CONCEPTS
The Firm <ul><li>Controlled by Entrepreneur – who decides </li></ul><ul><li>What to produce? </li></ul><ul><li>Where to pr...
Risk taking earns profit as rewards <ul><li>The firm organises all factors of production </li></ul><ul><li>Plant (Place of...
Firm and Industry <ul><li>Firm is an individual productive unit. </li></ul><ul><li>Industry is a set of all such firms eng...
Plant <ul><li>A Plant is a Technical Unit to be used in a broad sense to include Farms, Offices, Shops, Stores, Warehouses...
Firm <ul><li>A firm can own more than one plant. </li></ul><ul><li>Has unified control over all plants. </li></ul><ul><li>...
Industry <ul><li>An industry is a group of firms. There has to be some common factor among all the firms that make up the ...
Economic Concepts <ul><li>1.Opportunity Cost </li></ul><ul><li>2. Equi-marginal principle </li></ul><ul><li>3. Incremental...
Opportunity Cost <ul><li>When own capital is invested, the interest the entrepreneur would have earned had he invested els...
Equimarginal principle <ul><li>This is very significant in resource allocation.  </li></ul><ul><li>Resources are allocated...
Incremental Concept <ul><li>Incremental Revenue should be more than incremental cost. </li></ul><ul><li>This formula shoul...
Time Perspective <ul><li>The really important problem in decision making is to maintain the right balance between long-run...
Discounting Principle <ul><li>In this principle, the present gain is valued more than future gain. </li></ul><ul><li>If V ...
The scientific approach of Building an Economic Model <ul><li>1. Defining the Problem </li></ul><ul><li>2. Formulation of ...
Defining the problem <ul><li>A. statement of the problem to be solved. </li></ul><ul><li>B. Define correctly the problem b...
Formulation of Hypothesis <ul><li>Hypothesis is a tentative untested behaviour or assumption about the course of behaviour...
Abstraction /Model Building <ul><li>Choose and select only relevant information. </li></ul><ul><li>Assumptions and identif...
Data Collection <ul><li>Relevant data have to be collected as per the model specifications of the variables such as price,...
Testing the hypothesis <ul><li>Hypothesis is to be tested with the help of data collected by adopting the following major ...
Deduction <ul><li>Assuming that the hypothesis is accepted as it, not only, indicates cause effect relationship, but also ...
Evaluating the Test Result <ul><li>When real world events confirm a hypothesis, it is accepted. Acceptance is not proving....
Conclusion <ul><li>An accepted hypothesis can form the basis for decision making. </li></ul><ul><li>Interpretation and arr...
<ul><li>Empirical = Based on observation of facts and experiments and not based on theory. </li></ul>
Basic assumptions in Economic Models <ul><li>1. Ceteris Paribus assumption </li></ul><ul><li>2. Psychological assumption a...
Equilibrium in Economic analysis <ul><li>Equilibrium implies absence of change in the behavioural movement. </li></ul><ul>...
Partial Equilibrium <ul><li>Partial equilibrium is based on only restricted range of data – equilibrium price of a single ...
Major advantages of Partial Equilibrium <ul><li>It is simple. </li></ul><ul><li>It is useful for prediction purposes. </li...
Limitations of Partial equilibrium analysis: <ul><li>1. It can deal with one economic entity only. </li></ul><ul><li>2. It...
General Equilibrium <ul><li>An economy is in general equilibrium when all consumers, all firms, all factors of production,...
Usefulness of General Equilibrium analysis: <ul><li>It explains the structure, mechanism and operating forces and working ...
Limitations of General Equilibrium analysis. <ul><li>1. It is essentially static  in its approach. </li></ul><ul><li>2. It...
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Managerial Economics 2

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Managerial Economics 2

  1. 1. CONCEPTS
  2. 2. The Firm <ul><li>Controlled by Entrepreneur – who decides </li></ul><ul><li>What to produce? </li></ul><ul><li>Where to produce? </li></ul><ul><li>How to produce? </li></ul><ul><li>How much to produce? </li></ul><ul><li>Whom to sell? </li></ul><ul><li>At what price? </li></ul>
  3. 3. Risk taking earns profit as rewards <ul><li>The firm organises all factors of production </li></ul><ul><li>Plant (Place of production) </li></ul><ul><li>Labour – pays wages for services </li></ul><ul><li>Own funds – borroed funds (pays interest) </li></ul><ul><li>Manages the entire operation including </li></ul><ul><li>Stocking, distribution, selling and </li></ul><ul><li>recovery of sales proceeds. </li></ul>
  4. 4. Firm and Industry <ul><li>Firm is an individual productive unit. </li></ul><ul><li>Industry is a set of all such firms engaged in identical productive activity. </li></ul><ul><li>Homogenours products – steel, cement. </li></ul><ul><li>Same type of products – textile cloth. </li></ul><ul><li>Common raw materials – clay used for pottery, crockery. </li></ul><ul><li>Similar processes : engineering, transport. </li></ul><ul><li>Similar trade and services: banking – public, private, cooperative. </li></ul>
  5. 5. Plant <ul><li>A Plant is a Technical Unit to be used in a broad sense to include Farms, Offices, Shops, Stores, Warehouses, Workshops, Factories, etc. </li></ul><ul><li>A Plant enjoys autonomy within the broad framework laid down by the firm, and tkes decisions on technical aspects. </li></ul><ul><li>A Plant is a body of persons who work to specified timings and at a given place. </li></ul><ul><li>A Plant is controlled by a single firm. </li></ul><ul><li>A Plant produces products having similar technology. </li></ul>
  6. 6. Firm <ul><li>A firm can own more than one plant. </li></ul><ul><li>Has unified control over all plants. </li></ul><ul><li>The firm organises resources and organizes their efficient use. </li></ul><ul><li>A firm can be subsidiary of another firm. </li></ul><ul><li>A firm is a separate legal entity – can sue and be sued, whereas the plant is not. </li></ul><ul><li>Lon-term motive of the firm is to produce for profits, while in the short-run it may be to maximise sales, corner market, have steady income, business reputation, prestige etc. </li></ul>
  7. 7. Industry <ul><li>An industry is a group of firms. There has to be some common factor among all the firms that make up the industry. </li></ul><ul><li>Supply side : raw material used </li></ul><ul><li>production technique </li></ul><ul><li>Demand Side : Similarity among the products produced. </li></ul><ul><li> All the firms producing substitute products can be grouped under one industry. </li></ul>
  8. 8. Economic Concepts <ul><li>1.Opportunity Cost </li></ul><ul><li>2. Equi-marginal principle </li></ul><ul><li>3. Incremental principle </li></ul><ul><li>4. Time perspective; and </li></ul><ul><li>5. Discounting Principle </li></ul>
  9. 9. Opportunity Cost <ul><li>When own capital is invested, the interest the entrepreneur would have earned had he invested elsewhere is to be taken into account. </li></ul><ul><li>Similarly, time and effort devoted in organising the businesss will have to be valued. </li></ul><ul><li>If the business does not produce adequate profits in the long run compared to the sacrifice made, he will have to take a decision to shut down or reorganize the business for better profits. </li></ul>
  10. 10. Equimarginal principle <ul><li>This is very significant in resource allocation. </li></ul><ul><li>Resources are allocated in such a way that optimum efficiency is reached. </li></ul><ul><li>This can be done by ensuring that the Value of Marginal Product is the same in all the activities of the firm. </li></ul>
  11. 11. Incremental Concept <ul><li>Incremental Revenue should be more than incremental cost. </li></ul><ul><li>This formula should be applied to alternative decisions. </li></ul>
  12. 12. Time Perspective <ul><li>The really important problem in decision making is to maintain the right balance between long-run, short-run and intermediate-run perspectives. </li></ul>
  13. 13. Discounting Principle <ul><li>In this principle, the present gain is valued more than future gain. </li></ul><ul><li>If V = present value, A = annuity or returns expected during a year, I = current rate of interest, applying the formula </li></ul><ul><li>V = A = 110 = 100 </li></ul><ul><li> (1 + i ) 1+0.1 </li></ul><ul><li>Thus for comparison only Rs.100 is to be taken not 110. </li></ul>
  14. 14. The scientific approach of Building an Economic Model <ul><li>1. Defining the Problem </li></ul><ul><li>2. Formulation of Hypothesis </li></ul><ul><li>3. Abstraction/Model Building </li></ul><ul><li>4. Data Collection </li></ul><ul><li>5. Testing the Hypothesis </li></ul><ul><li>6. Deduction </li></ul><ul><li>7. Evaluating the Test Result </li></ul><ul><li>8. Conclusion </li></ul>
  15. 15. Defining the problem <ul><li>A. statement of the problem to be solved. </li></ul><ul><li>B. Define correctly the problem by framing appropriate questions. </li></ul><ul><li>C. Arrive at the nature, course and direction of the business research to be undertaken. </li></ul>
  16. 16. Formulation of Hypothesis <ul><li>Hypothesis is a tentative untested behaviour or assumption about the course of behavioural tendency and to discover the cause and effect relationships. </li></ul><ul><li>In managerial economics, hypotheses are formed to identify pattern of economic behaviour and discover business variables’ </li></ul><ul><li>relationship in order to test the proposition and arrive at a decision. </li></ul>
  17. 17. Abstraction /Model Building <ul><li>Choose and select only relevant information. </li></ul><ul><li>Assumptions and identificatioins are utilised to simplify and highlight essential features of the events. </li></ul><ul><li>Based on scientific enquiry, out of many choices only few or even one is chosen. </li></ul><ul><li>In cause effect relationship, all other factors which are unimportant for our study, are assumed to be constant. </li></ul><ul><li>The abstract should represent the real world phenomena. </li></ul>
  18. 18. Data Collection <ul><li>Relevant data have to be collected as per the model specifications of the variables such as price, demand, sales, advertising expenditure &c. </li></ul><ul><li>These data may be a) time series data b)Cross sectional data or c) Pooled data. </li></ul>
  19. 19. Testing the hypothesis <ul><li>Hypothesis is to be tested with the help of data collected by adopting the following major steps: </li></ul><ul><li>1. We first set up a hypothesis or assumption. Formulation of null hypothesis – Ho </li></ul><ul><li>2. Specify, alternates, H1, H2. </li></ul><ul><li>3. Accept Ho - null hypothesis if it is true based on evidence (supporting data). </li></ul><ul><li>4. Reject Ho – if not supported by evidence. </li></ul>
  20. 20. Deduction <ul><li>Assuming that the hypothesis is accepted as it, not only, indicates cause effect relationship, but also serves as the basis of predictions. </li></ul><ul><li>Predictions, forecasts are obtained by deductive reasoning. </li></ul><ul><li>Example: Increase in ad. Expenditure, resulted in improved sales. It is deduced that the firm can increase expenditure on advertisements. </li></ul>
  21. 21. Evaluating the Test Result <ul><li>When real world events confirm a hypothesis, it is accepted. Acceptance is not proving. It needs to be tested, to find out whether the predictions are correct. </li></ul><ul><li>If observed facts contradict the predictions, the hypothesis is rejected. </li></ul><ul><li>But if it successfully survives a number of tests, it is accepted as a theory. </li></ul>
  22. 22. Conclusion <ul><li>An accepted hypothesis can form the basis for decision making. </li></ul><ul><li>Interpretation and arriving at inferences from empirical results for taking decision about the future course of action, will call for the skill of the manager. </li></ul>
  23. 23. <ul><li>Empirical = Based on observation of facts and experiments and not based on theory. </li></ul>
  24. 24. Basic assumptions in Economic Models <ul><li>1. Ceteris Paribus assumption </li></ul><ul><li>2. Psychological assumption about rational behaviour of man. </li></ul><ul><li>3. Structural assumptions such as all land is not tillable or production cannot be doubled by doubling the working hours of the worker. </li></ul><ul><li>4. Institutional Assumptions: </li></ul><ul><li>Capitalist economic system – free market economy. </li></ul><ul><li>Socialistic system – Govt. control on economic resources. </li></ul><ul><li>Mixed economy – Strategic role of Public sector and relative scope of private sector. </li></ul>
  25. 25. Equilibrium in Economic analysis <ul><li>Equilibrium implies absence of change in the behavioural movement. </li></ul><ul><li>Equilibrium is the best possible stage under existing circumstances, and there is no need for change, so long as circumstances remain the same. </li></ul>
  26. 26. Partial Equilibrium <ul><li>Partial equilibrium is based on only restricted range of data – equilibrium price of a single commodity, assuming all other things to be equal. </li></ul>
  27. 27. Major advantages of Partial Equilibrium <ul><li>It is simple. </li></ul><ul><li>It is useful for prediction purposes. </li></ul><ul><li>It can be applied to solve micro-economic problems. </li></ul><ul><li>It is a stepping stone to analyse general equilibrium of the economy. </li></ul><ul><li>It is useful in reviewing market mechanism in a free enterprise economy. </li></ul><ul><li>It is useful to understand rational human behaviour for maximising satisfaction. </li></ul><ul><li>It analyses firm’s profit maximisation behaviour. </li></ul>
  28. 28. Limitations of Partial equilibrium analysis: <ul><li>1. It can deal with one economic entity only. </li></ul><ul><li>2. It is not applicable for the entire economy. </li></ul><ul><li>3. It is based on ceteris paribus. </li></ul><ul><li>4. Its unrealistic assumptions, makes it unsuitable for application to world phenomenon. </li></ul><ul><li>5. Its analysis is incomplete as only primary and not secondary effects are studied. </li></ul><ul><li>6. Its segregation of individual behaviour from the rest of the economy is unrealistic. </li></ul>
  29. 29. General Equilibrium <ul><li>An economy is in general equilibrium when all consumers, all firms, all factors of production, all industries, all markets are in equilibrium simultaneously. </li></ul><ul><li>Two sets of conditions are to be fulfilled to attain general equilibrium:- </li></ul><ul><li>1. A subjective condition : Each individual economic entity is attaining its maximisation goals. </li></ul><ul><li>2. An Objective condition: Each market (commodity as well as factor) is in equilibrium with demand equal to supply. </li></ul>
  30. 30. Usefulness of General Equilibrium analysis: <ul><li>It explains the structure, mechanism and operating forces and working of the entire economic system. </li></ul><ul><li>It analysses inter-sectoral changes and their impact. </li></ul><ul><li>It explains the complexities of commodity and factor markets and their inter-relationship. </li></ul><ul><li>It examines functions of prices and price structure in the economy. </li></ul><ul><li>It is useful in planning process by providing conceptual basis for input-output analysis. </li></ul><ul><li>It is useful in public poilicy formulation. </li></ul><ul><li>It is used in modern welfare economics and monetary theory. </li></ul>
  31. 31. Limitations of General Equilibrium analysis. <ul><li>1. It is essentially static in its approach. </li></ul><ul><li>2. It is unrealistic in its assumptions such as perfect competition. </li></ul><ul><li>3. It analysis is complicated involving series of simultaneous equations. </li></ul><ul><li>4. It ignores leads and lags and considers only instant happenings, which is not realistic. </li></ul>

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