Managerial Econoics

8/9/2019 Managerial Econoics

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Unit 1


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ECONOMICSThe term economics comes from the Ancient Greek word

(oikonomia, "management of a household,administration") hence "rules ofthe house(hold)".

There are many definitions given by many experts theimportant four def initions are the basic for theeconomics are

y Science of wealthy Science of Material welfarey Science that Deals with Scarcityy Science of Economic Growth


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Economics as a Science of wealth

y J.B. Sayhas defined economics as the science which deals withwealth.

y Adam Smith defined economics as "a science which studies thenature and causes of the wealth of nations. For Adam Smithwealth was to be-all and end-all of economic activity. Thisdefinition came in for sharp criticism for its narrowvision, andhence, since has largely been abandoned.

But this definition has been criticized on the following grounds :y Adam Smith laid all emphasis on wealth but ignored man and

his welfare.

y He gave restricted meaning of wealth as he included in wealthonlymaterial goods like tea, biscuits, butter and excluded non-material goods, i.e. services like those of doctor, soldier.

y He pre-supposed the existence of an economic man who is tosatisfyhis own interest having no social interest.

y This definition makes the earning of wealth an end in itself andignores the proprietyof means to achieve it


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Economics as a Science of Material Welfare

According to Alfred Marshall, "Economics is a study of man's actions in theordinary business of life. It enquires how he gets his income and how hespends it". Thus, it is on the one side, a study of wealth and on the other andmore important side, "a part of the study of man.

Marshall'sview regarding the definition of economics can be expressed as follows

(1) Economics is a studyof man,(2) Economics is concerned onlywith those activities of man which are relatedto the acquisition and enjoyment of wealth.

Bobbins criticized Marshall'sdefinition on the following grounds:

y

Marshall'sview of economics is narrow and unscientific.y Material welfare, which cannot be measured by any scale, cannot be

accepted as end of economics.

y Marshall offered normative view of economics. But economics is neutralbetween ends and does not givevaluejudgement.


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Economics as a Science of Allocation of Scarce Resources

y According to Robbins, "Economics is the science which studies human

behaviour as a relationship between ends and scarce means which havealternative uses."

Critisism

y It ignores social aspects of economic activities.

y Verywide scope of economic.

y Scarcity is not the cause of economic problem.

y Complex & abstract.

Economics as a Science of economic growth

Satisfactory Definition of Economics

y According to Prof. Paul. A. Samuelson:"Economics is the studyof how manand society choose, with or without the use of money, to employ scarceproductive resources which could have alternative uses, to produce variouscommodities over time and distribute them for consumption now and in futureamongvarious people and groups of society."

y The definition focus on both scarcityand growth.

y It is also known as thegrowth definition of economics.


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y Economic analysis is of two types (a) Micro economic analysis and (b)Macro economic analysis

Micro economics:

y According to E. Boulding, "Micro economics is the studyof particularfirm, particular household, individual price, wage, income, industry,and particular commodity."

y In the words of Leftwitch, "Micro economics is concerned with theeconomic activities of such economic units as consumers, resourceownersand business firms."

y 'Micro' is a Greek word means 'small.y Micro economic theorystudies the behaviour of individual decision-

making units such as consumers resource owners, business firms,individual households, wages of workers, etc

y It studies the composition of flows and how the prices of goods andservices in the flowaredetermined.

y In this analysis economists pick up a small unit and observe the detailsofits operation.

y It provides analytical tools for the study of the behaviour of marketmechanism.

y It is also called as Price theory.


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Importance of Micro economics:y Micro economics occupies a very important place in the study of

economic theory. It has both theoretical and practical importance. Itexplains the functioning of a free enterprise economy.

y It tells how millions of consumers and producers in an economy takedecisions about the allocation of productive resources among millionsof goods and services.

y It explains the determination of the relative prices of the various

products and productiveservices.y It helps in the formulation of economic policies calculated to promote

efficiency in production and the welfare ofthe masses.

Limitations:y It cannot give an idea ofthe functioning ofthe economyas a whole. An

individual industry may be flourishing, where as the economy as awhole may be languishingy It assumes full employment which is a rare phenomenon, at anyrate in

the capitalistworld. Therefore it is an unrealistic assumption


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Macro economics:

yAccording to E. Boulding "Macro economics deals not withindividual quantities as such but with aggregates of thesequantities, not with individual income but with nationalincome not with individual prices but with price levels, notwith individual outputs butwith national output."

y Macro economics is the obverse of microeconomics.y It is the studyof economic systemasawhole.

y It studies not one economic unit like a firm or an industrybut the whole economic system

y

Therefore it deals with totals or aggregates national incomeoutput and employment, total consumption, saving andinvestment and the genera level of prices.

y It is also called as Income theoryand

y It is also called as aggregative economics.


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Importance:y It helps in understanding the functioning of a complicated

economic systemy It gives a bird's eyeview ofthe economicworldy For the formulation of useful economic policies for the nation

macro economics is ofthe utmost significance.

y It is far more fruitful to regulate aggregate employment andnational income and towork out a national wage policy

y It occupies most important place in economic theory in itspursuit ofthe solution ofurgent economic problems.

Limitations:y Individual is ignored altogether. It is individual welfare which isthe main aim of economics.

y It overlooks individual differences. Say the general price levelmay be stable, but the price of food grains may have gonespelling ruin to the poor.


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r.no cro econom cs acro econom cs

1. Difference in thedegree ofaggregation

It studies the individual units ofthe economy like a f irm, aparticular commodity.

It deals with aggregates likenational income and aggregatesavings. It studies the problem

ofthe economyasaw hole2. Difference in

objectivesIt is to study of principles,problems and policiesconcerning the optimumallocation of resources

It studies the problems, policiesand principles relating fullemployment of resources andgrowth of resources

3. Method of study Micro economics laws establish

relationship between the causesand effects of economicsphenomena and it is formulatedby taking some assumptions

Macro economics elements are

categorized into aggregateunits like aggregate demand,aggregate supply, totalconsumption, totalinvestment, etc

4. Difference of

subject matter

It deals with the

determination of price,consumer's equilibrium,distribution and welfare, etc.

It is full employment,

national income, general price-level, trade cycles, economicgrowth, etc

5. Difference of theforces ofequilibrium

It studies the equilibriumbetween the forces ofindividual demand and supply

or market demand and supply.

It deals with equilibriumbetween the forces demandand supplyof whole economy.


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Economics as a science

y A science is a systematized bodyof knowledge about a particular branch oftheuniverse and which contains concepts, theories and principles which arebased on cause and effect relationship and are universal in nature.

Judged by this standard, economics is undoubtedly a science because it is asystematized bodyof knowledge about economic activities.

y Economics as a science has also got the scientific methods of deduction for itsstudy. Economics like other sciences deduces conclusions or generalizationsafter observing, collecting and examining facts.

y It is based on the facts .

y But some economists feel that economics cannot be treated as a sciencebecause different economists may suggest different solutions to the sameproblem

y It has been called a social science as it deals with the economic decisionstaken byhuman beings.

Nature of economics


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Economics as an art

y "An art issystemofrulesfor theattainment ofagiven end".This implies thatart ispractical.

y Applying thisdefinition ofart toeconomicswecan say it isan art.Itsseveralbrancheslikeconsumption,production andpublicfinanceprovidepracticalguidance tosolveeconomicproblems.

y Art isalsodefinedas"acollection or bodyofrulesfor theexecution ofexternal

works."Theapplication ofcertain ruleswillresult in theattainment ofspecificresults.Thus,sincesolution toeconomicproblemsrequireslot ofapplicationofeconomicskills,economics is treatedasan art.

y Economics is both a science and an art.


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y The question whether economics is a positive or

normative science has been discussed for a very longtime.

y Positive science is which ask why, when & normativescience is which ask what ought to be.

y "A positive science is a body of systematisedknowledge concerning what is and a normative scienceor regulative science is a body of systematisedknowledge relating to the criteria of what it ought to

be". In other words, a positive science describes thingsthey are. For this reason, it is also called descriptivescience. But normative science, on the other hand,explains things not as theyare but as they ought to be.


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Economics as a Positive Science

y The classical economists proposed' that economics should boconcerned only

with "what is" and not "what ought to be". In other words, they maintainedthut oconomics is onlya positive science. Theysaid that economics should notexplain rightness and wrongness of things and economists should not passmoral judgement. Cairns said that economics should stand neutral asmechanics stand between rival schemes of railway construction. Striglerobserved, "Strictly speaking words like 'ought* and "bad' cannot occur in

economic discussions". Lionel Robbins reaffirmed the view that economics isnothing but a positive science. The above statod views are based on thefollowing reasons :

y If economics is to inquire about the norms or ends of economics, there willarise much confusion regarding the desirabilityor otherwise of economic ends.

y If economics is treated as a normative science, ethical considerations will enterinto the realm of economics. This will lead first to difference of opinions andthen to perpetual disagreement among economists regarding economic norms.This, in turn, will obstruct thegrowth of economics.

y If economics becomes a normative study, economists will be forced to passmoral judgements. Such judgements based on their moral judgements mayprove to be wrong in practical situations.

y If economics is concerned with ends, itwill become related to ethics.


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Economics as a Normative Science

y According to Marshall, economics is a normative science because it has anorm,viz. welfare. Macifie remarks that "economics is fundamentallya science,not merelya positive science like chemistry".

y Howtrey feels that economics is a normative science because there is an'economics oughf as it is in ethics. Subscribing to thisview, other economistshave also put up a strong case for normative scicnce.

y If economics is considered to be a positive science, it will become a merevalue

theory. Prof. Eraser is ofthe opinion that economics is something more than amerevalue theoryor equilibrium analysis".

y Further if economics does not deal with any norm, economists will be reducedto the position of theorists. As such theymay explain and expound but notadvocate and condemn. But economists must tell what should be done and

what should be avoided.

yWhen economics is neutral between ends, it becomes abstract complex andunreal. But as a normative science, it isveryhuman and realistic.

y Economics is a social science which suggests the modes of promotion ofeconomic welfare with limited means. It can be of great service of mankind as anormative science. It can help a person to get maximum welfare from thelimited resources. Normative economics can also be of great help in achieving

the national goals of removing poverty, increasing employment and raising thequalityoflife ofthepeople.


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Definition of Managerial Economics:

y Managerial economics in general defined as the study ofeconomic theories, logic and methodology which aregenerally applied to seek solutions to the practicalproblems ofbusiness.

y Business Economics consists of the use of economicmodes of thought to analyse business situations.- McNairand Meriam

y Business Economics (Managerial Economics) is theintegration of economic theorywith business practice forthe purpose of facilitating decision making and forwardplanning bymanagement." - Spencerand Seegelman.

y Managerial economics is concerned with application ofeconomic concepts and economic analysis to the problems

of formulating rational managerial decision." -M

ansfield


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EconomicsEconomics--TheoryandMethodologyTheoryandMethodology

BusinessManagementBusinessManagement--Decision ProblemDecision Problem

ManagerialEconomicsManagerialEconomics--

Application ofApplication ofEconomics tosolvingEconomics tosolvingbusinessproblembusinessproblem

OptimalSolution toOptimalSolution tobusinessproblembusinessproblem


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ScopeofManagerial Economics:The scope of managerial economics is not yet clearlylaid out because it

is a developing science. Even then the following fields may be said togenerallyfall under Managerial Economics:y Demand Analysis and Forecastingy Cost and ProductionAnalysisy Pricing Decisions, Policies and Practicesy ProfitManagementy Capital Management

These divisions ofbusinesseconomics constitute its subject matter.Recently, managerial economists have started making increased use ofOperation Research methods like Linear programming, inventorymodels, Games theory, queuing up theoryetc., have also come to beregarded as part of Managerial Economics

y Demand Analysis and Forecasting: A major part of managerial decision makingdepends on accurate estimates of demand. A forecast of future sales serves as aguide to management for preparing production schedules and employing resources.Demand analysis also identifies a number of other factors influencing the demandfor a p roduct. Demand analysis and forecasting occupie s a strategic place inManagerial Economics.


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y Cost and production analysis: A firm's profitability depends much on its cost ofproduction. A wise manager would prepare cost estimates of a range of output, identify thefactors causing variations in cost estimates and choose the cost-minimising output level,

taking also into consideration the degree of uncertainty in production and cost calculations.Production processes are under the charge of engineers but the business manager is supposedto carryout the production function analysis in order to avoid wastages of materials and time.Sound pricing practices depend much on cost control. The main topics discussed under costand production analysis are: Cost concepts, cost-output relationships, Economics andDiseconomies of scale and cost control.

y Pricing decisions, policies and practices: Price is the genesis ofthe revenue of a firm

and as such the success of a business firm largely depends on the correctness of the pricedecisions taken by it. The important aspects dealt with this area are: Price determination invarious market forms, pricing methods, differential pricing, product-line pricing and priceforecasting.

y Profit management: Business firms are generallyorganized for earning profit and in thelong period, it is profit which provides the chief measure of success of a firm. Economics tellsus that profits are the reward for uncertainty bearing and risk taking. A successful business

manager is one who can form more or less correct estimates of costs and revenues likely toaccrue to the firm at different levels of output. The more successful a manager is in reducinguncertainty, the higher are the profits earned by him. In fact, profit-planning and profitmeasurement constitute the most challengingarea of Managerial Economics.

y Capital management: Capital management implies planning and control of capitalexpenditure because it involves a large sum and moreover the problems in disposing the capitalassets off are so complex that theyrequire considerable time and labour. The main topics dealt

with under capital management are cost ofcapital, rate of return and selection of projects.


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Characteristics of Managerial Economics

y Managerial Economics is microeconomics.

y Managerial Economics largely uses that body ofeconomics concepts and principles which is knownas Theoryof Firm.

y Managerial Economics is pragmatic.

y Managerial Economics belongs to normativeeconomics.

y It is having a multidisciplinaryapproach.y It is the integration of economics & business

management.


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Managerial economics & other disciplines

Managerial economics & mathematics-y Estmatesvarious economic relationships.

y Use ofvarious mathematical tools like algebra, calculus, logarithm, exponentialare helpful.

Managerial economics & accounting y Accounting is recording the financial operation of a business firm.

y Accounting information is source of data for economist.

y Accountancy does provide the data support but in traditional economics,managerial economics stresses upn the logic or reasoning behind such data.

Managerial economics & operation research-

y Linear programming as well as goal programming models which areveryusefulfor managerial decisions.

y Helpful in solving problems related to allocation of resources, transportation,inventory, etc.


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Managerial economics & statistics-

Statistics help managerial economists in the following ways:

y Managerial economics calls for marshalling of quantitative data and reachinguseful measure of appropriate functional relationships involved in decisionmaking. Statistics provides the detailed data about a firm, which is useful in themanagerial economics for decision making.

y Managerial Economics employs statistical methods for empirical testing of

economic generalizations. These generalizations can be accepted in practiceonlywhen theyarevalidated against the data from the world of realityand arefoundvalid.

y Managers do not usuallyhave exact information about thevariables affectingthe decisions and have got to deal with the uncertaintyof future events, theoryof probability, uponwhich


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Role & functions of a managerial economics

y A managerial economist is an expert who advises businessmanagement in economic matters & problems faced by the businessorganisation.

y Analysis of business environment- help in making corporate plan byforecasting the economic environment.

y

Analysis of in ternal factors- price determination, use of installedcapacity, investment decisions, expansion

y Economic intelligence- supply management with economicinformation of general interest so that it can be used in confrences &seminars.

y

Collected from government publication,RBI, trade & industry journals,newspaper.

y Decision making

y Pricing strategy- helps in setting the price ,analysis of price in differentmarket.


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Specific function & responsibilities-

y Salesforecasting

y Market research

y Economicanalysisofcompetingfirms

y Pricingproblemofindustry

y Evaluation ofcapitalprojects

y Security/ investment analysis

y Production & inventorycontrol

y Environmentalforecasting

y Adviceon international trade&foreign exchaangemanagement.

Social responsibility

Firmshould not indulge in illegalactivity.

Should beonewhich isdealing in good&servicewhichdo not harmpeopleatlarge.

Reasonableremuneration to theworkers.

Childlabourshould beavoided.


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Meaning and Nature of Sciencey Science is the systematised body of knowledge pertaining to a particular field of

enquiry. Such systematised body of knowledge pertaining to a particular fieldcontains concepts, theories and principles which are universal and true.

y Science has the following features :

y Systematised bodyof knowledge.

y Scientific methods ofobservation.y Tests ofvalidityand predictability.

y Universal application of principles.

y Whatever field of enquiry fulfills the above criteria is called a science. Theimportant examples of science are physics, chemistry, biology, zoology, etc.

y

Science is a social institution.y There is a method of science which is used to solve problems arising either out of

social and economic needs for individual curiosity.

y Science h a s a cumulative tradition of knowledge. The stock of previousknowledge forms the basis for new knowledge, with the previous knowledgemerging into the new knowledge.


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y Science has several functions in a given society. It plays a major role in the

maintenance and development of production processes.

y Science is influenced by the prevailing social thought. And, in turn, radicalchanges in scientific ideas influence the general attitudesand beliefs in society.

y In science, theory and practice are intimately related. Hence, scienceprogresses rapidly in societies and in conditions, where practitioners andthinkers mix and interact. Theory without practice is as barren as practice

without theory.

Science and EconomicDevelopmenty Science passes through three stages of growth before coming to the level of

productionwhich results in economic development. These stages are :

y Stage I: formulation of scientific principles

y Stage II: Application ofthe scientific principles (known as innovations)

y Stage III : Development of the innovations to the point of commercialexploitation e. g., (development of a solar cooker).


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Science as the PrimeDriver for Inventions

y An inv ention is a scientific discovery e. g., (invention of a wheel). It is thecreation of a new idea. Invention is triggered because of a desire to do

something and this desire can be to:(i) Solve some practical problem (viz., how to travel distance in lesser time).

(ii) Take advantage of a cheaper input. For example, if labour supply becomescostly, then i t is better to switch over to robotics/ computerisation (i.e., capitalinput).

(iii) Satisfywidening markets. When the demand of a particular item (product)

increases steps are taken to resort to mass production ofthat product.Innovation

y It is the practical application of an inv ention. It is the use of an idea intoproduction process. Innovation mayhappen i n three ways :

y Bychance discovery.

y Bydeliberate search (i.e., through research and developmentcalled (R& D).

y During the process of production.

y Innovations cause changes in the following areas which result in economicdevelopment:

(i) Increasing productivity.

(ii) Changing the combination of factors (Input) ( viz. Land, Labour, Capital).


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Meaning and Nature of Engineeringy Engineering involvesapplication ofscientificknowledge.It iscomposedofthe

skillsand ingenuity in adaptingknowledge to theusesofhuman race.y According to theEngineersCouncilforProfessional Development,

"Engineering is the profession in which knowledge of the mathematical andnatural sciences gained by study, experience and practice is applied with

judgement to develop ways to utilize economically, the materials and forces ofnature for the benefit of mankind".

y Thepurposeofan engineer is toapplyhisknowledge toparticularsituations toproduceproductsandservices.To theengineer,knowledge is not an end initselfbut is the toolfromwhichhefashionsstructures,machinesandprocesses.Thus,engineering involves thedetermination ofthecombination ofmaterials,forcesandhuman factors thatwill yieldadesiredresultwithareasonabledegreeofaccuracy.

y Modern civilization rests toalargeextent upon engineering.Most productsUsed tofacilitatework,communication and transportation,and tofurnishsustenance,shelterandeven healthcarearedirectlyor indirectlyaresult of

engineeringactivities.


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y Engineeringhasalso been instrumental in providing instrumentsof

entertainment andleisure.Through thedevelopment oftheprintingprocess, television andrapid transportation.

y Engineeringhasprovided themeansfor bothculturalandeconomicimprovement ofthehuman race.

y In addition,engineeringhas becomean essential input for national

defense.This isevident from thefact that alarge numberofengineersofdifferent branchesare in theemployment ofarmedforcesofalmostallcountries.


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Engineering and EconomicDevelopment

Engineering is a profession in which the knowledge of mathematics and naturalsciences is applied. This knowledge is applied to develop ways to utilise thematerials and the forces ofnature (viz., building a Hydroelectric Plant or NuclearThermal Power Station) economically for the benefit of mankind. Engineeringfacilitates economic development in twoways :

(i) By mechanisation of Production Process. The introduction ofmachines resultin large scale production, saves time and efforts. For example, usage of machines(e.g. Tractors) in agriculture sector has helped in increasing agriculturalproduction

(ii) Development of Infrastructure. Engineering is extensively used in thedevelopment of infrastructure which is almost a precondition for economic

development of a country. Better infrastructure consists of better means oftransport (roads etc.), better means of energy(electricity, power etc.), and bettermeans of communication (better connectivity). Thus, engineering is used in theships, aeroplanes etc.

It has been mentioned in World Development Report that, "The adequacy ofinfrastructure helps determine one country's success to another country's failure in

diversifying production, expanding trade, coping with population growth, reducingpoverty and improving environmental conditions."


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Meaning and Nature of Technology

y Broadly speaking, technology refers to the body of knowledge, skills and

procedures for preparing, using and doing useful things. It is often identified withthe knowledge and skills in utilizing machines and processes with some specificobjectives in view. Technological development is a continuous process. Improvedtechnologyreplaces the existing technology to increase productivityand qualityof production.

Types of Technology Labour intensive technology:- It involves more oflabour and less ofcapital for

producing a unit ofoutput. It is more appropriate for underdeveloped countries,where labour is in abundance and capital is scarce.

Capital intensive technology:- It involves more ofcapital and less oflabour forproducing a unit of output. It is more suitable for an advanced countrywhere

capital is in abundance and labour is scarce.

Neutral technology:- It is neither labour saving nor capital saving.

Intermediate technology:- It is that technology which is midway betweencapital intensive technology and labour intensive technology. For example,manufacturing a washing machine which works on electricity(when electricity

is available) as also can be operated byhand (when electricity is not available).


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The significant of aspects of technology that affect human life and economicdevelopment include the following:

y

The nature of technology adopted determines the various jobs beingperformed by individuals in an organization. With change in technology thejobs are changed because it is the technology that determines the level of skillneeded.

y Technology is a major factor of productivity improvement in the organizationand economyas a whole. Though people are primarilyresponsible for handling

technology their efficiency is determined by the nature and type oftechnologyadopted.

y The f irms/countries using latest technology in v arious fields enjoy acompetitive edge over others.


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Role of Science and Technology in EconomicDevelopment

Utilisation of Natural Resources

One aspect ofthe development of science and technology is fuller utilisation ofthe

wealth or resources with which a countryhas been endowed.Increased Efficiency

y The essence of technological change lies in the introduction of new techniques ofproduction leading to product improvement, cost reduction and increasedproductivity. These are achieved in either of the two ways. Firstly, it raises output

with given input of resources. Secondly, it produces the same output with lesserinputs. In either case , the result would be increase in efficiency. Knowledge ofeconomics would help the engineer to achieve increased output with little additionofinputs.

Factor Substitution

y Technology often allows the engineers to substitute one factor for another

depending upon the availability of the factors. Cost of factors, requirements ofcustomers, etc.

Overcoming Scarcity

y Application of latest technologyloosens the constraints of scarcityof resources inthe country. It does so in the following ways:

y (i) Use of existing resources in an efficient manner to get greater outputs.

y (ii) Discoveryofnew resources and substitutes to feed the production processes.

Managerial Econoics

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