Managerial Economics

1

“The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to avoid being deceived by economists”

- Joan Robinson 76% of senior executives say that it is important they have the

knowledge and skills to respond to trends like resource scarcity, the low carbon economy and doing business in emerging markets

2

Session IConception of Economics

3

What is Economics?

Unlimited wants and scarce resources

Science [methodology] or Art [Application]…?

4

What is Economics? …Contd

5

Economics is the study of nature and

uses of national wealth.

Father of Economics

Adam Smith (1723-1790)

Basic AssumptionsI. Ceteris Paribus- Other things remaining equal

It is a Latin word means ‘with other things (being) the same’

“ The existence of other tendencies is nor denied, but their disturbing effect is neglected for a time” - Marshall

6

Basic AssumptionsII. Rationality Implies that consumers and producers measure and

compare costs and benefits before taking decisions

Consumers: Maximising utility and minimising sacrifice Producers : Maximising profits and minimising costs

7

Types of Economic Analysis A. Micro(individual consumers and firms) Macro (Aggregates- Industry, not firm)

B. Positive (factual statements- “What is”) – The distribution of income in India is unequal.

Normative (Value judgments- “What ought to be”) – The distribution of income in India should be equal.

8

Types of Economic Analysis C. Time period

Short run -A time period not long enough for consumers and producers to adjust to a new situation- K/L

Long run- Planning horizon- A time period long enough for consumers and producers to adjust to a new situation- All inputs can be varied- K and L- Whether to change product lines, build new plant etc.

9

Kinds of Economic Questions1. What to Produce? (Micro)2. How to Produce? (Micro)3. How much to produce? (Micro)4. For Whom to Produce? (Micro)5. Are Resources Used optimally? (Micro)

6. Are Resources fully employed? (Macro)7. Is the economy Growing? (Macro)8. In what phase of business cycle is the economy? (Macro)

10

Session IIConception of Managerial Economics

11

Managerial Economics- Meaning

“Application of economic theory and tools of analysis of decision science to examine how an organization can

achieve its objectives most efficiently”- Salvatore

12

MeaningSpencer and Siegelman: “… Integration of economic theory

with business practice for the purpose of facilitating decision making and forward planning by management”

Evan Douglas: “Application of economic principles and methodologies to the decision-making process within the firm or organization…under conditions of uncertainty”

13

Conceptualization of ME

14

Users of Managerial Economics

15

Thank you sir I learned many

economic concepts from

you. It’s helping me a

lot

ManagerEconomist

Nature Microeconomics Normative economics Uses theory of firm Takes the help of macroeconomics Aims at helping the management A scientific art Prescriptive rather than descriptive

16

Scope of ME Theory of demand

Demand AnalysisDemand Theory

Theory of production Variable factor of productionFixed factor of production

Theory of exchange or price theory

Theory of profit

17

Theory of capital and investment

Environmental issuesBusiness cycles Industrial policy of the

country Trade and fiscal policy of the

country Taxation policy of the country Price and labour policy

Session IIIDecision Making ProcessDecision Making Process

18

Decision Making Process

19

Meaning & Nature of DMPoImportance of Quantitative Tools

oAnalysis of variables is a key procedure in economic analysis.

oEconomic research and policy-making require up-to-date data and extensive analysis.

oUse of Mathematical tools

20

…Meaning & Nature of DMPoUse of Statistical Techniques

oTime Series: For Demand forecastingoRegression: Two or multiple variables used to study interrelationships, estimation and predictionoMeasures of central tendency and variation

21

Conventional Decision Rules [Principles relevant to managerial decisions]

A. Concept of Scarcity

◦Human wants are unlimited, but human capacity to satisfy such wants is limited.

22

…Conventional Decision Rules [Principles relevant to managerial decisions]

B. Concept of Opportunity Cost

◦ It is the benefit foregone from the alternative that is not selected.

◦The economist has to make rational choice in all aspects of business by sacrificing some of the alternatives, since resources are scarce and wants are unlimited.

23

…Conventional Decision Rules [Principles relevant to managerial decisions]

C. Production Possibility Curve (PPC)

◦ PPC is a graph that shows the different combinations of the quantities of two goods that can be produced (or consumed) in an economy, subject to limited availability of resources.

24

…Conventional Decision Rules [Principles relevant to managerial decisions]

D. Concept of Margin

◦ The Marginality deals with a unit increase in cost or revenue or utility.

25

Session IVRole of Economics and Managerial EconomistRole of Economics and Managerial Economist

26

Role of EconomicsWhat is the role of Economics in Business?Costs, prices, output, compensation, strategic behaviour and ethics making.

The Big Picture- Whose job is this? Economic theory forms the basis for different management areas such as accounts, finance, marketing, systems and operations.

27

…Role of Economics A manager has to deal with problems pertaining to the individual firm as well as domestic and global environment.

Microeconomics: Deals with individual unit Macroeconomics: Deals with aggregates

28

…Role of EconomicsMicroeconomics: Theory of demand and supply- consumer behavior, demand theory,

demand forecasting and factors affecting individual and market supply- Helps in choice of commodities for production.Helps in choice of commodities for production.

Theory of Production: Production function and laws of returns to scale etc- gives an idea about I/O relations, input requirement size of firm, technology choice of output- Helps producer to plan Helps producer to plan production, cost and budget.production, cost and budget.

29

…Role of EconomicsMarket Analysis:Market Analysis: helps understand degrees of competition, pricing-output decisions, price discrimination, monopoly power, advertising

Profit Analysis: Profit Analysis: Provides logical analysis of break-even point, emergence of profits, profit-maximising output, dealing with risk and uncertainty

30

…Role of EconomicsMacro economic: variables and policies impact business

@Behavior of macro economic indicators: GDP, GNP, GDCF(Gross Domestic Capital Formation), HDI (Human Development Index) etc.

@Business Cycles – Inflation- Employment @Fiscal Policy: Taxes and Govt. Expenditure@Monetary Policy: Savings and Investment@Foreign Trade: Imports and exports, Exchange rate, trade policies

and capital flows

31

Role of Economics in Business Economics is a tool, means to an end:

To help efficient allocation efficient allocation and achieve business achieve business objectivesobjectives

To optimising resources - Maximise goals, minimize costs under constraint

Logic, tools and techniques of economics to analyse business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision.

32

Role of Managerial EconomistRole Of Managerial Economist: To decide What to produce? Where? How ? How much? Allocation of resources For whom to produce? Which price to sell?

33

…Role of Managerial Economist

Plan and control business operations- Cost minimisation Profit maximisation ?? Managing competition Economic intelligence Market research

34

…Role of Managerial Economist

Uncertainty & Risk management

Forecast change in environment and policies- domestic and international

To manage change in global scenario Everything comes at a price- quality is not free

35

Growing Challenges to the Managerial Economist

A) GlobalizationWhat is Globalization ?

People-goods-services- communication- Finance- Ideas

36

…Growing Challenges to the Managerial Economist

Global corporations- Research & production facilities across countries- Global markets- Global Finance- Employment Diversity- Global work culture

37

…Growing Challenges to the Managerial Economist

Increased competition Increased Opportunity Tastes converging internationally? Customising to local tastes

38

Growing Challenges to the Managerial Economist

B) Computerisation and Technology Easier model-building and simulation Quick and easier data analysis Rapid spread of information Internet changing both buyers and sellers Videoconferencing- saving cost and time Paperless administration Speed of dispatch, lower inventories, less waste

39

Session VQuiz & lessons Quiz & lessons

40

1.Who sells the largest number of cameras in India? 2. Who has the biggest revenue from music business in India? 3. Who gained the most when business of British Airways was affected due to the 2008 recession?

41

Answers to the Lessons?1: Samsung (whose main line of business is NOT cameras but cell phones)2: Airtel (which is not in music business)- by selling caller tunes makes more money than HMV etc3: videoconferencing and telepresence services of HP and Cisco.

42

What are the Lessons? Nokia missed the Smartphone bus. Apple's I phone and Google's Android are making life difficult for Nokia.

But Google is not a mobile company Nokia is a global behemoth, with 35% of the world’s handset market.

43

What are the Lessons? Products have vanished from the market in the past 20 years:

◦ Black & white TVs◦ Fountain pens◦ Type writers◦ Alarm Clocks

44

What are the Lessons? Lessons by the Managerial economist: Today's competitor is obvious. Tomorrow's is not- Think beyond conventional framework; think beyond the obvious Need to identify competition (present) Need to foresee competition (Future) Need to beat competition (Strategies)

45

Session VIObjectives of FirmObjectives of Firm

46

Objectives of the Firm Why do people do business?

What motivates the owners /investors / promoters to take so much of risk and conduct their own businesses, rather than going for a secured employment?

Is it only maximization of profits that drives businesses? ◦ Or is it something beyond?

47

Profit Maximization Theory Objective of business is generation of the largest amount of

Profit = (Total Revenue-Total Cost) Traditionally, efficiency of a firm measured in terms of its profit generating capacity

CriticismConfusion on measure of profitValidity questioned in competitive markets

48

Baumol’s Theory of Sales Revenue Maximization

In competitive markets firms aim at maximizing revenue through maximization of sales

Sales volumes determine market leadership in competition

Manager’s salary and other benefits linked with sales volumes, rather than profits

Criticism Insufficient empirical evidence

49

Marris’ Hypothesis of Maximization of Growth Rate

Two sets of goals:Owners (shareholders) aim at profits and market share (Uo )Managers aim at better salary, job security and growth (Um)

Both achieved by maximizing balanced growth of the firm (G), which depends on Growth rate of demand for the firm’s products (GD) and Growth rate of capital supply to the firm (GC)

G = GD = GC

GD = f(d, k)

GC = f(r, π)

50

Where,d = diversification,k = success rate,r = financial security ratio,π = constant rate of profit increase

…Marris’ Hypothesis of Maximization of Growth Rate

Constraints in the objective of maximization of balanced growth:Managerial Constraint : Non availability of managerial skill sets

in required size creates constraints for growth Financial Constraint : debt equity ratio (r1), liquidity ratio (r2)

and retained profit ratio (r3) Um = f(Salary, Power, Status, Job Security) U0 = f(Profit, Market Share, Brand Image)

51

Williamson’s Model of Managerial Utility Function

Managers apply their discretionary power to maximize their own utility function Constraint of maintaining minimum profit to satisfy shareholders

Utility function of managers (Um) depends on: salary, Job security, power of discretionary investment (ID)

Um = f (S, M, ID)

ID = πD (πD is discretionary profit)

π D = (Actual profit – Minimum profit) – Tax

Therefore :

Um = f (S, πD)

An increase in S is only possible by decrease in πD and vice versa.

Managers’ try to find an optimum combination of S and πD

52

Where,S=Salary,M=Managerial Emoluments,

Behavioural Theories Simon’s Satisficing Model Biggest challenge before modern businesses is lack of

full information and uncertainty about futureThe objective of maximizing either profit, or sales, or

growth is not possible. they act as constraints to rational decision making the firm has to operate under "bounded rationality" can only aim at achieving a satisfactory level of profit, sales and growth

53

Behavioural Theories Model by Cyert and March Apart from dealing with inadequate information and uncertainty,

businesses also have to satisfy a variety of stakeholders, who have different and oft conflicting goals

‘Satisficing behaviour’ aims at satisfying all stakeholders. Managers form an Aspiration level on basis of past experience,

past performance of the firm, performance of other similar firms, and future expectations

54

Reasonable Profit Objective Profit is necessary in the long run

◦ It is an indicator of the financial health of the company and growth

Shareholders, creditors and other investors are satisfied that the firm is growing and their capital is well-invested

The possibility of profit maximization may attract competition, while reasonable profit may make the market less attractive

Workers and unions refrain from demanding higher wages as profits are not huge

Thus a minimum reasonable profit is a must for any firm

55

References

1. Managerial Economics in a Global Economy – Dominick Salvatore2. Managerial Economics – Geetika, Piyali Ghosh and Purba Roy

Choudhury3. Managerial Economics – R. L. Varshney and K.L. Maheshwari

56