ASSIGNMENT

MANAGERIAL ECONOMICS
ECONOMIC WAY OF THINKING:LEARNING FOR A MANAGER

MANAGERIAL ECONOMICS

ECONOMIC WAY OF THINKING:LEARNING FOR A MANAGER

INTRODUCTION
Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. Economics includes a vast range of topics, important ones include Studies international trade and finance and the impacts of globalization. Looks at growth in developing countries. Explores the behaviour of the financial markets, including interest rates and stock prices. How the governmental policies can be used to pursue important economics aspects like efficient use of resources, price stability and a rapid growth. Managerial economics therefore refers to the application of economic theory and the tools of analysis of decision science to examine how an organization can achieve its aims or objectives most efficiently. There are basically two key ideas associated with economics; the goods are scarce and that the society must use them in the most efficient way. Indeed, economics is an important subject because of the fact of scarcity and the desire for efficiency. Ours is a world of scarcity, full of economic goods. Scarcity is an economic problem of humans who have unlimited wants and needs in a world of limited resources. Here comes the role of Efficiency, which denotes the most effective use of societys resources in satisfying peoples wants and needs. The essence of economics is to acknowledge the reality of scarcity and then figure out how to organize society in a way which produces the most produces the most efficient use of resources. That is where economics makes its unique contribution.

BRANCHES OF ECONOMIC ANALYSIS

There are two branches of economic theory which helps the organizations to solve their management decision problems by the application of the theory and the tools of decision science. Economic theory refers to microeconomics and macroeconomics.

Microeconomics is the study of economic behaviour of individual decisionmaking units, such as individual consumers, resource owners, and business firms, in a free enterprise system. It examines how these decisions and behaviours affect

the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the quantity supplied and quantity demanded of goods and services. One of the goals of microeconomics is to analyze market mechanisms that establish relative prices amongst goods and services and allocation of limited resources amongst many alternative uses.

Macroeconomics is the study of the total or aggregate level of output, income,

employment, consumption, investment, and prices for the economy viewed as a whole. This includes national, regional and global economies. Today macroeconomics examines a wide variety of areas, such as how total investments and consumptions are determined, why some nations grow rapidly while others stagnant. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions. Economic relationships are often complex, involving many different variables, and hence one tends to confuse about the exact reason behind the impact of policies on the economy. The following are some of the common fallacies encountered in economic reasoning: The post hoc fallacy: The post hoc fallacy occurs when we assume that, because one event occurred before another event, the first event caused the second event. An example of this syndrome occurred in the Great Depression of the 1930s in the United States. Failure to hold other things constant: It is essential to hold other things constant when you are analyzing the impact of a variable in the economic system. The fallacy of composition: When you assume that what is true for the part is also true for the whole, you are committing the fallacy of composition. An example to this is if one farmer has a bumper crop, he has a higher income; if all farmers produce a record crop, farm incomes will fall. The ultimate goal of economic science is to improve the living conditions of people in their everyday lives. There are three fundamental questions of economic organization- what, how and for whom. What commodities are produced and in what quantities? How are goods produced? For whom are goods produced? Who gets to eat the fruit of economic activity?

Positive Economics vs. Normative Economics

Positive economics deals with questions such as Why do doctors earn more
than janitors? What is the impact of computers on productivity? Although these are

all difficult questions to answer, they can be resolved by reference to analysis. That puts them in the realm of positive economy.

Normative economy involves ethical precepts and norms of fairness. Should

poor people be required to work if they are to get government assistance? These questions involve ethics and values rather than facts.

Market, Command and Mixed Economies

Market economy is one in which individuals and private firms make the major
decisions about production and consumption. Firms produce the commodities that yield the highest profits by the techniques of production that are least costly and consumption is determined by individuals decisions about how to spend the wages and other incomes and property ownerships.

Command economy is one in which the government makes all the important
decisions about production and consumption. The government answers the major economic questions through its ownership of resources and its power to enforce decisions.

Mixed economy is an economy which comprises of elements of both market

economy and command economy. No economy is strictly a market economy or command economy. All the economies have some elements of both the economies. Examples of such economy are India.

PRODUCTION POSSIBILITY FRONTIER

The PPF shows the maximum amounts of production that can be obtained by an economy, given its technology and quantity of inputs available. The production possibility frontier shows there are limits to production, so an economy, to achieve efficiency, must decide what combination of goods and services can be produced. Example:

As we can see at point B in order to produce more capital goods, some of the consumer goods resources will have to be sacrificed and at point A capital good is being sacrificed in order to produce more consumer good. Here all the three point

i.e. A, B & E represent efficiently utilization of resources. Now its up to economy to choose any combination among them.

Opportunity Cost
It is value of what is foregone in order to achieve something else. For instance an individual has a choice between two telephone services. If he or she were to buy the most expensive service, that individual may have to reduce the number of times he or she goes to the movies each month. Giving up these opportunities to go to the movies may be a cost that is too high for this person, leading him or her to choose the less expensive service. So here the amount which he/she earlier use to invest in watching movie is foregone. This foregone amount is Opportunity Cost.

THE FIRM, VALUE & WEALTH CREATION

A firm is an organization that combines and organizes resources for the purpose of producing goods and/or services for sale. There are millions of firms in India which include individual owned firms, partnerships and corporations. Firms produce about 70 percent of all goods and services produce in India. In the process of supplying the goods and services that society demands, firms provide employment to workers and pay taxes, which the government uses to provide services.

Goals of Firms
The main goal of the firm is to maximize profits. Profits are the revenues collected by the firm less the costs incurred in the production of the commodities or services. Profit = Total Revenue Total Cost Where total revenue is determined by the level and nature of the competition in the market and the total cost is determined by factor market prices and the firms technology or production function. These profits are also called as Economic Profits. The other goals that the firm might pursue are market share, profit margin, return on investment, technological advancement, customer satisfaction, shareholder value.

Functions of Profit

Profit serves a crucial function in a free-enterprise economy. High profits show that the customers want more of the output of the industry, on the other hand, lower profits or losses are the signal that the consumers want less of the commodity and/or that production methods are not efficient.

Present Value, Future Value & Net Present Value Present Value is the value of a commodity at the present time or given date. Future Value is the value of the commodity in sometime in future or on a certain
date in future.

Net Present Value is the difference between the present value and the actual
spending on a commodity or asset. If the value is negative, the deal will result in a loss & if positive then profit.

Maximization of Shareholders Wealth

Means maximization of the market value of the existing shareholders common stock price because the effects of all financial decisions are included. Private Investors react to poor investment or dividend decisions by selling stocks and causing the total market value of the public shares to fall. Investors can react to good decisions by pushing up the price of stocks and create wealth for the Shareholder. The market price of the public corporation reflects the value of the public corporations seen by its owners (investors = shareholders = equity holders) and takes into account the complexity and complications of the real-business risks. The unifying objective in corporate finance is to maximize the share value of the public firm. Investment projects, financing structure and dividend decisions must be directed by management toward share value maximization objective. The objective is narrowed from maximizing firm value to maximizing stockholder value or stockholder wealth.

Value =
t =1

E CF$, t

1 k t

E (CF$,t )= expected cash flows to be received at the end of period t in $ or . n=the number of periods into the future in which cash flows are received k=the required rate of return by investors

DEMAND, SUPPLY AND MARKET EQUILIBRIUM

Demand and supply are one of the most fundamental concepts of economics and the powerful tools for explaining the changes in an economic environment. For example the increase in the price of gasoline occurred either because the demand for gasoline had increased or because the supply of oil had decreased. The same is true for every market; change in supply and demand drive changes in output and prices.

Demand refers to how much (quantity) of a product or service buyers desire at a

certain price. The relationship between price and quantity demanded is known as the demand relationship.

Supply represents how much the market can offer. The quantity supplied refers to
the amount of a certain good producers are willing to supply when receiving a certain price. The dynamics between price and how much of a good or service is supplied to the market is known as the supply relationship. In market economy theories, demand and supply theory allocates resources in the most efficient way possible. There exists a definite relationship between the market price of a good and the quantity demanded of that good, other things held constant. This relationship between price and quantity bought is called the demand schedule.

THE DEMAND CURVE

The graphical representation of the demand schedule is the demand curve. The market demand curve is found by adding together the quantities demanded by all individuals at each price. Law of downward sloping demand: When the price of a commodity is raised, buyers tend to buy less of the commodity. Similarly when the price is lowered, other things being constant, quantity demand increases. A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantities demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the inverse relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C).

Forces behind the Demand Curve

A whole array of factors influences how much will be demanded at a given price. The average income of consumers is a key determinant of demand. As peoples income rise, individuals tend to buy more of almost everything, even if prices dont change. The size of the market. The prices and availability of related goods influence the demand for a commodity.

THE SUPPLY CURVE

The supply side of a market typically involves the terms on which business produce and sells their products. The supply schedule for a commodity shows the relationship between its market price and the amount of that commodity that producers are willing to produce and sell, other things held constant.

The Law of Supply: Like the law of demand, the law of supply demonstrates the
quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at higher price increases revenue.

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantities supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the price will be P2, and so on.

Forces behind the Supply Curve

Technology: Computerized manufacturing lowers production costs and increases supply. Input prices: A reduction in the wage paid to workers lowers production costs and increases supply. Prices of related goods: If truck prices falls, the supply of cars rises. Government policy: Removing quotas and tariffs on imported automobiles increases total automobile supply. Special influences: Internet shopping and auctions allow consumers to compare the prices of different dealers more easily and drives highcost sellers out of business.

SHIFT IN DEMAND & SUPPLY CURVE

A shift in a demand or supply curve occurs when a good's quantity demanded or supplied changes even though price remains the same. For instance, if the price for a bottle of beer was $2 and the quantity of beer demanded increased from Q1 to Q2, then there would be a shift in the demand for beer. Shifts in the demand curve imply that the original demand relationship has changed, meaning that quantity demand is affected by a factor other than price. A shift in the demand relationship would occur if, for instance, beer suddenly became the only type of alcohol available for consumption. Conversely, if the price for a bottle of beer was $2 and the quantity supplied decreased from Q1 to Q2, then there would be a shift in the supply of beer. Like a shift in the demand curve, a shift in the supply curve implies that the original supply curve has changed, meaning that the quantity supplied is affected by a factor other than price. A shift in the supply curve would occur if, for instance, a natural disaster caused a mass shortage of hops; beer manufacturers would be forced to supply less beer for the same price.

THE MARKET EQUILIBRIUM:

This comes at that price and quantity where the forces of supply and demand are in balance. At the equilibrium price, the amount that buyers want to buy is just equal to the amount that sellers want to sell. At this point there is no reason for price to rise or fall, as long as other things remain constant. The equilibrium price is also called the Market Clearing Price which denotes that all the demand and supply orders are filled; the books are cleared of orders, and demanders and suppliers are satisfied. It is the point at which the supplier and the consumer are happy to sell and purchase the commodity. If the supply is too high than it will be a surplus, in which the sellers have to cut down the market price of a commodity in order to clear the market and if the supply is low and the demand is too high it will be a shortage than the supplier has to increase the price with increase in supply to bring the market to its equilibrium point.

Fig-6 Market Equilibrium comes at the intersection of supply and demand curve