Why Economics to Business
The reasons for integrating managerial Economics to Management
Studies
Transition from family business to big industries
Decision making process
becoming complex day by day
Use of economic logic, concepts
etc to business decision making
Rapid increase in professionally
trained managerial power
What is Economics
It is social science
Basic function is to study-how people( individuals and households,
firms, nations-
max gains from their limited resources and opportunities
(Optimizing behavior is selecting best of available options with aim of
max gains from limited resources)
Eg: Aneesha is head of household and Earning 25000 per month, and
she is she only one earning member for three family members
Economics study how with her limited resource(income)-choice
making behavior people
What is Managerial Economics
Can be broadly defined as study of
economic theories,
logic and
tools of economic analysis that are used in the process of business
decision making.
Application of Economics to
Managerial Decision Making
Contribution of economics to managerial
decision functions
Business are subject to uncertainty and risk(uncertain market forces, changing
business environment,international factors etc.)
Helps to build analytical models, which help to
recognize the structure managerial problems
and eliminate minor details
A set of analytical methods which can be used
to enhance capabilities of business analyst
Provideclarity to terms used in
business(imports, Exports)
Application of Economics to
Business Decisions
Eg: A firm deciding to launch new product (robot vacuum cleaner) for
which has close substitutes are available
Issues comforting
Production related
Sales prospects and problems
To solve these inputs(production ) and Output( sales and market)
application of economic theories helps
Scope of Managerial Economics
Can be applied directly too two categories
Micro Economics –operational / internal issues
Macro Economics- External issues
Internal Issues
Arises within business organization and that is under control of
management
Choice of technology (choice of factor combination),
nature of product,
choice of price,
how sales should be promoted,
how to decide on new investments
Solutions to this( DD theory dealing with consumer theory, product
theory explaining relationship between input and output), Price theory
explaining how price is determined under different market conditions)
Understanding how profits can be maximized,
Macro economics- related to overall economic, social and political
atmosphere
Type of economic system
Trends in national income, employment, savings investments etc.
Structure and working of financial institutions
Trends in foreign trade
Political environment
Government economic policies
Environmental Factors
Economic Concepts and their use in business
decision making
1. Opportunity cost
2. Marginal Principle
[Link] Principle
[Link] Principle
[Link] concept
6. Equi Marginal principle.
Economic Concepts and their use in business
decision making
Opportunity cost and decision rule
Resources(man made, natural ) are scarce in relation to demand .
Resources has alternative uses( coal, petrol)
Scarcity and Alternative uses give rise to- opportunity cost
Resources available to business unit are limited
1. Imagine a firm (Samsung) 1million for year 2022 for it disposal
A. Expand size
B. New production unit
C. Buy shares or reinvest etc.
Annual Return
Alternative 1: expansion of size- Rs 20 million
Alternative 2 : setting new product unit- RS 18 million
Alternative 3: buying shares- RS 16 miiion
What will be you as a decision maker rationally will choose?
18 million – Opportunity cost
Cost for next best gone alternative
Opportunity cost of availing an opportunity is the forgone income
expected from second best opportunity of using the
resources.
Actual earning- Opportunity cost= Economic gain / Economic
profit.
Applied not only to finance but also other areas where you have to
choose from two alternative.
Cost and Benefit is evaluated for any decision making.
2. Marginal principle and Decision
rule
Marginal analysis is widely used- change (increase/ decrease)
Marginal utility- consumer theory
Marginal cost- production theory
Marginal revenue – pricing theory
For eg: given Factor prices, Total depends on number of units produced.
MC= change in total cost as a result of producing one additional unit of
commodity.
MC = TCn- TCn-1
TC n= total cost of producing n units
Tcn-1= total cost of producing n-1 units
EG: TC for producing 100 units= Rs 2500
TC for 101 units = Rs 2550
Ans:?
TR= depends on no of units sold
MR = TRn- TRn-1
Decision rule= how much to produce so that profit is max
Necessary condition MR= MC(profit of firm is maximized at that
output level cost of producing additional output = rev received from
sale of that additional unit.
limitations
Can be used only when TC , Tr, MC , MR data is available (sell it in
bulk)
Can be applied when only variable cost changes, but most cases both
fixed and variable cost changes
Increment Principle and Decision
rule
Both fixed and variable cost changes , they use increment principle
Incremental principle is applied to business decisions which involve bulk production
and large increase in total cot and total revenue.
Huge increase in TC and TR is called increment cost increment revenue.
Incremental costs
A firm decides to increase production by adding a new plant
Increases total cost of production from 100 million to 115 million=
15 million = Cost change is incremental cost
Components of IC
Present explicit
costs
Opportunity
cost
Future
costs.
Present explicit costs
Present explicit costs= A. fixed cost
[Link] cost
Opportunity cost=expected income from second best forgone
alternative.
Future Costs=depreciation and advertisements cost.
Incremental revenue:
Increase in revenue due to a business decision.
Eg: decision to increase production – increases sales.
Incremental Reasoning –used in Accepting or rejecting business
decisions.
Eg: Cost of new plant- 15 million but incremental revenue expected is
20 million so here they will take decision start the plant.
Time perspective
Time is an important factor in
business decision making. A
timely decision is always
important and rewarding, if
appropriate.
Long Run
Short Run
Time Perspective
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.
Short-run refers to a time period in which some factors of production are
fixed while others are variable
long-run is a time period in which all factors of production can become
variable
Time concept
Short run
Long run
Certain decision may be viable only in short run, sometimes even if it
is loss in short run it will capture market in long run.
Eg: spending on labour advancements.
Taking a decision to produce crackers for long run is unwise.
Discounting Principle
A present gain is valued more than a future gain.
According to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible.
This is essential because a rupee worth of money at a future date is not worth a rupee
today. Money actually has time value
Equi - marginal principle
Its very significant in determining optimal condition in
resource allocation.
Marginal Utility is the utility derived from the additional
unit of a commodity consumed. The laws of equi-
marginal utility states that a consumer will reach the
stage of equilibrium when the marginal utilities of various
commodities he consumes are equal.
A manger can make rational decision by allocating/hiring
resources in a manner which equalizes the ratio of
marginal returns and marginal costs of various use of
resources in a specific use.