerial Economics – Study Notes - Module 1

BASIC PRINCIPLES OF Managerial Economics


1. Marginal concept
2. Incremental concept
3. Time concept
4. Opportunity cost concept
5. Discounting concept
6. Equi-marginal concept
7. Risk and uncertainty concept

1. Marginal Concept
Marginal generally refers to small changes. Marginal analysis implies judging how the change in
one variable input impacts on the change in output. Marginal revenue is the change in total revenue
as per unit change in output sold. Marginal cost refers to change in total costs as per unit change in
output produced. The theory of marginal analysis states that whenever marginal benefit exceeds
marginal cost, a manager should increase activity to reach the highest net benefit. Similarly, if
marginal cost is higher than marginal benefit, activity should be decreased. If the marginal revenue
is greater than the marginal cost, then the firm should continue to produce the products or bring the
change in price.
Sunk costs, fixed costs, and average costs do not affect marginal analysis. They are irrelevant to
future optimal decision-making. Marginal analysis can only address what happens if the firm hires
one additional employee, produces one additional product, devotes additional space to research
and so forth.

2. The Incremental Concept


Incremental analysis refers to the change in the firm’s performance for a given managerial decision.
It refers to changes in cost and revenue due to a policy change. Change in output due to change in
process, product or investment is considered as incremental change. Incremental concept involves
estimating the impact of decision alternatives on costs and revenues, emphasizing the changes in
total cost and total revenue resulting from changes in prices, products, procedures, investments in
the decision. Incremental principle states that a decision is profitable, if revenue increases more than
costs or if costs reduce more than revenues.

The two major concepts in incremental analysis are incremental cost and incremental revenue.
Incremental cost denotes change in total cost resulting from a particular decision; whereas
incremental revenue means change in total revenue resulting from a particular decision of the firm.

3. Time Perspective Concept


The time perspective concept states that the decision maker must give due consideration to the
various time periods, such as Short run and Long run effects of his decisions. In the short period,
the firms cannot change their size of operation and they can vary only variable factors. In the long
period, the firms have enough time to increase their sizes and also change both variable and fixed
inputs. Managerial economists are concerned with the short run and long run effects of decisions on
revenues as well as costs. The main problem in decision making is to establish the right balance
between long run and short run.

5
Managerial Economics – Study Notes - Module 1

4. Opportunity Cost Concept


Opportunity cost represents the benefits or revenue forgone by pursuing one course of action rather
than another best available alternative course of action. Opportunity cost of a decision is the
sacrifice of best available alternatives required by that decision. Opportunity cost concept is useful
in decision involving a choice between different alternative courses of action. Resources are scarce,
we cannot produce all the commodities. For the production of one commodity, we have to forego
the production of another commodity. We cannot have everything we want; therefore, we are forced
to make a choice. The economic significance of opportunity cost is: (i) It helps in determining
relative prices of different goods; (ii) It helps in determining normal remuneration to a factor of
production; (iii) It helps in proper allocation of factor resources.

5. Equi-Marginal Concept
The equi-marginal principle states that an input should be allocated so that value added by the last
unit is the same in all cases. An optimum allocation cannot be achieved if the value of the marginal
product is greater in one activity than in another. It would be, therefore, profitable to shift labour
from low marginal value activity to high marginal value activity, thus increasing the total value of
all products taken together. It is behind any rational budgetary procedure, and investment decisions
and fund allocation of various projects. For a consumer, this concept implies that money may be
allocated over various commodities such that marginal utility derived from the use of each
commodity is the same. Similarly, for a producer this concept implies that resources be allocated in
such a manner that the marginal product of the inputs is the same in all uses.

6. Discounting Concept
This concept is an extension of the concept of time perspective. Since future is unknown and
incalculable, there is lot of risk and uncertainty in future. Everyone knows that a rupee today is
worth more than a rupee will be two years from now. In technical parlance, the present value of one
rupee available at the end of two years is the present value of one rupee available today. The
mathematical technique for adjusting for the time value of money and computing present value is
called ‘discounting’. For making a decision in regard to any investment which will yield a return
over a period of time, it is advisable to find out its ‘net present worth’. Unless these returns are
discounted and the present value of returns calculated, it is not possible to judge whether or not the
cost of undertaking the investment today is worth. The concept of discounting is found most useful
in managerial economics in decision problems pertaining to investment planning or capital
budgeting.

7. Risk and Uncertainty


Future is uncertain and involves risk. The uncertainty is due to unpredictable changes in the
business cycle, structure of the economy and government policies. The management must assume
the risk of making decisions for their institution in uncertain and unknown economic conditions in
the future. Firms may be uncertain about production, market prices, strategies of rivals, etc. Under
uncertainty, the consequences of an action are not known immediately for certain. Risks from
unexpected changes in a firm’s cost and revenue data cannot be estimated. The managerial
economists have tried to take account of uncertainty with the help of subjective probability. The
probabilistic treatment of uncertainty requires formulation of definite subjective expectations about
cost, revenue and the environment.

You might also like