Managerial Economics

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Managerial Economics :

Managerial Economics MS-09

Management:

Management Koontz & O'Donnell define MANAGEMENT as the creation & ``maintenance of an internal environment in an enterprise where individuals, working together in groups, can perform efficiently & effectively towards the attainment of group goals.

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Scarcity of resources results from: Human wants are virtually limited Economic resources to satisfy these demands are unlimited

ECONOMICS:

ECONOMICS Economics is the social science that studies the production, distribution, and consumption of goods and services.

We have to make choice of::

We have to make choice of: What to produce? How to produce? For whom to produce?

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scarcity Unlimited choice Limited resources What to produce? How to produce? For whom to produce?

Managerial economics:

Managerial economics M.E. is the use of economic modes of thought to analyze business situation ---McNair and Meriam M.E is concerned with the applications of economic principles & methodologies to the decision making process within the firm or organization under the conditions of uncertainty --Prof Eva J Doglus

Scope of managerial economics:

Scope of managerial economics Objectives of a firm –profit optimization Demand analysis & forecasting- scare resource allocation Production & cost analysis- Pricing policies- Inventory management Investment /capital management

M.E & other disciplines:

M.E & other disciplines Micro economics Macro economics Operation research Theory of decision making Statistics Management theory & accounting

MICRO ECONOMICS:

MICRO ECONOMICS Microeconomics is a branch of economics that studies how individuals, households and firms and some states make decisions to allocate limited resources, typically in markets where goods or services are being bought and sold

MACRO-ECONOMICS:

MACRO-ECONOMICS Macroeconomics is a branch of economics that deals with the performance, structure, and behavior of a national or regional economy as a whole.Along with microeconomics, macroeconomics is one of the two most general fields in economics. Macroeconomists study aggregated indicators such as GDP, unemployment rates, and price indices to understand how the whole economy functions.

Objective of the firm:

Objective of the firm Profit maximization Implicit cost: these are the cost reflected in cash outlay by the firm but are the costs associated with foregone opportunities. Such implicit cost are not included in the accounting statement but but must be included in any rational decision making framework. Eg-the owner invested Rs 1 lakh in the business. If this amount is invested in the risk less investment like in bank, it would return Rs 10000, which is implicit cost.

Alterative objectives of firm:

Alterative objectives of firm According to the Economist Robins marris owner & managers have different utility functions to maximize. Um (manger’s utility function)=f(salary, job, power, prestige, status) Uo(owner’s utility functions)=f(output, capital, profir, share)

Firm’s constraints:

Firm’s constraints Resource constraints Legal constraints Moral constraints Contractual constraints

The opportunity cost principle:

The opportunity cost principle The opportunity cost of anything is the return that can be had from next best alternative use. The Production possibility reflects opportunity costs. PPC reflects the different combination of goods,which an economy can produce, given its state of technology & total resources.E g-butter & gun ,food & computer The quantity of food , which has to be sacrifices to produce an additional unit of computer, is called opportunity costs of computer(in terms of food) Increasing opportunity Cost of computer means that to produce each additional unit of computer , more & more units of food have to be sacrificed.

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Point A in the diagram for example, shows that F A of food and C A of computers can be produced when

Demand concept & analysis:

Demand concept & analysis

Demand:

Demand Demand refers to the quantity of goods that consumers are willing & able to purchase at various prices during a give period of time. Person’s demand for a product means the demand over some appropriate time period

The demand function:

The demand function The demand function sets out the variables which are believed to have an influence on the demand for a particular product. Qd =f (Po, Pc, Ps, Yd, T, A, CR, R, E, O)

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Po- price of the own product Pc- price of the complementary product Ps- price of the substitute product Yd- disposable income T- taste A- advertising CR- availability of the credit R- rate of interest E- expectation ( of income & price) N- no. of potential consumers 0- miscellaneous factors

The law of demand:

The law of demand Other things being equal, a fall in price leads to expansion in demand & a rise in price leads contraction in demand. The inverse relationship between price & quantity demanded is called law of demand.

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P1 P0 Q1 Q0 Quantity demanded Price A* B* DEMAND CURVE

Exception to law of Demand:

Exception to law of Demand It states that with a fall in price, demand also falls & with a rise in price demand also rises.

Determinants of exception of law of demand:

Determinants of exception of law of demand Giffen’s paradox Veblen’s effect Fear of shortage Fear of future rise in price Speculation Conspicuous necessaries Emergencies Ignorance Necessaries

Changes /shifts in demand curve:

Changes /shifts in demand curve If demand changes not because of price changes but because of other factors, then in that case there would either increase or decrease in demand. Eg: At a price Rs.15,the initial demand of the cold-drink is 10000 units. If demand increases reaches 12000 units with same price , it will be known as increase in demand curve.

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price Qty dd D1 D2 D1 D2 D3 D3 P1 Q3 Q1 Q2 Increase and decrease in demand curve

Elasticity of demand :

Elasticity of demand It is defined as the responsiveness or sensitiveness of demand to a given change in the price of a commodity. It shows the reaction of one variable with respect to a change in other variables on which it is dependent. It is an index of reaction.

Kind of elasticity of demand:

Kind of elasticity of demand Price elasticity of demand Income elasticity of demand Cross elasticity of demand

Price Elasticity of Demand:

Price Elasticity of Demand Price elasticity of demand measures the responsiveness of the sold to changes in the product’s price, ceteris paribus. Ep = %age change in qty demanded %age change in price

Different degree of price elasticity of demand :

Different degree of price elasticity of demand n = 0 Perfectly inelastic. 0 > n > -1 Relatively inelastic. n = 1 Unitary elastic. -1 > n > -∞ Relatively elastic. n = -∞ Perfectly elastic.

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Perfectly elastic of demand

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P1 P0 Q1 Q0 Quantity demanded Price A* B* RELATIVELY ELASTIC DEMAND

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P1 P0 Q1 Q0 Quantity demanded Price A* B* UNITARY ELASTIC DEMAND

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P1 P0 Q1 Q0 Quantity demanded Price A* B* RELATIVE INELASTIC DEMAND

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Perfectly Inelastic demand

Determinants of price elasticity of demand :

Determinants of price elasticity of demand Nature of the demand Existence of substitutes Number of user of the commodity Durability & reparability of the commodity Possibility of postponing the use of a commodity. Level of income of the people Range of the price Habits Existence of complementary goods

Measurement of price elasticity of demand:

Measurement of price elasticity of demand Arc price elasticity Point elasticity advertising

Point price elasticity:

Point price elasticity Prof. Marshall advocated this method The point method measures price elasticity of demand at different points on a demand curve. Ep= %age change in demand % change in price or Ep= dq * p dp q

Arc Price Elasticity :

Arc Price Elasticity When elasticity is measured over an interval of a demand curve, the elasticity is called as an interval or Arc elasticity Arc elasticity= Q2-Q1 * P2+P1 P2-P1 * Q2-Q1

Income Elasticity Of Demand:

Income Elasticity Of Demand Income Elasticity Of Demand may be defined as the ratio or proportionate change in the quantity demanded of a commodity to a given proportionate change in the income. Ey= % change in demand % change in income

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Ey can be positive, negative or zero. When Ey is positive, the commodity is normal(used in day to day life) When Ey is negative, the commodity is inferior(jowar, beedi) When Ey is positive & greater than one, the commodity is luxury When Ey is positive , but less than one, the commodity is essential When Ey is Zero, the commodity is neutral(salt, match box)

Cross Price Elasticity:

Cross Price Elasticity It may be defined as the proportionate change in the quantity demanded of a particular commodity in response to a change in the price of another related commodity Ec =% change in Qty dd of commodity X %age change in the price of Y

Advertising /promotional elasticity of demand:

Advertising /promotional elasticity of demand Advertising elasticity refers to the responsiveness of demand or sales to change in advertising or other promotional expenses. Ea= % change in demand or sales %age change in adv expenditure

Production Function:

Production Function A Production function is the function relationship between input & output It shows the maximum output which can be obtained from a given combination of inputs. Input refers to all those things which are required by the firm to produce a particular product.Four factor of production are Land, Labor, Capital. Output refers to the finished products. Q= f (X1,X2,X3………………Xn) If there are only 2 inputs, capital(k) & labor(l), we write production function as : Q = f (l, k)

Economic efficiency:

Economic efficiency When it produces a given output at the lowest cost for a combination of inputs provided that prices of inputs are given.

Technical Efficiency:

Technical Efficiency A firm is technically efficient when it obtains maximum level of output from any given combination of inputs.

Short run:

Short run Short run is a period of time in which only the variable factors can be varied while fixed factors like plants, machineries, etc would remain constant.

Short run production function:

Short run production function Quantities of all inputs both fixed & variable will be kept constant & only one variable input will be varied. E.g. law of variable proportion. Quantities of all factor inputs are kept constant & only two variable factor inputs are varied.e.g. Iso Quants & Iso cost.

Long run:

Long run Long run is a period of time where in the producers will have adequate time to make any sort of changes in the factor combinations.

Use of production function:

Use of production function It can be used to calculate or work out the least cost input combination for a given output It is useful in working out an optimum, & economic combination of inputs for getting a certain level of output It also help in making long run decision. If return to scale are increasing, it is wise to employ more factor units & increase production.

Production function with one variable input:

Production function with one variable input In this consider 2 input production process-where one input with a fixed quantity & other input with variable quantity. TP is the total amount of output resulting from the use of different quantities of inputs. MP is the change in total product per unit change in variable input. MP=change in TP /change in L AP is defined as total product per unit of L. AP=TP/L

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Quadratic Production Function From the origin to point A, the firm is PRODUCTION FUNCTION

Relationship of TP,MP,AP curves:

Relationship of TP,MP,AP curves If MP>0,TP will be rising as L increases. If MP=0,TP will be constant as L increases. If MP<0, TP will be declining as L increases. MP intersect AP (MP=AP) at maximum point on the AP curve.

Stages of production:

Stages of production Stage 1: MP>0, AP rising. Thus MP>AP Stage 2: MP>0, but AP is falling. MP<AP but TP is increasing. MP<0.in this case TP is falling.

Production function with 2 variables:

Production function with 2 variables

Production Iso-quant:

Production Iso-quant Greek word ISO means equal or same. A production Iso-quant is the locus of all those combinations of two inputs which yields a given level of output. With 2 variable inputs, capital & labor, the Iso-quant gives the different combination of capital & labor that produces the same level of output.

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0 1 2 3 4 5 6 7 9 8 7 6 5 4 3 2 1 Production isoquant

Isoquant map:

Isoquant map These iso-quant shows various combination of capital labor inputs that can produce Q1-10,Q2-15,Q3-20 units of output. A group of iso-quant is called isoquant map.

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Production map

Marginal rate of technical substitution :

Marginal rate of technical substitution In economics , the marginal rate of technical substitution ( MRTS ) or the Technical Rate of Substitution ( TRS ) is the amount by which the quantity of one input has to be reduced when one extra unit of another input is used, so that output remains constant Along an isoquant, the MRTS shows the rate at which one input (e.g. capital or labor) may be substituted for another, while maintaining the same level of output. The MRTS can also been seen as the slope of an Isoquant at the point in question. MRTS L for K = change in K change in L

Iso-cost line:

Iso-cost line What combination of (k,L) should the firm choose in order to maximize output for a given level of cost?

Long run production function:

Long run production function

Return to scale:

Return to scale This shows when all inputs are increased in the same proportion, how does output change.

Increasing return to scale :

Increasing return to scale If output increases by more than an increase in input(I.e say more than 10%), then the situation is one of increasing returns to scale. 150 100 50 K L O A B C

Decreasing return to scale :

Decreasing return to scale If output increases by less than an increase in input(I.e say more than 10%), then the situation is one of decreasing returns to scale. 150 100 50 K L O A B C

Constant return to scale :

Constant return to scale If output increases by exactly the same proportion as input(I.e say more than 10%), then the situation is one of constant returns to scale. 150 100 50 K L O A B C

Cost Concept & Analysis I:

Cost Concept & Analysis I

PowerPoint Presentation:

Actual cost and Opportunity costs Explicit cost and Implicit cost Accounting cost and Economic cost Out-of pocket cost and Book cost Relevant cost and Irrelevant cost Sunk cost and incremental cost Direct cost and indirect cost Separable cost and common cost Total cost, average cost and marginal cost Fixed cost and variable cost Short run cost and long run cost

Economies of scale:

Economies of scale The advantage or benefits that accrue to a firm as a result of increase in its scale of production are called “Economies of scale” If LRAC declines as output increases a, then we say that the firm enjoys economies of scale. It arises due to specialization of productive factors,more advanced technologies & more efficient capital equipment, effective utilization of by- products.

Kind of economies of scale:

Kind of economies of scale Internal economies are those economies which arise because of the action of an individual firm to economize its cost. External economies of scale are those which accrue to a firm as a result of expansion in the output of whole industry & they are not dependent on the output level of individual firm.

Diseconomies of scale:

Diseconomies of scale When a firm expand beyond the optimum limit, economies of scale will be converted in to diseconomies of scale. If LRAC increases as output increases, then we say that the firm enjoys economies of scale. This problem lead because of overcrowding of labors, managerial inefficiencies etc.

Market structure :

Market structure Market structure refers to the degree of competition in that particular market. The higher the degree of competition , the less market power the firm has & vice- versa.market power is the ability of the firm to influence price.

Characteristics of the market structure:

Characteristics of the market structure Number & size distribution of sellers Number & size distribution of buyers. Product differentiation Condition of entry & exit

Perfect competition:

Perfect competition Large number of buyer & seller Identical product Buyer & seller are unable to influence the price Individual buyer or seller are Price taker Free entry & exit No firm can excessive profit.

Factor determining the nature of competition:

Factor determining the nature of competition Effect of buyer Production characteristics Product characteristics

Barriers to entry:

Barriers to entry Legal barriers Initial capital cost Vertical integration optimum scale of production Product differentiation

Characteristics of monopoly:

Characteristics of monopoly Existence of a single seller Absence of substitute Price maker Entry barrier Existence of super normal profit.

Monopolistic competition:

Monopolistic competition A large number of seller A large number of buyer Sufficient knowledge Differentiated product Free entry & exit

Oligopolistic competition:

Oligopolistic competition If there are only two sellers, it is known as duopoly If the product is homogeneous , it is known as pure oligopoly If the product s differentiated, it is known as differentiated oligopoly.

PowerPoint Presentation:

Type of market Nature of product No. of buyers No. of sellers Entry condition Price Pure/ perfect competition Homogeneous for all firms Large Large Free entry, free exit Uniform everywhere Monopoly Homogeneous for all firms Large One Entry barrier High Monopolistic competition Product differentiation by each firm Large Many Many Higher than perfectly competitive firm but lower than monopolistic Oligopoly competition Can be homogeneous or differentiated large A few Entry barrier High

Price discrimination:

Price discrimination The practice of charging different prices to various consumers for a given product. The price discrimination can be first degree price discrimination, second degree price discrimination, third degree price discrimination.

First degree price discrimination:

First degree price discrimination It refers to a situation where the monopolist charge the different price for different units of output according to the willingness to pay of the consumer. E.g-a doctor who is the only super specialist in the town may charge different fee for conducting surgery from different patient based on their ability to pay.

Second degree price discrimination:

Second degree price discrimination It refers to a situation where monopolist charges different prices for different set of units of the same product. E.g- The railway passenger fares.The per kilometer fare is higher for the first few kilometers which declines as distance increases.

Third degree price discrimination :

Third degree price discrimination When the monopolist firm divides the market into two or markets & charges different prices in each market , is known as third degree price discrimination E.g- airline ticket.lower rates are applicable to senior citizens than business travelers Electricity rates applicable to residential users are lower than to commercial establishment

Peak loading pricing:

Peak loading pricing It is a type of third degree price discrimination in which the discrimination base is temporal. Telephone calls is one of the example of peak loading pricing. Telephone companies & their competitors use pricing scheme that encourage people to make class at slack times when personnel & equipments are less busy. Prices are highest at 8 am till 8 pm & reduced further from 8 pm to 8 am. Consumers are encouraged to shift demand from peak to slack periods through the price mechanism

Bundling:

Bundling Bundling is the practice of selling two or more separate products together for a single price Bundling take place when goods & services which could be sold separately, are sold as package. Bundling can be pure bundling, mixed bundling & typing

Pure bundling:

Pure bundling Products are sold only as bundles E.g – Microsoft’s bundle of windows & internet explorer.

Mixed bundling:

Mixed bundling Product are sold both separately only as bundles. McDonald meals & Microsoft office

Typing :

Typing The purchase of main product require the purchase of another product which is generally an additional complementary product. IBM

PowerPoint Presentation:

A two-part tariff is a price discrimination technique in which the price of a product or service is composed of two parts - a lump-sum fee as well as a per-unit charge. In general, price discrimination techniques only occur in partially or fully monopolistic markets . It is designed to enable the firm to capture more consumer surplus than it otherwise would in a non-discriminating pricing environment. Two-part tariffs may also exist in competitive markets when consumers are uncertain about their ultimate demand. Health club consumers, for example, may be uncertain about their level of future commitment to an exercise regime

Two-part tariff:

Two-part tariff A two-part tariff is a price discrimination technique in which the price of a product or service is composed of two parts - a lump-sum fee as well as a per-unit charge. In general, price discrimination techniques only occur in partially or fully monopolistic markets . It is designed to enable the firm to capture more consumer surplus than it otherwise would in a non-discriminating pricing environment. Two-part tariffs may also exist in competitive markets when consumers are uncertain about their ultimate demand. Health club consumers, for example, may be uncertain about their level of future commitment to an exercise regime

The discounting principle:

The discounting principle The time value of money refers to the fact that a rupee received in the future is not worth a rupee today. PV = A (1+I) n

The Equi-marginal principle:

The Equi-marginal principle This principle states that a a rational decision maker would allocate the resources in such a way that it provide equal marginal benefit per unit of cost. MU1/MC1=MU2/MC2=MUn/MCn

The invisible hands:

The invisible hands According to Adam smith,the economic system , left to itself, is self regulating.the basic driving force in such a system is trying to enhance its own economic well-being.but the action of each unit, acting according to its own self interest , are also in the interest of economy as a whole.

Barometric forecasting:

Barometric forecasting It is used to give the decision maker an insight into the direction of likely future demand changes. The indicators are: Leading indicators Coincident indicators Lagging indicators

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