1.
Managerial economics and gap between theory and practice
Managerial economics is economics applied in decision making. It is based on economic
analysis for identifying problems, organizing information and evaluating alternatives.
Managerial Economics assists the managers of a firm in a rational solution of obstacles faced in
the firm’s activities. It makes use of economic theory and concepts. It helps in formulating
logical managerial decisions
Managerial economics applies economic theory and methods to business and administrative
decision making Managerial economics links economics and the decision sciences to develop
tools for managerial decision making. This approach is successful because it focuses on the
application of economic analysis to practical business problem solving.
2. Theory of production and production decision
PRODUCTION WITH ONE VARIABLE INPUT
Short-Run and Long-Run Production
Our analysis of production and cost makes an important distinction between
the short run and the long run. In the short run one or more of the firm’s inputs is fixed; that is,
they cannot be varied. In the long run the firm can vary all of its inputs. There is no universal
rule for distinguishing between the short and long run; rather, the dividing line must be drawn on
a case-by-case basis.
Within the limits of its production technology, the firm’s managers face a number of important
decisions.
We have already discussed finding the optimal use of single input in the short run and choosing
the best mix of inputs in the long run. We now consider two other decisions:
1
(1) The allocation of a single input among multiple production facilities and
(2) The use of an input across multiple products.
Production is the process of turning inputs into outputs.
To maximize profit, the firm should increase usage of a variable input up
to the point where the input’s marginal cost equals its marginal revenue product.
To minimize the cost of producing a particular amount of output, the
firm should choose an input mix such that the ratio of the marginal product to the input’s
cost is the same across all inputs.
In allocating an input among multiple plants, the firm maximizes total output when
marginal products are equal across facilities.
In allocating an input among multiple products, the firm maximizes total profit when
marginal profits per unit input are equal across products.
3. Why is the understanding of the principles of managerial economics
necessary for businesses manager?
identify goals and constraints
recognize the nature and importance of profits
understand incentives
understand markets
recognize the time value of money; and
Use marginal analysis.
4. What is meant by monopoly profit
Asserts that some firms are sheltered from competition by high barriers to entry.
To maximize profits, a monopoly will choose to produce that output level for which marginal
revenue is equal to marginal cost. Because the monopoly, in contrast to a perfectly competitive
firm, faces a negatively sloped market demand curve, marginal revenue will be less than
the market price.
A profit-maximizing monopolist produces that quantity for which marginal revenue is equal to
marginal cost.
2
5. Briefly discuss the reason it is important for manger to understanding the
various types of demand?
It arranges the factors of production,
It assembles and organizes the resources,
It integrates the resources in effective manner to achieve goals.
It directs group efforts towards achievement of pre-determined goals
6. What are the possible consequence of a large scale firm placing its product
in the market without having estimated the demand for its product?
It will result the following consequences:
The firm of the entity my experience loss on its business
The market share may be taken by other competitors
The firm may run out of the business
Its income will reduce in large amount
The firm may not regain its ability to stay in the market for some other time
7. How do incremental and sunk cost differ from marginal cost?
Incremental cost Sunk cost
Is the change in cost caused by a given Inherent in the incremental cost concept is
managerial decision. Whereas marginal the principle that any cost not affected by a
cost is the change in cost following a one- decision is irrelevant to that decision. A cost
unit change in output, incremental costs that does not vary across decision
typically involve multiple units of output. alternatives is called a sunk cost; such costs
do not play a role in determining the optimal
course of action.
3
8. Why do profit vary among firms?
Even after risk adjustment and modification to account for the effects of accounting error and
bias, ROE numbers reflect significant variation in economic profits. Many firms earn significant
economic profits or experience meaningful economic losses at any given point. To better
understand real-world differences in profit rates, it is necessary to examine theories used to
explain profit variations.
Frictional profit theory
abnormal profits observed following unanticipated changes in demand or cost conditions
Monopoly profit theory
Above-normal profits caused by barriers to entry that limit competition
Innovation profit theory : Above-normal profits that follow successful invention or
modernization
Compensatory profit theory : Above-normal rates of return that reward efficiency
9. Role of business in society?
Business contributes significantly to social welfare.
Benefits of that growth have also been widely distributed. Suppliers of capital, labor, and other
resources all receive substantial returns for their contributions. Consumers benefit from an
increasing quantity and quality of goods and services available for consumption. Taxes on the
business profits of firms, as well as on the payments made to suppliers of labor, materials,
capital, and other inputs, provide revenues needed to increase government services. All of these
contributions to social welfare stem from the efficiency of business in serving economic needs.
[Link] are the relation among historical cost , current cost and opportunity
cost?
Opportunity cost: is the foregone value associated with the current rather than next-best use
of an asset. In other words, cost is determined by the highest-valued opportunity that must
be foregone to allow current use.
4
Historical cost: Actual cash outlay
For tax purposes, historical cost, or actual cash outlay, is the relevant cost. This is also generally
true for annual 10-K reports to the Securities and Exchange Commission and for reports to
stockholders
Current cost: is the amount that must be paid under prevailing market conditions. Current cost
is influenced by market conditions measured by the number of buyers and sellers, the present
state of technology, inflation, and so on. For assets purchased recently, historical cost and current
cost are typically the same.
Current costs are a measure of the market value of an asset at the present time.
11. The president of small firm has been complaining to his controller about rising
labor and material cost. However the controller notes that average cost have no
increased during the past year. Is it possible?
They represent unknown quantities to be solved for. The decision maker can control the value of
the objective, which is achieved through choices in the levels of decision variables. For example,
how much of each product should be produced in order to obtain the greatest profit?
[Link] does the term corporate social responsibility mean? Why should
firms expend resource on such concern?
What does all this mean with respect to the value maximization theory of the firm? Is the model
adequate for examining issues of social responsibility and for developing rules that reflect the
role of business in society.
Firms are primarily economic entities and can be expected to analyze social responsibility from
within the context of the economic model of the firm. This is an important consideration when
examining inducements used to channel the efforts of business in directions that society desires.
Similar considerations should also be taken into account before applying political pressure or
regulations to constrain firm operations.
5
[Link] are those sources of uncertainty?
Uncertainty is a situation which can result in a number of outcomes but one is not sure as to
which outcome is to be materialized
Since human beings are limited in its aspects of knowing tomorrow
The environment we live are also dynamic
[Link] why the price elasticity of demand will be greater for luxury motor
cars than for a pint of milk ?
Price elasticity of demand relates to the responsiveness of quantity demand of a good to
the change in its price. According to the minimax regret criterion, the decision should be to
expand rather than the maintan status quo or sell now.