103 EABD: Course Structure

• Topic 1. Basics of economic analysis

• Topic 2. Demand and supply

– Topic 2.1. Individual consumer demand
– Topic 2.2. Market demand and supply

• Topic 3. Production analysis and cost analysis

– Topic 3.1. Production policy
– Topic 3.2. Theory of cost

• Topic 4. Market structure analysis

– Topic 4.1. Perfect competition and monopoly
– Topic 4.2. Monopolistic competition and oligopoly

• Topic 5. Consumption and Investment Function

– Topic 5.1. Business Cycle theories
– Topic 5.2. Business Cycle and Business Decisions
 ECONOMICS
Study of nature and uses of national wealth.
By ADAM SMITH

The science which studies human behavior as a

relationship between ends and scarce resources
which have alternative uses.
By Prof Lionel Robbins

Dr. Mital Bhayani 2

“Economics – the science of making
decisions in the presence of scarce
resources”
Resources
 What is Economics??
The study of economies and the factors
affecting economies is called economics.

The discipline of economics can be broken into

two major areas of focus, microeconomics,
and macroeconomics.

Dr. Mital Bhayani 5

► Salient Features
of economics

1.Unlimited wants

2.Scarce resources

3.Alternative uses

4.Choice

Dr. Mital Bhayani 6

 MANAGERIAL ECONOMICS
► DEFINATION
“The integration of economic theory with business practice for
the purpose of facilitating decision making and forward
planning by the management.”
Spencer and Siegelman.
“The application of economic theory and methodology to
business administration practice.”
Brigham and Pappas.
“The study of how to direct scarce resources in a way that
most efficiently achieves a managerial goal.”
Michael R. Bay

Dr. Mital Bhayani 7

Managerial Economics vs. Microeconomics: Common and
Different

Computer Manufacturer (e.g.: IBM)

Similar concepts

Microeconomics Managerial Economics

In which way How should the prices

were the prices be set?
set?
NATURE OF MANAGERIAL ECONOMICS
►Close to microeconomics
►Operates against the backdrop of
macroeconomics
►Normative statements
►Prescriptive actions
►Applied in nature
►Offers scope to evaluate each alternative
►Interdisciplinary
►Assumptions and limitations

Dr. Mital Bhayani 9

SCOPE OF MANAGERIAL ECONOMICS
►Demand decision
►Supply decision
►Pricing
►Cost
►Production
►Profit
►Investment decisions
►Economic forecasting and forward planning

Dr. Mital Bhayani 10

• Classical economists assume that the most
important factor in a product's price is its cost
of production.
• Neoclassical economists argue that the
consumer's perception of a product's value is
the driving factor in its price
“Neoclassical economics dominates mainstream
economics today”
“So the theory of the firm influences decision-
making in a variety of areas” including
- resource allocation
- production techniques
- volume of production
- pricing adjustments
THEORIES OF FIRM

Dr. Mital Bhayani 13

A theory is a set of accepted beliefs or organized
principles that explain and guide analysis

Firm: A firm refers to a commercial or business

institution aiming at the attainment of
economic objectives.

Market: It is place or kind of arrangement where

buyers and sellers interact to exchange goods,
services, shares, contracts and so on.
Dr. Mital Bhayani 14
 Definition of 'Theory of the Firm'
• Theory of firms tells the ways in which firms
behaves.
• A microeconomics that states that firms exist
and make decisions in order to maximize
profits.
• Businesses interact with the market to
determine pricing and demand and then
allocate resources according to models that
look to maximize net profits.

Dr. Mital Bhayani 15

 Necessity of theory of Firm

• Different firms belonging to the same industry,

facing the same market environment, behave
differently, Thus, the necessity for theories of
the firm.

Dr. Mital Bhayani 16

Dr. Mital Bhayani 17
Maximizing, Optimizing and Satisficing

Dr. Mital Bhayani 18

Dr. Mital Bhayani 19
Objectives of the Firm
Optimizing (Maximizing )
• Profit Maximizing Theory
• Managerial Theories of firm
• Growth Maximization Model

Non Optimizing (Satisficing)

• Simons Model
• Cyert and March’s
Profit Maximizing Theory
 debated and expanded….
Maximize Profits…….

…………In Short run or Long run??

What about Competition??

……… long-term profits could only be maximized if there's

a balance between short-term profits and investing in the
future!!!!!
 Risks exist for companies that subscribe to a profit-
maximization goal……….

• Public perception ?
• Loss of goodwill ?
• Publically Held companies?
• Chief executive officers (CEOs) will have
multiple goals ?
 Managerial Theories of the Firm
(a) Baumol’s Sales Revenue Maximisation
Model.
(b) Managerial Utility Models consisting of:
 Baumol’s Sales Revenue Maximizing Model
• Prof. Baumol in his book Business Behaviour,
Value and Growth (1967)
• Separation of ownership and control in modern
corporations. (Principal Agent Problem)
• Managers seek prestige and higher salaries by
trying to expand company sales even at the
expense of profits.
• Has assumed greater significance in the context
of the growth of Oligopolistic firms
 Supporting Arguments
• Salaries and other earnings are correlated with sales
• Banks, creditors and the capital market don’t
finance if sales decline
• Personnel problems are handled more satisfactorily
when sales are growing
• If firm’s sales are large, there are economies of scale
and the firm expands and earns large profits.
“Criticized for Less Empirical evidences”
 Managerial Discretion by Oliver. E. Williamson
Managerial Utility function as given by
Williamson is as follows:
U = f(S, M, ID)
Here, U = Managerial utility
S = Additional expenditure on staff
M = Managerial emoluments
ID = Discretionary investment
 Marris’ Growth Maximization Model
Ownership and control belongs to owners and managers
The Utility functions:
UM = f(salaries, power, status, job security)
UO = f(profits, market share, output, capital, public
esteem)
“Both have one thing in common size of company and
can be achieved by balanced Growth rate”
 G= Gd= Gc

G= growth rate
Gd= growth rate of demand
Gc= growth rate of capital supply to the firm
 Constraints
• Managerial
• Financial
- Debt Equity Ratio = Borrowed Capital/Owners Capital
- Liquidity Ratio = Current Assets/Current Liabilities
- Retention Ratio = Retained Profits/Total Profits

“growth and profits are competing goals”

Non Optimizing (Satisficing)
1. Simons satisficing model
- Lack of full information and uncertainty
- Operates under bounded rationality
- Maximizing profit, sales or growth is
impossible
- Firms can only aim at achieving satisfactory
level of profits, sales or growth.
Cyert and March’s Behavioural Theory of the
Firm:
- Firm is a coalition of groups
- Each group has its own goals
- The Goals are conflicting
- Firms aims at satisfying all stakeholders
- Decision making Involves multiple and varying
goals.
“ Critised for low empirical tests”
Summary: Optimizing (Maximizing )
1. Profit Maximizing Theory (Theory of Firm)
“Maximize Profit- Improvised to Maximize
Value of Firm:
2. Managerial Theories of firm
- Baumol’s Sales Revenue Maximisation
- Managerial Utility Models
3. Marris’ Growth Maximization Model Growth
“Maximize the growth rate ( size of company)
 “Opportunity Cost Concept”
- Represent the potential benefits missed out
on when choosing one alternative over
another.
-Because they are by definition “unseen” they
can be easily overlooked.
- Allows for better decision-making
“Opportunity cost is simply
the difference between the
Opportunity Cost= FO−CO expected returns of each
option.”
where:
FO=Return on best forgone option
CO=Return on chosen option​
 Example
Option A : to invest in the stock market Expected Return =12%

hoping to generate capital gain returns

Option B: to reinvest your money back into

the business, expecting that newer Expected Return =10%

equipment will increase production

efficiency and higher profits

OC= 12-10 = 2%
 Accounting Profit and Economic Profit

• Accounting Profit = TR-TC (Accounting Cost)

• Economic Profit= TR- TC (Economic Cost)

 Accounting costs:
• An accounting costs are the direct monetary costs
that enters the books of accounts of a business firm
• The accountant will include only explicit cost in the
cost of production, but not the profits made by the
entrepreneur.
• Explicit cost :
It refers to the actual money outlay or out of pocket
expenditure of a firm to buy or hire the productive
resources it needs in the process of production.

Dr. Mital Bhayani 38

• The following items will be included in the explicit
costs;
1. Cost of raw material
2. Wages and salaries
3. Power charges
4. Rent of factory
5. Interest payments
6. Insurance premium
7. Taxes
8. Miscellaneous expenses (marketing, advertising)

Dr. Mital Bhayani 39

Economic costs:
• Economic cost is a broader term and includes, all the
costs such as implicit costs, explicit costs,
opportunity costs etc.
• Implicit costs:
Implicit costs are the opportunity costs of the use of
factors which the firm does not buy or hires but
already owns.
• Implicit costs are the payments which are not
directly or actually paid by the firm as no contractual
disbursement is fixed for them

Dr. Mital Bhayani 40

Following items will be included in the implicit
costs:

• Rent of land and premises belonging to entrepreneur

• Normal returns or profits of entrepreneur
• A compensation needed for his management and
organizational activity.

Economic cost = Accounting cost + Implicit cost

Dr. Mital Bhayani 41

 Tools of Managerial Economics
►Economic Model
►Marginal Analysis
►Equilibrium

Dr. Mital Bhayani 42

 Economic Model
• Variables, relations and predictions.
• Exogenous and Endogenous
• Exogenous variable is one whose value is
determined outside the model and is
imposed on the model
• An endogenous variable is a variable whose
value is determined by the model.
 Marginal analysis

Marginal analysis is an examination of the

additional benefits of an activity compared to
the additional costs incurred by that same
activity.
 Equilibrium
• A state or condition
that will continue
indefinitely as long
as exogenous factors
remain unchanged

• that is, as long as no

outside factor upsets
the equilibrium.
• an over-supply of goods or services causes
prices to go down, which results in higher
demand
• while an under-supply or shortage causes
prices to go up resulting in less demand.
• The balancing effect of supply and demand
results in a state of equilibrium.
 Profit
Profit
Maximizing n
TRt − TCt

Theory of
Firm Marginal
Analysis
t =1 (1 + i )t

Equilibrium
Which How
Cost? Price?
product? Much?
THANK YOU!!!!