MANAGERIAL

ECONOMICS
BY
PARAS SABBERWAL

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Managerial + Economics

• Managerial Economics is
economics applied in
decision-making
• Link between abstract theory
and managerial practice.
• Analysis for identifying
problems, organizing
information and evaluating
alternatives.

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 Managerial Economics &
Business Decision-making

Decision Problem

Tools &
Traditional Managerial Economics Techniques
Economics
of Analysis

Optimal Solution to Business Problems

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 Nature of Managerial Economics

Spencer and Siegelman point to the fact

that “Managerial Economics.. is the
integration of economic theory and business
practice for the purpose of facilitating
decision-making and forward planning by
management.”

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 Chief Characteristics of
Managerial Economics/Nature
• Managerial economics is micro-economic in character
as it concentrates only on the study of the firm and not
on the working of the economy.
• Managerial economics takes the help of macro-
economics to understand and adjust to the
environment in which the firm operates.
• Managerial economics is normative rather than
positive in character.
• It is both conceptual (theory) and metrical
(quantitative techniques).
• The contents of managerial economics are based mainly
on the “theory-of firm’.
• Knowledge of managerial economics helps in making
wise choices.

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 Significance of Managerial
Economics
• In order to enable the manager to
become a more competent model
builder,managerial economics provides
a number of tools and techniques.
• Managerial economics provides most of
the concepts that are needed for the
analysis of business problems.
• Managerial economics is helpful in
making decisions.
• Evaluating choice of alternatives.

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Scope of Managerial Economics

Following aspects constitute its subject matter:-

 Objectives of a Business Firm

 Demand Analysis and Demand Forecasting
 Production and Cost
 Competition
 Pricing and Output
 Profit
 Investment and Capital Budgeting and
 Product Policy, Sales Promotion and Market Strategy.

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 Managerial Economics & Other
Disciplines

• Managerial Economics & Traditional Economics

• Managerial Economics & Operations Research

• Managerial Economics & Mathematics

• Managerial Economics & Statistics

• Managerial Economics & the Theory of

Decision-making
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FUNDAMENTAL
CONCEPTS

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 Fundamental Concepts

• Incremental Reasoning
• Opportunity Cost
• Contribution
• Time Perspective
• Time Value of Money – Discounting
Principle &
• Equi-Marginal Principle
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 1.Incremental Reasoning
The two basic concepts in the incremental analysis
are : incremental cost and incremental revenue.
• Incremental cost may be defined as the
change in total cost as a result of change in the
level of output, investment, etc
•Incremental Revenue is change in total
revenue resulting from change in level of output ,
price etc.
Use of Incremental Reasoning
While taking a decision, a manager always
determines the worthwhile ness of a decision on
the basis of criterion that the incremental revenue
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should exceed incremental cost.
Illustration:
The firm gets an order The addition to cost due
which can get it an to new order is the
additional revenue of Rs.
2000. The normal cost following:
of production of this Labour Rs.400
order is:
Materials 800

Labour Rs.600 Overheads 200

Materials 800 Full cost Rs.1400

Overheads 720 • Firm would earn a net

Selling & 280 profit of Rs 2,000 – Rs.
administrati 1400 = Rs. 600 while at
on expenses first it appeared that the
firm would make a loss
Full cost Rs.2400
of Rs.400 by accepting
the order.

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A course of action should be
pursued up to the point where its
incremental benefits equal its
incremental costs.

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 2.Opportunity Cost
• Opportunity cost, therefore, represents the
benefits of revenue forgone by pursuing one
course of action rather than another.
For e.g:
(a) The opportunity cost of the funds employed
in one’s own business is the amount of interest
which could have been earned had these funds
been invested in the next best channel of
investment
(b) The opportunity cost of using an idle
machine is zero, as its use needs no sacrifice of
opportunities.
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 Opportunity Cost
•Opportunity cost includes both the explicit and
implicit costs:-

Explicit costs are recognized in the accounts , e.g.,

the payments for labour, raw materials, etc

Implicit (or imputed) costs are sacrifices that are

not recorded in accounting e.g. cost of capital
supplied by owners of business.

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 3.Contribution

•Contribution tells us about the contribution of a

unit of output to overheads and profit.
•It helps in determining the best product mix when
allocation of scarce resources is involved.
•It also indicates whether or not it is advantageous
to accept a fresh order, to introduce a new product,
to shut down to continue with the existing plant etc.
•Unit contribution is the per unit difference of
incremental revenue from incremental cost

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 4.Time Perspective
Economists often make a distinction between short
run and long run.
•Short run means that period within which some of
the inputs (called fixed inputs) cannot be altered.
•Long run means that all the inputs can be
changed.
Economists try to study the effect of policy
decisions on variables like prices, costs, revenue,
etc, in the light of these time distinctions.

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 5.Discounting Principle
•The concept of discounting future is based on the
fundamental fact that a rupee now is worth more than a rupee
earned a year after.
•Unless these returns are discounted to find their present
worth, it is not possible to judge whether or not it is worth
undertaking the investment today.

Illustrations

Suppose a sum of Rs.100 is due after 1 year. Let the rate of

interest be 10% . We can determine the sum to be invested
now so as to produce the return (R) of Rs.100 at the end of 1
year. The present value of the discounted value of Rs. 100
will then be,

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 R 100
V1    Rs.90.90
1  i  1.10
The same reasoning can be used to find the present value of longer
periods. A present value of Rs.100 due two years later would be,
Rs.100 Rs.100 Rs.100
V2     82.64
1  i  (1.10)
2 2
1.21
We can thus write the present worth of a stream of income spread over n
years (i.e R 1 , R 2 ...R n )as
R1 R2 R3 Rn
, , ............,
(1  i)  (1  i) 1  i 
2 3
1  i n
The sum of present values for n years would thus be
n
R1 R2 R3 Rn Rk
1  i n 
V    ............, 
(1  i)  (1  i) 2 1  i 3 k 1 1  i k

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 6.The Equi-Marginal
Principle
•The law of equi-marginal utility states that a utility
maximizing consumer distributes his consumption expenditure
between various goods and services he/she consumes in such
a way that the marginal utility derived from each unit of
expenditure on various goods and service is the same.
•This principle suggests that available resources (inputs)
should be so allocated between the alternative options that
the marginal productivity (MP) from the various activities are
equalized.
For eg. Suppose a firm has a total capital of Rs. 100 million
which it has the option of spending on three projects, A,B,
and C. Each of these projects requires a unit expenditure of
Rs. 10 million.
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 The Equi-Marginal
Principle
Marginal Productivity (MP) Schedule of Projects A, B, and C

Units of Marginal Productivity (MP)

Expenditure
(Rs.10 million)

Project A Project B Project C

1st 50 40 35
2nd 45 30 30
3rd 35 20 20
4th 20 10 15
5th 10 0 12
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 The Equi-Marginal
Principle

The equi marginal principle suggests that a profit (gain) maximizing

firms allocates its resources in a proportion such that
MPA  MPB  MPC  ...  MP N

The equi - marginal principle can be applied only where

(i) firms have limited investible resources
(ii) resources have alternative uses and
(iii) the investment in various alternative uses is subject to diminishin g
marginal productivi ty or return.

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