ECONOMICS FOR MANAGERS

Module 1
Introduction to Economics:

Economics is a study of human activity both at individual and national level. Any activity
involved in efforts aimed at earning money and spending this money to satisfy our wants such as
food, Clothing, shelter, and others are called “Economic activities”.
It was only during the eighteenth century that Adam Smith, the Father of Economics, defined
economics as the study of nature and uses of national wealth’.
Prof.Alfred Marshall, one of the greatest economists of the nineteenth century, writes
“Economics is a study of man’s actions in the ordinary business of life: it enquires how he gets
his income and how he uses it”.
Prof. Lionel Robbins defined Economics as “the science, which studies human behavior as a
relationship between ends and scarce means which have alternative uses”.

Microeconomics
 The study of an individual consumer or a firm is called microeconomics.
 Micro means ‘one millionth’.
 Microeconomics deals with behavior and problems of single individual and of micro
organization.
 It is concerned with the application of the concepts such as price theory, Law of Demand
and theories of market structure and so on.

Macroeconomics:
 The study of ‘aggregate’ or total level of economic activity in a country is called
macroeconomics.
 It studies the flow of economics resources or factors of production (such as land, labor,
capital, organization and technology) from the resource owner to the business firms and
then from the business firms to the households.
 It is concerned with the level of employment in the economy.
 It discusses aggregate consumption, aggregate investment, price level, and payment,
theories of employment, and so on.

MANAGERIAL ECONOMICS Managerial Economics refers to the firm’s decision making

process. It could be also interpreted as “Economics of Management” or “Business economics”.
Managerial Economics is a discipline that combines economic theory with managerial practice.
It tries to bridge the gap between the problems of logic that intrigue economic theorists
and the problems of policy that plague practical managers.

Nature of Managerial Economics:

 Art and science.- Managerial Economics requires a lot of creativity and logical thinking
to come up with a solution. A managerial economist should possess the art of utilizing his
capabilities, knowledge, and skills to achieve the organizational objective. Managerial
Economics is also considered as a stream of science as it involves the application of
different economic principles, techniques, and methods, to solve business problems.

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 Microeconomics: Managers typically deal with the problems relevant to a single entity
rather than the economy as a whole. It is therefore considered an integral part of
microeconomics.
 Uses of Macro Economic: A corporation works in an external world, i.e., it serves the
consumer, which is an important part of the economy. For this purpose, managers must
evaluate the various macroeconomic factors such as market dynamics, economic changes,
government policies, etc., and their effect on the company.
 Multidisciplinary: Managerial economics uses many tools and principles that belong to
different disciplines, such as accounting, finance, statistics, mathematics, production,
operational research, human resources, marketing, etc.
 Prescriptive or Normative Discipline: By introducing corrective steps managerial
economics aims at achieving the objective and solves specific issues or problems.
 Management Oriented: This serves as an instrument in managers’ hands to deal
effectively with business-related problems and uncertainties. This also allows for setting
priorities, formulating policies, and making successful decisions.
 Pragmatic: The solution to day-to-day business challenges is realistic and rational.
Different individuals take different views of the principles of managerial economics.
Others may concentrate more on customer service and prioritize efficient production.
 Uses theory of firm: Managerial economics largely uses the body of economic concepts
and principles towards solving the business problems. Managerial economics is a special
branch of economics to bridge the gap between economic theory and managerial practice

Scope of Managerial Economics:

 Demand analysis and forecasting. The foremost aspect regarding scope is demand
analysis and forecasting. A business firm is an economic unit which transforms
productive resources into saleable goods. Since all output is meant to be sold, accurate
estimates of demand help a firm in minimizing its costs of production and storage. A
firm must decide its total output before preparing its production schedule and deciding
on the resources to be employed. Demand forecasts serves as a guide to the management
for maintaining its market share in competition with its rivals, thereby securing its profit.
 Cost and production analysis. A firm's profitability depends much on its costs of
production. A wise manager would prepare cost estimates of a range of output, identify
the factors causing variations in costs and choose the cost- minimizing output level,
taking also into consideration the degree of uncertainty in production and cost
calculations. Production process are under the charge of engineers but the business
manager works to carry out the production function analysis in order to avoid wastages
of materials and time. Sound pricing policies depend much on cost control.
 Pricing decisions, policies and practices- Another task before a business manager is the
pricing of a product. Since a firm's income and profit depend mainly on the price
decision, the pricing policies and all such decisions are to be taken after careful analysis
of the nature of the market in which the firm operates. The important topics covered in
this field of study are : Market Structure Analysis, Pricing Practices and Price
Forecasting.
 Linear programming and theory of games : Linear programming and theory of games
have came to be regarded as part of managerial economics recently.

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 Environmental issues: There are certain issues of macroeconomics which also form a
part of managerial economics. These issues relate to general business, social and
political environment in which a business enterprise operates.
 Profit management. Each and every business firms are tended for earning profit, it is
profit which provides the chief measure of success of a firm in the long period.
Economists tells us 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 at different levels of output. The more successful a manager is in reducing
uncertainty, the higher are the profits earned by him. It is therefore, profit-planning and
profit measurement constitute the most challenging area of business economics.
 Business cycles: Business cycles affect business decisions. They refer to regular
fluctuations in economic activities in the country. The different phases of business cycle
are expansion, peak, recession, depression, trough and recovery.
 Inventory management: A firm should always keep an ideal quantity of stock. If the
stock is too much, the capital is unnecessarily locked up in inventories At the same time
if the level of inventory is low, production will be interrupted due to non-availability of
materials. Hence, a firm always prefers to have an optimum quantity of stock.
Therefore, managerial economics will use some methods such as ABC analysis,
inventory models with a view to minimizing the inventory cost.
 Capital management. Still another most challenging problem for a modern business
manager is of planning capital investment. Investments are made in the plant and
machinery and buildings which are very high. Therefore, capital management requires
lot of efforts for the right decision.

Importance of Managerial Economics:

 Business Planning and Forecasting: Managerial economics plays an efficient role in

formulating business policies by forecasting future demands and uncertainties. It assists
in the effective decision making of an organization by supplying all information using
economic tools and techniques.

 Analyze Cost and Production level: Managerial economics focuses on minimizing the
cost of business. It determines the cost associated with different business processes and
finds out the cost-minimizing level of output. Managerial economics enables business
managers in ensuring that there is no resource wastage which reduces the overall cost.

 Formulate pricing policies: It helps in determining the right pricing policies for
organizations. Pricing method affects the profitability and revenue of the business
organization and therefore fixing the right price is essential. Managerial economics
analyses the market pricing structure and strategies for deciding the firm prices.

 Manages profit: Managerial economics monitor and control the profitability of the
business organization. Profit is the ultimate goal of every business and determines its
success or growth. It ensures that the desired profit is earned by making an estimate of
the revenue and expenses of an organization at different levels of outputs.

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 Capital Management: Capital management is one of the important functions played by

managerial economics. It manages and analyses all capital expenditures of business
which involves huge expenditures. Before investing any amount anywhere it measures
the profitability of such a source for allocating funds.

Significance of Managerial Economics:

 Business Planning: Managerial economics assists business organizations in formulating

plans and better decision making. It helps in analyzing the demand and forecasting future
business activities.
 Cost Control: Controlling the cost is another important role played by managerial
economics. It properly analyses and decides production activities and the cost associated
with them. Managerial economics ensure that all resources are efficiently utilized which
reduces the overall cost.
 Price Determination: Setting the right price is one of the key decisions to be taken by
every business organization. Managerial economics supplies all relevant data to managers
for deciding the right prices for products.
 Business Prediction: Managerial economics through the application of various economic
tools and theories helps managers in predicting various future uncertainties. Timely
detection of uncertainties helps in taking all possible steps to avoid them.
 Profit Planning And Control: Managerial economics enables in planning and managing
the profit of the business. It makes an accurate estimate of all cost and revenue which
helps in earning the desired profit.
 Inventory Management: Proper management of inventory is a must for ensuring the
continuity of business activities. It helps in analyzing the demand and accordingly,
production activities are performed. Managers can arrange and ensure that the proper
quantity of inventory is always available within the business organization.
 Manages Capital: Managerial economics helps in taking all decisions relating to the
firm’s capital. It properly analyses investment avenues before investing any amount into
it to ensure the profitability of an investment.

Limitations of Managerial Economics:

 Lack of Reliability: Business economics is a dependant study based on the financial and
cost accounting information. Hence, the management analysis as the outcome of business
economics cannot be reliable, if the generated information is inaccurate.
 Inaccurate Conclusions: The outcomes of business economics can be inaccurate as
many of the economics theories are based on the past information or events. Thus, it may
not give suitable solutions for the changed circumstances.
 Biased Outcome: The final decisions/final outcome of manager can be influenced
because the business. Economics is subject to the personal preferences of an individual
manager.
 Expensive Process: Business economics is not an economical method because many of
the organizations need specific number of managers to ensure the proper functioning of
business operations.

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 Uncertainty: The study of business economics is new and not completely developed.
Hence, it is full of uncertainty in respect of certain scenarios.
 No Unified Outcome: The different managers, who address the economic situation in the
economy, may come up with different solutions even when they work together. They
hardly come up with unified outcome because economic activities are based on human
behaviours. Thus, they can't make accurate prediction about the market changes.
 Narrow Scope: Business economics emphasizes only on the internal management of the
firm.

RELATIONSHIP OF MANAGERIAL ECONOMICS WITH OTHER DISCIPLINES:

1. Managerial Economics and Micro Economics: Managerial Economics is mainly micro
economics in character, making use of many of the concepts and tools provided by micro
economic theory. The concept of elasticity of demand, Marginal cost, Market structure, Pricing
theory are fully made use of by managerial economics.
2. Managerial Economics and Macro Economics: Macro Economics is aggregative in
character and the concepts are used in managerial economics in the area of forecasting general
business conditions. It is essential that the business executives should know the aggregative
nature of the economy. Macroeconomic concepts like National Income, Social accounting,
Multiplier, Acceleration.
3. Managerial Economics and Mathematics: Managerial Economics is becoming increasingly
metrical in character. Mathematics is used in managerial economics in estimating various
economic relationships and employing them in decision-making and forward planning. The
business executive should have knowledge of Algebra, Geometry, Integral and Differential
Calculus.

4. Managerial Economics and Statistics:

a. Managerial Economics requires collecting of quantitative data to find out
functional relationship involved in decision-making
b. Statistical tools are used for empirical testing in managerial economics
c. The theory of probability evolved by statistics helps them for taking a logical
decision.
5. Managerial Economics and Accounting: Accounting has close relationship with managerial
economics. Accounting refers to the recording of pecuniary transaction of the firm in certain
prescribed books. The decision-making process of a firm mostly depends on accounting
information.
6. Managerial Economics and Decision-Making: Managerial Economics is closely related to
the theory of decision-making. It deals with the selection of a particular course of action in the
background of different alternatives.

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7. Managerial Economics and Operational Research: Operational Research is the application

of mathematical techniques in solving business problems. It deals with model-building i.e.
construction of theoretical models that helps the decision making process.

Decision Making:
Decision-making is core aspect of managerial economics. Decision-making is the process of
selecting a particular course of action from among the various alternatives. Every business
manager has to work on uncertainties and the future cannot be precisely predicted by anyone.
The decision maker must be very careful in choosing a particular course of action in order to
realize the objectives.

Decision making is the process of identifying alternative courses of action and selecting an
appropriate alternative in a given decision situation. This definition presents two important parts:
1. Identifying alternative courses of action means that an ideal solution may not exist or might
not be identifiable.
2. Selecting an appropriate alternative implies that there may be a number of appropriate
alternatives and that inappropriate alternatives are to be evaluated and rejected. Thus, judgment
is fundamental to decision making.
Economic decision making refers to the process of making business decisions involving money.
All economic decisions of any consequence require the use of some sort of accounting
information, often in the form of financial reports. Anyone using accounting information to make

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economic decisions must understand the business and economic environment in which
accounting information is generated, and they must also be willing to devote the necessary time
and energy to make sense of the accounting reports.
Economic decision makers are either internal or external.
Internal decision makers are individuals within a company who make decisions on behalf of the
company, while external decision makers are individuals or organizations outside a company
who make decisions that affect the company
Internal Decision Makers decide whether the company should sell a particular product, whether
it should enter a certain market, and whether it should hire or fire employees. Note that in all
these matters, the responsible internal decision maker makes the decision not for himself or
herself, but rather for the company. Depending on their position within the company, internal
decision makers may have access to much, or even all, of the company’s financial information.
They do not have complete information, however, because all decisions relate to the future and
always involve unknowns.
External Decision Makers make decisions about a company. External decision makers decide
whether to invest in the company, whether to sell to or buy from the company, and whether to
lend money to the company.

Kinds of Economic Decisions

Strategic Decisions and Routine Decisions
As the name suggests, routine decisions are those that the manager makes in the daily
functioning of the organization, i.e. they are routine. Such decisions do not require a lot of
evaluation, analysis or in-depth study. In fact, high-level managers usually delegate these
decisions to their subordinates. strategic decisions are the important decisions of the firm. These
are usually taken by upper and middle-level management. They usually relate to the policies of
the firm or the strategic plan for the future. Hence such decisions require analysis and careful
study. Because strategic decisions taken at this level will affect the routine decisions taken daily.

Programmed Decisions and Non-Programmed Decisions

Programmed decisions relate to those functions that are repetitive in nature. These decisions are
dealt with by following a specific standard procedure. These decisions are usually taken by lower
management. For example, granting leave to employees, purchasing spare parts etc are
programmed decisions where a specific procedure is followed.
Non-programmed decisions arise out of unstructured problems, i.e. these are not routine or daily
occurrences. So there is no standard procedure or process to deal with such issues.
Usually, these decisions are important to the organization. Such decisions are left to upper
management. For example, opening a new branch office will be a non-programmed decision.
Policy Decisions and Operating Decisions

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Tactical decisions pertaining to the policy and planning of the firm are known as policy
decisions. Such decisions are usually reserved for the firm’s top management officials. They
have a long term impact on the firm and require a great deal of analysis.
Operating decisions are the decisions necessary to put the policy decisions into action. These
decisions help implement the plans and policies taken by the high-level managers.
Such decisions are usually taken by middle and lower management. Say the company announces
a bonus issue. This is a policy decision. However, the calculation and implementation of such
bonus issue is an operating decision.

Organizational Decisions and Personal Decisions

When an executive takes a decision in an official capacity, on behalf of the organization, this is
an organizational decision. Such decisions can be delegated to subordinates.
However, if the executive takes a decision in a personal capacity, that does not relate to the
organization in any way this is a personal decision. Obviously, these decisions cannot be
delegated.

Individual Decisions and Group Decisions

When talking about types of decisions, let us see individual and group decisions. Any decision
taken by an individual in an official capacity it is an individual decision. Organizations that are
smaller and have an autocratic style of management rely on such decisions.
Group decisions are taken by a group or a collective of the firm’s employees and management.
For example, decisions taken by the board of directors are a group decision.

ECONOMIC SYSTEM:
According to W.W. Loucks, “An economic system consists of those institutions which a given
nation or group of nations has chosen or accepted as the means through which their resources are
utilized for satisfaction of human wants”
There are four main types of economic systems.

 The Traditional Economic System

 The Command Economic System
 The Market Economic System
 The Mixed Economic System
Each system has its strengths and weaknesses

Traditional Economic System:

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• In a traditional economy, the customs and habits of the past are used to decide what and
how goods will be produced, distributed, and consumed. Each member of society knows
from early on what their role in the larger group will be.
• Jobs are passed down from generation to generation so there is little change in jobs
over the generations. In a traditional economy, people are depended upon to fulfill their
jobs. If someone fails to do their part, the system can break down.
• Farming, hunting, and herding are part of a traditional economy. Traditional economies
can be found in different indigenous groups. In addition, traditional economies bartering
is used for trade.
• Bartering is trading without money. For example, if an individual has a good and he
trades it with another individual for a different good.
Traditional Economy-The production of goods and services are based on a particular society’s
traditional customs or beliefs; people will make what they have always made and will do the
same work their parents did; exchange of goods is done through bartering.

 Traditional economies base economic decisions on cultural values and beliefs. This
economy relies on farming, hunting, and fishing.
 Traditional economies can be negatively affected by other economy types that use
large amounts of natural resources

Command Economy:
In a command economy, the government planning groups make the basic economic decisions.
The government determines which goods and services are to be produced, the prices and the
wage rate. The government, not the people, own farms and businesses. Workers are told what to
produce and how much to produce. They are given a quota to fulfill. All workers are given a
quota and are expected to fill it. A problem with a command economy is deciding what needs to
be produced. A benefit is that prices are controlled and people know what something will cost.
Command Economy- The central or state government determines the goods produced, prices of
goods, services provided and the wages of workers. Typically found in communist governments.

Pros:
● Can manipulate large amounts of resources for large projects without lawsuits or
environmental regulatory issues.
● An entire society can be transformed to conform to the government's vision, from
nationalizing companies to placing workers in new jobs after a governmental skill
assessment.
Cons:

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● Rapid change can completely ignore society's needs, forcing the development of a black
market and other coping strategies.
● Goods production is not always matched to demand, and poor planning often leads to
rationing.
● Innovation is discouraged and leaders are rewarded for following orders rather than
taking risks.

Market Economy:
● In a market economy, decisions are guided by changes in prices that occur between
buyers and sellers. Market economies are also known as free enterprise, capitalism,
and laissez- faire.
● Businesses and farms are owned by individuals and corporations. Each business or farm
decides what it wants to produce. Supply and demand determines the price people pay
for things. Supply is the amount of goods available and demand is how many consumers
want the goods.
● A benefit of a market economy is that consumers can find the goods they want and can
buy as much as they can afford. A problem is there is no stability in prices and
businesses, if mismanaged, can go out of business. If this happens, then workers lose
their jobs and income.

Mixed Economy:
• A mixed economy typically combines the features of a market-based economy with a
strong public sector. While most prices are set by supply and demand, the government
may intervene in the economy by enforcing price floors or ceilings for certain goods, or
by directing public funds to certain industries at the expense of others.
• The following are common examples of mixed-economy policies

• Social Welfare Programs

• Most mixed economies, even heavily market-oriented ones, offer benefits to those living
at or near the poverty level. Many countries have extremely generous social welfare
programs, as well as government-provided health care and strong labor protections.

• Price Controls / Subsidies

• While prices in a mixed economy are generally set by the market, the government may
intervene to prevent the prices of certain commodities from rising or falling below a
certain level. For example, most mixed economies have minimum wage laws to prevent
exploitation of the workforce, and they may use subsidies to support farmers or other key
industries.

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• Strong Business Regulations

• While most business activity is guided by the free market, governments may use
regulations to protect the public from dangerous products, pollution,
or monopolistic business practices. Many mixed economies have anti-trust laws to ensure
that the marketplace remains competitive.

PRINCIPLES/CONCEPTS OF MANAGERIAL ECONOMICS:

MARGINAL CONCEPT
Marginal means change in total quantity or value due to one unit change in its determinant.
Marginal analysis implies judging the impact of a unit change in one variable on the other. It is
used in maximization and minimization problems. Concepts involve Marginal cost and marginal
revenue.
Marginal cost(MC)=TCn-TCn-1
Where TCn= Total cost of producing n units
TCn-1= Total cost of producing n-1 units

Marginal revenue(MR)=TRn-TRn-1
Where TRn= Total revenue of producing n units
TRn-1= Total revenue of producing n-1 units
MC refers to the total costs per unit change in output produced.
MR refers to the total revenue per unit change in output sold

INCREMENTAL CONCEPT
The incremental concept involves the estimation of the impact of decision alternatives on cost
and revenues that result from changes in prices, products, procedures, investment, etc,.
Incremental concept is closely related to the marginal cost and marginal revenues of economic
theory.
Incremental analysis is generalization of marginal concept. It refers to changes in cost and
revenue due to a policy change. For example - adding a new business, buying new inputs,
processing products, etc. Change in output due to change in process, product or investment is
considered as incremental change.
The two major concepts in this analysis are;
i) Incremental cost

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ii) Incremental revenue

Incremental cost denotes changes in total cost whereas incremental revenue means change in
total revenue resulting from a decision of the firm.
A decision is profitable only if;

i) It increases revenue more than cost

ii) It decreases some costs more than it increases others
iii) It increases some revenues more than it decreases others
iv) It reduces costs more than revenues

Generally businessman holds the view that they ‘must make a profit on every job’ in order to
make an overall profit. With this concept, business may refuse orders that do not cover full cost
(variable cost and fixed cost) plus a provision of profit. This will leads to rejection of an order
which prevents short run profit. The following example will illustrate this point.
Suppose a new order is estimated to bring in an additional revenue of Rs. 10,000. the cost are
estimated as under;
Labour cost = Rs. 3000
Material cost = Rs. 4000
Overhead charges = Rs. 3600
Selling & Administrative cost = Rs. 1400
Full cost = Rs. 12,000
The order appears to be unprofitable for it results in a loss of Rs. 2000. However, suppose there
is idle capacity which can be utilized to execute this order. If order adds only Rs.1000 to
overheads charges and Rs. 2000 by way of labour cost because some the idle worker already on
the payroll will be deployed without added pay and no extra selling and administrative cost,
Then the actual incremental cost is as follow;
Labour cost = Rs. 2000
Material cost = Rs. 4000
Overhead charges = Rs. 1000
Selling & Administrative cost = Nil
Incremental cost = Rs. 7,000

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Thus there is a profit of Rs. 3000. The order can be accepted on the basis of incremental
reasoning. Incremental reasoning does not accept all orders at prices which cover merely their
incremental costs.

INCREMENTALISM AND MARGINALISM

• Incremental cost or revenue is similar to marginal cost or revenue concept. But there exist some
differences between incremental concept and marginal cost / revenue concepts.
• In the marginal analysis, marginal revenue means the addition made to the total revenue by
selling an additional or extra unit of the output.

THE CONCEPT OF TIME PERSPECTIVE

The time perspective concept states that the decision maker must give due consideration both to
the short run and long run effects of his decisions. He must give due emphasis to the various time
periods. It was Alfred Marshall who introduced time element in economic theory.
Marshall explained four market forms based on time in economic theory i.e.,
i. Very Short Period
ii. Short Period
iii. Long Period
iv. Very long Period or Secular Period
1. Very Short Period: Very short period refers to the type of competitive market in which the
supply of commodities cannot be changed at all. The price of the commodity depends on the
demand for the product alone.
2. Short Period: Short period refers to that period in which supply can be adjusted to a limited
extent by varying the variable factors alone.
3. Long Period: Long period is the time period during which the supply conditions are fully able
to meet the new demand conditions. In the long run, all (both fixed as well as variable) factors
are variable.
4. Very long Period or Secular Period: The very long run is a situation where technology and
factors beyond the control of a firm can change significantly.
From consumers point of view, short-run refers to a period in which they respond to the changes
in price, given the taste and preferences of the consumers, while long-run is a time period in
which the consumers have enough time to respond to price changes by varying their tastes and
preferences.

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DISCOUNTING PRINCIPLE:
Discounting principles talks about the comparison of money value between present and future
time
• A rupee to be received tomorrow is worth less than a rupee today
• Whenever we make comparison between present and the future values of money, we always
discount future value to make it comparable with the present value.
• Example: Suppose there is a choice between receiving a gift of Rs. 1000/- today and Rs.1000/-
next year, naturally everyone would prefer Rs.1000/- today.
• Even though if there is a certainty of receiving Rs.1000/- next year, we choose to get Rs.1000/-
today, as it can yield some interest during one year by investing. Explaining the discounting
principle is to ask how much money today would be equivalent to Rs.100000 a year from now.
Assuming that rate of interest 12 per cent, we must discount the Rs.100000 at 12 per cent.
Discounting can be defined as a process used to transform future money into an equivalent
number of present money. For instance, Rs.1 invested today at 10% interest is equivalent to
Rs.1.10 next year.
Thus, FV = PV*(1+i)t
Where, FV is the future value (time at some future time), PV is the present value (value at t0, i is
the discount (interest) rate, and t is the time between the future value and present value.

THE CONCEPT OF OPPORTUNITY COST

 Both micro and macroeconomics make abundant use of the fundamental concept of
opportunity cost.
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 In Managerial Economics, the opportunity cost concept is useful in decision involving a

choice between different alternative courses of action.
 Resources are scarce; we cannot produce all the commodities. For the production of one
commodity, we have to forego the production of another commodity.
 When you choose a particular alternative, the next best alternative must be given up. For
example, if you choose to watch cricket highlights in T.V., you must give up an extra
hour study.
 Thus the “opportunity cost” is the cost of something in terms of an opportunity forgone.
In other words, the opportunity cost of an action is the value of next best alternative
forgone.

THE CONCEPT OF OPPORTUNITY COST INVOLVES THREE THINGS:

 The calculation of opportunity cost involves the measurement of sacrifices.

 Sacrifices may be monetary or real.
 The opportunity cost is termed as the cost of sacrificed alternatives.

THE ECONOMIC SIGNIFICANCE OF OPPORTUNITY COST IS AS FOLLOWS:

 It helps in determining relative prices of different goods.

 It helps in determining normal remuneration to a factor of production.
 It helps in proper allocation of factor resources

EQUI MARGINAL PRINCIPLE:

Marginal Utility is the utility derived from the additional unit of a commodity consumed. The
laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the
marginal utilities of various commodities he consumes are equal. It states that the consumer will
spend his money-income on different goods in such a way that the marginal utility of each good
is proportional to its price, i.e.,
MUx / Px = MUy / Py = MUz / Pz
Where, MU represents marginal utility and P is the price of good.
Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique
of production which satisfies the following condition:

MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3,

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.
Thus, a manger can make rational decision by allocating/hiring resources in a manner which
equalizes the ratio of marginal returns and marginal costs of various use of resources in a specific
use.
For E.g.:

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 Suppose a firm is involved in four activities, namely, A,B,C and D. all these activities
need the service of labour.
 Assuming that the firm has 100 units of labour and this is fixed so that the total payroll is
predetermined.
 Now the firm can increase any one of the activities by employing more labour, but this
can be done only at the cost of other activities.
 Suppose, the value of marginal product of labour in activity ‘B’ is Rs.40/- while in
activity A is Rs.50/-, then it is profitable to shift labour activity B to A.
 The value optimum will be attained when the value of the marginal product is equal in all
activities.

SCARCITY PRINCIPLE:
Excess demand of any commodity or service is referred to as 'scarcity'. At any time, if demand
(requirement) for anything exceeds its supply (availability) then that, thing is called 'scarce'.
Amount of demand in relation to supply determines the scarcity hence, it is known as a relative
concept. The scarcity requires managerial attention because it may be a root cause of any
problem.

For example, scarcity of jobs is known as unemployment. Scarcity of goods is known as

inflation. Unsold stock of inventory is essentially the scarcity of buyers. Under-utilised. capacity
at the plant level may be primarily due to scarcity of power or other supporting facilities. There
would be no managerial problems, if these scarcities are not present. Because of scarcity, a
manager has to make an optimum allocation.of scarce resources of men, materials, machines,
money, time and energy. This is one of the fundamental concepts of economics relevant for
business economics. This concept lies at the heart of resource allocation problem of a business
enterprise. Whether it is micro-economics or macro- economics, the essence of economic
problem is completely based on the scarcity of resources.. An individual analysing the economic
problem on account of a corporate unit or a national economy is subjected to encounter with the
problem of scarcity of one kind or the other.

PRINCIPLE OF RISK AND UNCERTAINITY:

The risk and uncertainty are the. important conditions faced by the managers at the time of
taking various kinds of decisions. The businessmen for taking better decisions should understand
these conditions properly.

Risk
Risk refers to the possibility of amount of uncertainty in the business. In other words, the
reduction in the number of possible outcomes to various alternative courses of actions is termed

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as 'risk'. Hence, risk is a way to predict the possibilities of outcome. The situation of risk is not
suitable in comparison to the certainty because the outcome of risk is based on the possibility.

Uncertainty:
Uncertainty refers to a situation where various alternatives are present and among them a specific
outcome is to be determined. The possibilities of happening and non- happening of resultant
outcome cannot be predicted. In other words,, uncertainty can be said as the "immeasurable risk'
because the decision-maker has inadequate knowledge about the availability of various
alternatives. Hence, in the -condition of uncertainty the decision-maker cannot forecast the exact
outcome of various alternatives thereby the probabilities of those outcomes cannot be measured.
Thus, it is just reverse of the condition of certainty.

MAXIMIZATION OF TOTAL REVENUE AND PROFIT

Revenue is the total income obtained by the sale of goods and services related to the primary
operations of the business.
Definition of Total Revenue (TR)
The total revenue is the total sales proceeds in the market. A firm sells different product
quantities to its customers at the prevailing market price. So, the total revenue can be calculated
by multiplying price by quantity.
TR=P×Q
Where TR= Total revenue; P= Price; Q=Quantity

Average Revenue (AR)

Average revenue is defined as the ratio of total revenue to the quantity of the product.
AR=TR/Q
Where AR=Average revenue; TR=Total revenue; Q=Quantity
On substituting TR=P×Q
we get, AR=P×Q/Q

∴AR=P
We can say that the average revenue is the same as the price of a product.In other words, the
average revenue is the revenue obtained by the firm on the sale of per unit product.

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Marginal Revenue (MR)

The marginal revenue is the increase in the total revenue due to sales of an extra unit of the
commodity by the firm in the market. In simpler words, marginal revenue is the addition to the
total revenue form selling an additional unit of goods.
MR=ΔTR/ΔQ
Where ΔTR→change in total revenue; ΔQ→change in quantity

Marginal Cost (MC)

The marginal cost is the increase in the total cost due to production of an extra unit of the
commodity by the firm . In simpler words, marginal cost is the addition to the total cost from
producing an additional unit of goods.
MC=ΔTC/ΔQ
Where ΔTC→change in total cost; ΔQ→change in quantity

Problems:
1. TC=Q3 – 8Q2+ 57Q + 2; P= 45-0.5Q, Find out the level of output and price that maximize
total revenue.
2. Given TR= 45Q – 0.5Q2, TC=Q3 – 8Q2+ 57Q + 2, Find out the level of output at which firm
maximize the profit.

TOOLS AND ANALYSIS FOR OPTIMIZATION:

When running a business, making the right choices is crucial. Luckily, economic analysis offers
tools and techniques to help you optimize your decisions, maximizing profits, minimizing costs,
or achieving whatever other goals you set. Here's a breakdown of the key elements:
1. Economic Variables: Imagine these as the building blocks of your decision-making process.
Think of things like:
 Price: How much your product or service costs.
 Quantity: How much you produce or sell.
 Demand: How much people want your product or service.
 Supply: How much of your product or service is available.
 Costs: The expenses involved in making your product or service.

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 Profit: The difference between your revenue (from sales) and your costs.
2. Slope and Decision-Making: The relationship between these variables can be visualized as
lines on a graph. The slope of these lines tells you how one variable changes when another
changes. For example:
 Positive slope: If the price goes up, demand might go down (a negative relationship).
 Negative slope: If you produce more, your cost per unit might go down (economies of
scale).
 Zero slope: No change in one variable affects the other (e.g., fixed costs).
Analyzing these slopes helps you understand how your decisions impact different aspects of your
business.
3. Optimization Techniques: These are like the toolkit for making the best choices. Some
common ones include:
 Calculus: Used to find the maximum or minimum values of functions related to your
business, like maximizing profit by analyzing your marginal cost (cost of producing one
more unit) and marginal revenue (income from selling one more unit).
 Linear Programming: Deals with problems where variables and constraints have linear
relationships. This is useful for optimizing things like resource allocation (using
ingredients efficiently), marketing mix (finding the best price, product, and promotion
combination), or inventory management (determining how much stock to keep).
 Game Theory: Helps you make optimal decisions in competitive situations by
considering how your competitors might react.
 Decision Trees: Visually represent different scenarios and potential outcomes, allowing
you to evaluate the best course of action.

ROLE AND RESPONSIBILITIES OF MANAGERIAL ECONOMIST:

Managerial economist is a person who manages business efficiently using various economic
theories and methodologies. He supports the management team in better decision making
through his analytical skills and specialized techniques.
A Managerial Economist is also termed as an economic advisor or business economist. He is
responsible for analyzing various internal and external environmental forces that influence the
functioning of business organizations. Managerial economist makes several successful business
forecasts and updates the management team regarding the economic trends from time to time.
Managerial Economist always remains in touch with all the latest economic developments and
environmental changes for informing the management. He has an efficient role in earning

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reasonable profits on invested capital as it supplies all relevant information which helps in
making proper plans and strategies. Managerial economist has three important roles in every
business organization: Demand analysis and forecasting, capital management and profit
management.

 Studies Business Environment

The managerial economist is responsible for analyzing the environment in which
business operates. Proper study of all external factors that affect the functioning of
organization is must for proper functioning. He studies various factors like growth of
national income, competition level, price trends, phase of the business cycle and
economy and updates the management regarding it from time to time.
 Analyses Operations Of Business
He analyses the internal operation of business and helps management in making better
decisions in regard to internal workings. Managerial economist through his analytical and
forecasting skills provides advice to managers for formulating policies regarding internal
operations of the business.
 Demand Forecasting And Estimation
Proper estimation and forecasting of future trends helps the business in achieving desired
profitability and growth. Managerial economist through proper study of all internal and
external forces makes successful forecasting of future uncertainties or trends.
 Production Planning
Managerial economist is responsible for scheduling all production activities of business.
He evaluates the capital budgets of organizations and accordingly helps in deciding
timing and locating of various actions.
 Economic Intelligence
He provides economic intelligence services by communicating all economic information
to management. Managerial economist keeps management always updated of all
prevailing economic trends so that they can confidently talk in seminars and conferences.
 Performing Investment Analysis
A managerial economist analyzes various investment avenues and chooses the most
appropriate one. He studies and discovers new possible fields of business for earning
better returns.
 Focuses On Earning Reasonable Profit
He assists management in earning a reasonable rate of profit on capital employed in the
business. Managerial economist monitors activities of organizations to check whether all
operations are running efficiently as per the plans and policies.
 Maintaining Better Relations
A managerial economist maintains better relations with all internal and external
individuals connected with the business. It is his duty to develop a peaceful and
cooperative environment within the organization and aims to reduce any opposition
taking place.

ROLE OF GOVERNMENT AND PRIVATE SECTOR:

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Both the government and the private sector play crucial roles in driving economic growth for a
country.
Government:
 Creating a Stable Environment: The government establishes the legal and regulatory
framework that businesses operate within. This includes enforcing property
rights, ensuring contract sanctity, and fostering competition.
 Investing in Public Goods: The government provides essential public goods and services
like infrastructure (roads, bridges, communication networks), education, healthcare, and
national defense. These investments create a foundation for economic activity and
improve the overall quality of life for citizens.
 Stabilizing the Economy: Through fiscal and monetary policies, the government can
manage economic cycles, mitigate inflation, and promote long-term economic stability.
 Investing in Research and Development: Government funding for research in areas like
science, technology, and innovation can lead to breakthroughs that drive economic
growth and competitiveness.
 Human Capital Development: Investing in education and training programs can improve
the skills and productivity of the workforce, making them more employable and
contributing to higher economic output.
Private Sector:
 Job Creation: Businesses are the primary source of job creation, providing employment
opportunities and income for citizens.
 Innovation and Investment: The private sector drives innovation by developing new
products, services, and technologies, leading to increased productivity and economic
growth.
 Entrepreneurship: Individuals starting new businesses generate new ideas, take risks, and
contribute to economic dynamism and diversification.
 Tax Revenue: Businesses generate tax revenue for the government, which funds public
goods and services.
 Exporting: Businesses that export goods and services contribute to the country's foreign
exchange reserves and promote economic growth through international trade.

COMPETITION VS COOPERATION:

Feature Competition Cooperation

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Focus Individual success Collective success

Mutual benefit, Shared

Drivers Self-interest, Scarcity
resources

Cost reduction, Market

access, Specialized
resources,
Innovation, Efficiency, Lower
Complementary
prices (potential for price wars,
Key Outcomes products (potential for
predatory practices, short-term
antitrust concerns,
thinking)
coordination
challenges, free-riding
problems)

Decision- Requires coordination,

Independent
making communication

Shared risk, shared

Risk & Reward High risk, high potential reward
reward

Long-term vs. Fosters long-term

Often short-term focus
Short-term collaboration, trust

Joint ventures,
research
Rival companies offering similar
Examples collaborations,
products
industry standards
committees

POSITIVE VS NEGATIVE EXTERNALITIES

An externality exists when a third party who is not directly involved in a transaction (as a buyer
or seller of the goods or services) incurs a cost or benefit. In other words, an externality arises
when a third party to a transaction experiences side effects (which can be negative or positive to
them) due to transactions between buyers and sellers. When the third party benefits from this, it

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is called a positive externality and when the third party suffers a loss or incurs a cost it is known
as a negative externality.
Externalities occur in an economy when the production or consumption of a specific good or
service impacts a third party that is not directly related to the production or consumption of that
good or service.

Types of Externalities
Externalities can be broken into two different categories. First, externalities can be measured as
good or bad as the side effects may enhance or be detrimental to an external party. These are
referred to as positive or negative externalities. Second, externalities can be defined by how they
are created. Most often, these are defined as a production or consumption externality.

Negative Externalities
Most externalities are negative. Pollution is a well-known negative externality. A corporation
may decide to cut costs and increase profits by implementing new operations that are more
harmful to the environment. The corporation realizes costs in the form of expanding operations
but also generates returns that are higher than the costs. However, the externality also increases
the aggregate cost to the economy and society making it a negative externality. Externalities are
negative when the social costs outweigh the private costs.

Positive Externalities
Some externalities are positive. Positive externalities occur when there is a positive gain on both
the private level and social level. Research and development (R&D) conducted by a company
can be a positive externality. R&D increases the private profits of a company but also has the
added benefit of increasing the general level of knowledge within a society. Similarly, the
emphasis on education is also a positive externality. Investment in education leads to a smarter
and more intelligent workforce. Companies benefit from hiring employees who are educated
because they are knowledgeable. This benefits employers because a better-educated workforce
requires less investment in employee training and development costs

PRODUCTION POSSIBILITY FRONTIER CURVE (PPFC)

Production possibility frontier (PPF) is referred to as a graph that shows the maximum possible
output that can be achieved by two goods when the input is maintained constant or fixed.
The factors that are included in the input are natural resources, capital goods, labour and
entrepreneurship.
The production of one good can be increased when the production of the other good is sacrificed.
The Production Possibility Frontier (PPF) is also known as the Production Possibility Curve.
The production possibility frontier represents the concepts of scarcity, tradeoffs and choice and
the shape of the curve will change based on whether the price costs are constant, increasing or
decreasing.

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The PPF is the area on a graph representing production levels that cannot be obtained given the
available resources; the curve represents optimal levels. Here are the assumptions involved:
 A company/economy wants to produce two products
 There are limited resources
 Technology and techniques remain constant
 All resources are fully and efficiently used
The slope of the PPF is indicative of the opportunity cost of producing a good in comparison to
another good. The same can be used for comparing the opportunity costs of another producer for
determining the comparative advantage.

Interpreting the PPF Curve

The shape of the PPF curve is like a bow in an outward position. The highest point on the graph
will be when a good is produced on the y-axis and the second good is not produced at all on the
x-axis.
The widest part of the curve will be represented by the point where no good is produced on y-
axis whereas maximum production is happening on the x-axis.
All other points in the graph are regarded as tradeoff points, which means both the goods are
produced in varying degrees in these points.

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The points on the PPF curve are said to be efficient and indicates that the resources of the
economy are utilised fully. This is known as the Pareto Efficiency, which refers to the idea that
an economy is operating at its full potential and there is no possibility of getting more output
from the available resources.
The points inside a PPF curve are known as inefficient points as the output from these points
could be greater than the economy’s current resources. Conversely, the points outside the PPF
curve represents production of two goods at its maximum level, which is not possible due to
limited or fixed resources.

Impact on Economy
It helps in letting the businesses understand how much quantity of good must be given up in
order to make space for producing another type of good

For example, if a non-profit agency provides a mix of textbooks and computers, the curve may
show that it can provide either 48 textbooks and six computers or 72 textbooks and two
computers. This results in a ratio of about six textbooks to one computer.
The agency's leadership must determine which item is more urgently needed. In this example,
the opportunity cost of providing an additional 30 textbooks equals five more computers, so it
would only be able to give out one computer with 78 textbooks. If it wanted more computers, it
would need to reduce the number of textbooks by six for every computer.
When this is plotted, the area below the curve represents computers and textbooks that are not
being used, and the area above the curve represents donations that cannot happen with the
available resources. The area above the curve is called the production possibility frontier, and the
curve (the line itself) is sometimes called the opportunity cost curve. The entire graph is
sometimes referred to as the production possibility curve.

Textbooks Computers

18 11

24 10

30 9

36 8

42 7

48 6

54 5

60 4

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Textbooks Computers

66 3

72 2

78 1

84 0

Point X represents an inefficient use of resources, while point Y represents a goal that the
economy simply cannot attain with its present levels of resources.

Some of its uses are as follows:

i. Enables the planning authority of a developed nation to divert the usage of its resources for the
production of necessary goods to the production of luxury goods and from consumer goods to
producer’s goods, after a certain point of time.
ii. Helps a democratic nation to focus and shift a major amount of resources in the production of
public sector goods instead of private sector goods. The public sector goods are supplied and
financed by government, such as public utilities, free education, and medical facilities. These
goods are free or involve a negligible cost. On the other hand, private sector goods are

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manufactured by privately owned organizations and are purchased by individuals at a certain

price.
iii. Helps in guiding the movement of resources from producer goods to capital goods, such as
machines, which, in turn, increases the productive resources of a country for achieving a high
production level.

ECONOMIC EFFICIENCY:
The focus of an economy is the allocation of scarce resources. When resources are allocated
optimally we have economic efficiency. Economic efficiency is a result of scarcity. Since
resources are limited, they must be used optimally. In an efficient economy, it is impossible to
increase the benefit of one party without hurting another.
Economic efficiency is ensuring that all resources available in an economy are utilised optimally
while minimizing inefficiency.
Economic efficiency is important because it allows businesses to reduce their costs and increase
output. For consumers, economic efficiency leads to lower prices for goods and services. For the
government, more efficient firms and higher levels of productivity and economic activity
increase economic growth.

Types of economic efficiency

The different types of economic efficiency are:
1. Productive efficiency
2. Dynamic efficiency
3. Static efficiency
4. Allocative efficiency
5. Social efficiency
Productive efficiency occurs when output is fully maximised from the available inputs.
Productive efficiency occurs when it is impossible to produce more of one good without
producing less of another. For a firm, productive efficiency occurs when the average total cost of
production is minimised.

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Figure 1 shows a production possibility frontier (PPF). It shows the maximum level of output
from available inputs at every point on the curve. The curve aids in explaining the points of
productive efficiency and productive inefficiency.
Points A and B are considered points of productive efficiency because the firm can achieve
maximum output given the combination of goods. Points D and C are considered points of
productive inefficiency and thus wasteful.

Dynamic efficiency explains the productive efficiency of firms over a long period of time. It
occurs when firms reduce their cost by implementing new processes of production.
Example: A printing business starts out by using a single printer with a capacity of printing 100
t-shirts in 2 days. However, over time, the business is able to grow and improve its production by
using a big scale printer. They now produce 500 printed t-shirts a day, thereby reducing cost and
increasing productivity.
This business has improved its production process while reducing its costs over time.

Static efficiency
As the name implies, this is concerned with efficiency at a particular point in time. This is a
type of economic efficiency focused on the best combination of existing resources at a particular
time.

Difference between dynamic and static efficiency

Dynamic efficiency is concerned with allocative efficiency and with efficiency over a period of
time. For example, it examines whether investing into technological development and research
over a period of time will help a firm be more efficient.

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Static efficiency is concerned with productive and allocative efficiency and efficiency at a
particular time. For example, it examines whether a firm can produce 10,000 units a year cheaper
by using more labour and less capital. It is concerned with producing outputs at a specific time
by allocating resources differently.

Allocative efficiency is a type of efficiency focused on the optimum distribution of goods and
services taking into consideration consumers’ preference. Allocative efficiency occurs when the
price of a good is equivalent to the marginal cost, or in a shortened version, with the formula P =
MC.
Everyone in society needs a public good such as healthcare. The government provides this
healthcare service in the market to ensure allocative efficiency.

Social efficiency occurs when resources are optimally distributed in a society and the benefit
derived by an individual doesn't make another person worse off. Social efficiency occurs when
the benefit of production is not greater than its negative effect. It subsists when all benefits and
costs are considered in producing an extra unit.

ECONOMIC STABILITY:
Economic stability refers to a situation where all the essential economic resources of a country
are available to its citizens, and no economic swings interrupt their daily lives. It helps achieve
macroeconomic objectives like reducing unemployment, balance payments, price stability, and
sustainable economic growth.
Economic disruptions alter economic stability through inflation, deficits, recession, political
riots, and policy changes. Therefore, the government constantly monitors and eliminates
deviations in an economy to keep it stable and growing.

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