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571102 ECONOMIC ANALYSIS FOR BUSINESS
FACILITATOR – PRAVEEN KUMAR.T
REFERENCE • MANAGERIAL ECONOMICS
– AUTHOR – GEETIKA , PIYALI GHOSH, PURBA ROY CHOUDRY
– PUBLICATION – TATA MACRAW HILL
• MANAGERIAL ECONOMICS ANALYSIS, PROBLEMS AND CASES
– AUTHOR –P.L.MEHTA
– PUBLICATION- SULTAN CHAND AND SONS
• BUSINESS LINE , ECONOMIC TIMES
• GOOGLE NEWS
• ECONOMIC FORUMS AND BLOGS……
EXPECTATION YOUR SIDE
INTERNAL MARKS
• INTERNAL / MODEL EXAMS- 10 MARKS
• ATTENDANCE
/ CLASS PARTICIPATION - 5 MARKS
• ASSIGNMENTS - 5 MARKS
Economics Is The Art Of Making The Most Of Life
- GB SHAW
WHAT IS ECONOMICS? • Scarcity – a basic human dilemma
– Limited resources vs. unlimited wants
– The human condition requires making choices
• Definitions of Economics
– Mankiw’s definition
• …is the study of how society manages its scarce resources
– Hedrick’s definition
• …is how society chooses to allocate its scarce resources among competing demands to improve human welfare
– Alternative definitions
• … what economists do.
• … is the study of choice.
DEFINITIONS – BY VARIOUS GURUS • The term economics comes from the Greek word
oikos (house) nomos (custom or law)
• Adam smith – father of economics – He saw economic as “ an enquiry into an nature and
causes of the wealth of nations”
• Alfred marshall – Economic s is the study of mankind in the everyday
business of life
• Lionel robins – Economics is the science which studies human
behavior as a relation ship between ends and scarce means which have alternative uses
Debate – Whether Economics Is A Science Or An Art?
BASIC ASSUMPTIONS
• Economic theories are based on certain assumptions.
• The assumptions are nothing but tools in the hands of economists to convert complications to their own advantages and simplicity.
• The basic assumptions are – Ceteris paribus – Latin word(things being equal/
constant) – Rationality(compare the cost and benefits of a
decision before going a head) • Firms aims at maximize profit and minimize cost • Consumer aims at maximizing utility and minimizing
sacrifice
TYPES OF ECONOMIC ANALYSIS
• Micro and macro.
• Positive and normative.
• Short run and long run.
• Partial and general equilibrium.
MICRO AND MACROECONOMICS • MICRO ECONOMICS
– It looks at the smaller picture of the economy.
– It is the study of behavior of smaller economic units such as that an individual consumer, producer/seller or a product.
– It focuses on the basic theory of supply and demand in individual markets.(Example- automobiles, FMCG, Telecommunication etc)
– It deals with the how individual businesses decide how much to produce and what price to sell it and how individual consumer decide how much to buy.
– It analysis the market behavior of individual consumers and firm and their decision making.
….CONTD
• MACRO ECONOMICS
– It is the branch of economics that deals with the study of aggregates.
– Study the industry as a unit and not the firm.
– It talks about aggregate demand and aggregate supply
– It talks about national income, GDP,GNP, inflation, employment etc.
• Micro and macro economics complement each other
POSITIVE AND NORMATIVE
• POSITIVE STATEMENT
– This are factual by nature, whose truth or falsehood can be verified by empirical study or logic.
• NORMATIVE STATEMENTS
– It involve some degree of value judgment and cannot be verified by empirical study or logic
ILLUSTARTION- FOR POSITIVE AND NORMATIVE ECONOMICS
• The distribution of income in India is unequal.
• The distribution of income in India should be equal.
..contd
• POSITIVE ECONOMICS – It establishes relationship between cause and
effect.
– It analysis problems on the basis of facts.
– It describe the probable effect of cause bit it would not provide any guidelines/instruction to avoid those causes.
• NORMATIVE ECONOMICS – It concerned with the questions involving value
judgment.
– It incorporates the value judgments about what the economy should be like.
SHORT RUN AND LONG RUN • Marshall gave the contribution of different period
time in market analysis.
• He defined the periods in market as a market period.
• Short run(less than a year) – It is a time period not enough for consumers and
producers to adjust completely to any new situation.
– In production decisions short run is a period when it may not be possible to change all the inputs.
– In this some input are fixed others are variable.
– Manager has to select different levels of variable input to combine with the fixed input in order to optimize the level of production
…CONTD
• LONG RUN
– It is a time period long enough for consumers and producers to adjust to any situation.
– All inputs can be varied.
– Managerial economist deals with decisions whether to expand capacity , change product lines etc.
– Time period – 5-6 years/ even as high as 20 years
PARTIAL AND GENERAL EQULIBRIUM
• EQUILIBRIUM
– It is a state of balance that occur in a model.
• Partial equilibrium analysis
– It studies the internal outcome of any policy action in a single market only.
– The effects are examined only in the markets which is directly affected not on other markets.
– We refer to partial equilibrium analysis when a single firm or a single consumer is in equilibrium others firms in industry may not be in equilibrium.
….CONTD
• General equilibrium analysis
– It is the branch of economics that seeks to explain economic phenomena like production, consumption and prices in a economy as whole.
– It tries to give an understanding of the whole economy by looking at the macro perspective.
KINDS OF ECONOMIC DECISION • Fundamental Questions of Economics - Scarcity
requires all societies to answer the following questions:
– What is to be produced?(consumer goods/capital goods)
– How is to be produced? (efficiency)
– For whom will it be produced? • Market economy
• Command economy
– Are resources used economically?
– Are resources fully employed?
– Is the economic growing
WHFM Questions
MANAGERIAL ECONOMICS-MEANING
“Managerial economics is a means to an end to managers in any business in terms of finding the most efficient way of allocating scarce organizational resources and reaching stated objectives.”
DEFINITION- MANAGERIAL ECONOMICS
• BY SALVATORE
– Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organization can achieve its objectives most effectively.
• BY DOUGLAS
– Managerial economics is the application of economic principles and methodologies to the decision making process with in the firm or organization.
MANAGERIAL ECONOMICS- MICRO VS MACRO
• Managerial economics is applied micro economics to a significant extent though it draws extensively from macroeconomics theory.
– Example : it draws demand analysis, cost and production analysis, pricing and output decision from micro economics. Where it also derives market intelligence knowledge from GDP,GNP, INFLATION etc.
MANAGERIAL ECONOMICS- NORMATIVE BIAS
• Managerial economics has a normative bias stating what firms should do. In order to reach certain objectives.
• Economic issues confronting managers would often involve value judgments.
• In managerial situations one has to take decisions which will affect organizations future therefore managers cannot be simply content with being factual
MANAGERIAL ECONOMICS – PARTIAL EQUILIBRIUM
• Managerial economics deals with partial equilibrium analysis with focus on equilibrium of a firm or an industry, not the economy.
• Decision making of managers would relate to the equilibrium of particular firm.
ECONOMIC PRINCIPLES TO MANAGERIAL DECISIONS
• The key economic concepts and principles that constitute the broad framework of managerial economics are – Concept of scarcity
– Concept of opportunity cost
– PPF – production possibilities curves
– Concept of margin or increment
– Discounting principle
• According to the above economic principles the decision are taken by managers in their operating environment.
Concept of scarcity
• The starting point of any economic analysis is the existence of human wants(unlimited).
• All desirable things(resources) are short in supply compare to our needs(demand).The decision should made to optimally utilize them.
RESOURCES DEMAND FOR
RESOURCES
…contd
• So the economic problems lies in making the best possible use of resources.
• In order to get maximum satisfaction (consumer point of view) or maximum output (producers point of view)
Concept of opportunity cost
• The managerial economist has to make rational choices in all aspects of business because of scarce resources and unlimited wants.
• Opportunity cost is the benefit from alternative that is not selected.
B C D E F A
Production Possibility Frontiers-PPF/PPC/TRANSFORMATION CURVE
• Show the different combinations of goods and services that can be produced with a given amount of resources.
• It also depicts the trade off between any two items produced /consumed.
• This curve measures the opportunity cost by indicating the opportunity cost of increasing one items production /consumption in terms of units of other.(slope of the curve)
• PPC highlights the significance of scarcity of resources and need to use them judiciously
..CONTD
• The concept of PPC used in both micro and macro economics.
• PPC for individual firm/consumer-micro
• PPC for entire society – macro.
Production Possibility Frontiers-individual
X axis- clothing y axis- food
M
N P
Q
A
Fp
Fq
Cp Cq B
Assumptions and explanation • What ever is earned by individual is spent. • At point P on AB shows
– At given income individual can buy Fp units of food and Cp units of clothing.
• If the individual wants to have any more clothing at same level of income they needs to sacrifice some units of food.
• That bring individual to point Q • Fq < Fp and Cq>Cp • M – not attainable it represents combination of
commodities beyond income. • N- not desirable combination of commodity that
would not maximally utilize the individuals income.
Production Possibility Frontiers-society
Capital Goods
Consumer Goods
Yo
Xo
A
B Y1
X1
If it devotes all resources to capital goods it could produce a maximum of Ym.
If it devotes all its resources to consumer goods it could produce a maximum of Xm
Ym
Xm
If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods
If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra Xo – X1 consumer goods is Yo – Y1 capital goods.
Production Possibility Frontiers- society
Capital Goods
Consumer Goods
Yo
Xo
A
.B
C Y1
X1
Production inside the PPF – e.g. point B means the country is not using all its resources
It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards.
…contd
• Assumptions – Factors of production are fixed in supply – Technology remains same
• No ‘ideal’ point on the curve • Any point inside the curve – suggests resources
are not being utilised efficiently • Any point outside the curve – not attainable with
the current level of resources • Useful to demonstrate economic growth and
opportunity cost
CONCEPT OF MARGIN AND INCREMENT
• Marginal analysis is one of the cornerstones of economic theory.
• The concept of marginality deals with a unit increase in cost or revenue or utility.
• Marginal cost – It is the change in total cost /total revenue/total
utility due to unit change in output.
– Marginal cost/marginal revenue/marginal utility is the total cost /total revenue/total utility of the last unit of output.
….contd • Marginal cost express in
– MCn =TCn-TCn-1………. Where n is the number of units of output
– Marginal cost= change in total cost/change in total output(dtc / dq )
How ever in reality variables may not be subject to such unit change as explained above. So for practical purpose we use incremental concept rather than marginal concept
• Incremental concept is applied usually when the changes are not necessarily in terms of a single unit but in bulk.
• In such additional revenue earned as “incremental revenue”
• Example = increase in sales
– Due to promotional activities
DISCOUNTING PRINCIPLE
• Discounting refers to the time value of money.
• The in hand today is more value than a rupee received tomorrow.
• The value of money depreciates with time.
• PVF=1/(1+r)n
PVF= present value of fund
n=period
r=rate of discount.
MANAGERIAL ECONOMICS AND FUNCTIONS OF MANAGEMENT.
PRODUCTION AND OPERATIONS
HUMAN RESOURCE
MARKETING
FINANCE & ACCOUNTING
SYSTEM AND LEGAL APPLICATIONS
MANAGERIAL ECONOMICS
RELATION OF MANAGERIAL ECONOMICS WITH DECISION SCIENCES
• Decision sciences provide the tools and techniques of analysis used in managerial economics.
• The theory of managerial economics largely utilizes the tools of mathematics and econometrics.
• Important aspects of decision sciences that are used in managerial economics include numeric and algebraic analysis , optimization , statically estimation , forecasting and game theory.
• Economic theory
• Theory of firm
• Price theory
• GNP GDP
• Managerial economics
• Quantitative analysis
• All your analysis
• Solution to managerial decision making
HOW DIFFERENT ECONOMICIES SLOVE THEIR ECONOMIC PROBLEMS?
• Economies are classified into three broad categories according to their mode of production , exchange , distribution and the role which government plays in economic activity.
– Capitalist economy.
– Socialist economy.
– Mixed economy.
CAPITALIST ECONOMY
• An economy is called capitalist or a free market economy if it has a following characteristics.
– The right of private property
– Freedom of enterprise
– Freedom to choice by the consumer(consumer sovereignty)
– Profit motive
– Competition
– Inequalities in income.
How capitalist economics solve their problems
• This economy has no central planning authority to decide what , how , and for whom to produce.
– Deciding what to produce
– Deciding how to produce
– Deciding for whom to produce
– Deciding about consumption , saving and investment.
THEORY OF FIRM
• FIRM
– Firm is an entity that draws various types of factors of production in different amounts from the economy and converts them into desirable output through a process with the help of suitable technology.
– There are five factors of production namely land , labor , capital , enterprise and organization.
Form of ownership
Private sector
Individual
proprietorship
collective
partnership cooperative
Public sector
company corporation department
Joint sector
OBJECTIVES OF FIRM
• Profit maximization
• Baumols theory of sales revenue maximization.
• Marris hypothesis of maximization of growth rate.
• williamson’s model of managerial utility function
• Behavioral theories……
How Do Economists Study Human Behavior?
• Economics as a Science – The scientific method
• Observation→Theory→Data→Testing
– Rational Behavior • Weighing benefits and costs and maximizing total net benefits • Marginal vs. Total Thinking
– Economic Theory and Models • Simplification by assumption • Ceteris Paribus – Holding other factors constant • Prediction vs. realism
– Microeconomic versus Macroeconomics
– Bias towards use of natural rather than controlled experiments
– The specialized language of economics (e.g. “He has lots of money.”) • Money – medium of exchange • Wealth – accumulated financial and non-financial assets • Income – the purchasing power earned during a given period
Why do Economists Study Human Behavior?
• Scientists versus policy makers • Positive Economics
– Descriptive - what the world is like. – Objective- value judgments need not be made – Positive statements can theoretically be tested by
appealing to the facts
• Normative Economics – Prescriptive - what the world ought to be like – Subjective – value judgments must be made – Normative statements cannot be tested appealing to facts.
Categories of Basic Principles of Economics
• How do people make decisions?
• How do people interact?
• How does the economy work overall?
How Do People Make Decisions?
• Principle #1 - People face tradeoffs
– Time allocation – an example of tradeoffs
– Efficiency versus equity
– Production Possibilities Frontier
• Principle #2 - The cost of something is what you have to give up to get it
– Opportunity costs are independent of monetary units
• Principle #3 - Rational people think at the margin
– Rational or irrational decision-making
– Marginal benefits and costs versus total benefits and costs
– Weighing marginal costs and benefits leads to maximizing net benefits (total welfare)
– The boxes example
.
• Principle #4 –People respond to incentives
– Reactions to changes in marginal benefits and costs
– Increases (decreases) in marginal benefits mean more (less) of an activity
– Increases (decreases) in marginal costs mean less (more) of an activity
How Do People Interact?
• Principle #5 - Trade can make everybody better off
• Principle #6 - Markets are usually a good way of organizing economic activity – the “failure” of centrally planned economies and the
movement towards markets for the WHFM questions
Markets
– Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society
– creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations
– in some cases markets fail to allocate resources effectively so,
• Principle #7 Governments can sometimes improve interaction that occurs in markets – there are circumstances when market signals fail to
allocate resources efficiently or equitably
– Public Goods, Externalities and Income Distribution
– Some goods or services that people desire will not be produced by markets.
– Some goods or services will either be underproduced (vaccines) or overproduced (pollution) because markets fails to register certain benefits or costs.
– markets may also fail to provide an equitable or fair distribution of resources
– government intervention with its ability to coerce (the opposite of voluntary) can regulate, tax and subsidize to change market outcomes
– efficiency and equity: the pie analogy
– if government intervention always the proper solution?
How Does the Economy Work as a Whole?
• Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services – Materialism – more toys mean more welfare
– wealth: a necessary or sufficient condition for happiness (are rich people happier, children with lots of toys)
• Principle #9 – The general level of prices rises when the government prints and distributes too much money