MODULE-1AND2 (1)

MANAGERIAL ECONOMICS
MODULE -1
Introduction
To keep the pace with the change in the nature of business

organizations and how business is conducted.
To supplement the real life cases
To explore the techniques of business
To make students understand the various dimensions of

business problems and possible solutions.
Meaning
• Managerial economics is a branch of
economics involving the application of
economic methods in the organizational
decision-making process.
• Economics is the study of the production,
distribution, and consumption of goods and
services
Nature of Managerial Economics
Coordination
An activity or ongoing process
A purposive process
An art of getting things done by other
people
Decisions like: what, how for whom to
produce?
Scope of Managerial Economics
Resource allocation
Inventory and queuing problem
Pricing problem
Investment problems
Demand analysis
Cost analysis
Pricing theory and
policies
Profit analysis with special reference to
break- even point
Capital budgeting for investment decisions
The business firm and objectives
Competition
Linked with microeconomic theory, macro
economic theory , operation research, theory
of decision making, statistics, management
theory & accounting
Managerial Economists in Decision making
Defining the problem

Determining the objective
Exploring the alternatives
Predicting the consequences
Making choice
Performing sensitivity
analysis
Decision Making process
Micro & Macro Analysis
Partial and General Equilibrium Analysis
Static, Comparative Static and Dynamic Analysis
--allowing no change at a point of time (static)
-- allowing once for all change at a point of time
(comparative static)
--allowing successive changes over a period of
time (dynamic)
Positive and Normative analysis
FUNDAMENTAL PRINCIPLES OF
MANAGERIAL ECONOMICS
Opportunity Cost (Opportunity Lost)
The next best alternative is forgone
Costs of sacrificed alternatives
Manager takes a decision by
choosing one course of action,
sacrificing the other alternatives
Production of car or scooter?
Production possibility curve & increasing marginal
opportunity cost
Incremental Principle
The incremental principle is used to measure the profit potential

of a project. According to this theory, a project is sound if it
increases total profit more than total cost.
--To have a proper estimation of profit potential by application of
incremental principle, several guidelines should be maintained:
the
remains related
--Incidental to theAny
Effects: other activities
kind of the
of project firm.
taken byBecause of this,
a company
the particular
either project
negatively influencesIt all
or positively. canthe other activities
increase carried
the profits out,
for the firm
or it may cause losses. These incidental effects must be
considered.
represent an expenditure
Sunk Costs: These costsdone by not
should the be
firmconsidered.
in the past.Sunk
These
costs
denote all those
expenditures areexpenditures thatany
not related with areparticular
done for the preliminary
project. work
These costs
related to the project, unrecoverable in any case.
The main objective of this principle is maximization of profits. Or
In other words to raise the profits in the business
General rule:
By increasing in the production, the total cost of the product
raises and simultaneously profit also rises.
Practicality in the business:
How much we extra we should produce to get the best profits
and how much extra cost is incurring for the extra production.
It is related to the marginal cost and marginal revenue concepts
in economic theory. 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 or
whatever else may be at stake in the decisions. The two basic
components of incremental reasoning are:
Incremental cost
Incremental revenue.
Incremental cost may be defined as the change in total cost
resulting from a particular decision. Incremental revenue is the
change in total revenue resulting from a particular decision.
The incremental principle may be stated as follows: A decision is
a profitable one if—
a) it increases revenue more than cost
b) it decreases some costs to a greater extent than it increases
others
c) it increases some revenues more than it decreases others
and
d) it reduces cost more than revenues.
Suppose a firm gets an order that brings additional revenue of
Rs 3,500. The cost of production from this order is:
Rs
Labour 800
Materials 1,300
Overheads 1,000
Selling and administration expenses 700
Full cost 3,800
At a glance, the order appears to be unprofitable. But suppose the firm has some idle
capacity that can be utilised to produce output for new order. There may be more efficient
use of existing labour and no additional selling and administration expenses to be incurred.
Then the incremental cost to accept the order will be:
Rs
Labour 600
Materials 1,200
Overheads 900
Total incremental cost 2700
Time Perspective
All business decision are taken with a certain time perspective.
The time perspective refers to the duration of time period

extending from the relevant past* and foreseeable future taken
in view while taking a business decision.
period of past experience and trends which are relevant for

business decisions with long run implications.
All business decisions do not have the same time perspective.
Eg: Manufacturing of Crackers

Eg: Management Institute.
Principle of time perspective
Time Perspective
Principle: “a decision by the firm should take

into account of both short-run and long-run
effects on revenues and cost & maintain the
right balance between the long run and short
run.
According to this principle, a manger/decision

maker should give due emphasis, both to
short-term and long-term impact of his
decisions, giving apt significance to the
different time periods before reaching any
decision.
factors are
Short-run refers to a time period in which some
fixed while others are variable. The

production can be increased by
increasing the quantity of variable
factors. While long-run is a time period
in which all factors of production can
become variable. Entry and exit of
seller firms can take place easily.
From consumers point of view, short-
run refers to a period in which they
respond to the changes in price, given
the taste and preferences of the
consumers, while long-run is a time
period in which the consumers have
enough time to respond to price
changes by varying their tastes and
preferences.
Discounting principle
A present gain is valued more than a future gain.
Thus, in investment decision making, discounting of future
value with the present one is very essential.
The following formula is useful in
this regard:
V= A
(1 + i)
Where , V = present value, A =
annuity or returns expected during
a year, i
= current rate of interest.
To illustrate the formula, suppose A = 110 and i = 10%
or 1/10, we can ascertain the present value Rs. 110
one year after as:
V = 110 = 110 = 100

1 + 0.1 1.1
In business decision making process, thus, the discounting
principle may be stated as: “If a decision affects costs and
revenues at future dates, it is necessary to discount those costs and
revenues to present values before a valid comparison o alternatives is
possible”
EQUI MARGINAL PRINCIPLES
This principle suggests that available resources

(inputs) should be so allocated between the
alternative options that the marginal productivity
gains (MP) from the various activities are equalized.
Example: students allocating limited
available days for existing subjects during
examinations for getting best percentage.
14 days to go for examinations and
having 7 subjects. Students may not
always allot 2 days for each subject, they
may allot more days for hard subject and
less days for easy subject to maintain
good percentage
Example:
Equi-marginal principle is applied in the allocation of the
resource in the way of production. Example a farmer is having
different four agricultural farms like
1. Paddy
2. Mangoes
3. Sugar cane
4. Corns.
The above four agricultural farms are in the total 80 acres,
each farm in the 20 acres, all together 80 acres. The farmer is
having limited 80 employees with him for employing in the
four farms for production. In general, 80 employees are divided
and employed for four farms evenly as each farm will be
allotted with 20 employees. However, in reality there is no
need to allot 20 employees for each farm, because mango
farm need less number of employees, whereas paddy farm
needs more number of employees. Sugarcane and corn farms
require average number of employees. Like shown below
Farms Labour employees
Paddy 30
Mangoes 20
Sugarcane 15
Corns 15
Total 80
The above table reveals the allocation of the resources (labour) available
with a farmer according to the production nature and requirement.

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MANAGERIAL ECONOMICS

To keep the pace with the change in the nature of business

To supplement the real life cases

To explore the techniques of business

To make students understand the various dimensions of

Defining the problem

The incremental principle is used to measure the profit potential

All business decision are taken with a certain time perspective.

The time perspective refers to the duration of time period

period of past experience and trends which are relevant for

All business decisions do not have the same time perspective.

Eg: Manufacturing of Crackers

Principle: “a decision by the firm should take

According to this principle, a manger/decision

fixed while others are variable. The

V = 110 = 110 = 100

This principle suggests that available resources

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