Managerial economics


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Managerial economics

  1. 1. MANAGERIAL ECONOMICS Prof. Swaha Shome
  2. 2. Managerial Economics <ul><li>Objectives </li></ul><ul><ul><li>Understand usefulness of economics in describing managerial behavior. </li></ul></ul><ul><ul><li>Understand how economics can be used to improve managerial decisions. </li></ul></ul><ul><ul><li>Appreciate vital role of business in society. </li></ul></ul>
  3. 3. What is Managerial Economics? Howard Davies - “ It is the application of economic analysis to business problems; it has its origin in theoretical microeconomics.”
  4. 4. Why Managerial Economics? <ul><li>A powerful “analytical engine”. </li></ul><ul><li>A broader perspective on the firm. </li></ul><ul><ul><ul><li>what is a firm? </li></ul></ul></ul><ul><ul><ul><li>what are the firm’s overall objectives? </li></ul></ul></ul><ul><ul><ul><li>what pressures drive the firm towards profit and away from profit </li></ul></ul></ul><ul><li>The basis for some of the more rigorous analysis of issues in Marketing and Strategic Management. </li></ul>
  5. 5. Contents <ul><li>Introduction to economics- scarcity, choice and Efficiency. Role of Government </li></ul><ul><li>Demand and Supply analysis </li></ul><ul><li>Consumer behaviour </li></ul><ul><li>Production and costs </li></ul><ul><li>Markets </li></ul>
  6. 6. Market Structures <ul><li>Perfect competition </li></ul><ul><li>Monopoly </li></ul><ul><li>Oligopoly </li></ul><ul><li>Monopolistic Competition </li></ul>
  7. 7. <ul><li>Pricing practices- transfer pricing </li></ul><ul><li>Current developments </li></ul>
  8. 8. TEN PRINCIPLES OF ECONOMICS <ul><li>How people make decisions: </li></ul><ul><li>People face trade offs </li></ul><ul><li>The cost of something is what you have to give up. </li></ul><ul><li>Rational people think at the margin </li></ul><ul><li>People respond to incentives </li></ul>
  9. 9. <ul><li>How people interact? </li></ul><ul><li>Trade can make everybody better off </li></ul><ul><li>Markets are usually a good way to organize economic activity </li></ul><ul><li>Government can sometimes improve market outcomes </li></ul>
  10. 10. <ul><li>How the economy as a whole works? </li></ul><ul><li>A country’s standard of living depends on the its ability to produce goods and services </li></ul><ul><li>Prices rise when Govt prints too much money </li></ul><ul><li>Society faces a short run trade off between inflation and trade off </li></ul>
  11. 11. Scarcity and Economic System <ul><li>What are the opportunity costs of the choices you make? </li></ul><ul><li>How does a production possibility frontier (PPF) illustrate opportunity cost, specialization of resources, inefficiency, and economic growth? </li></ul><ul><li>What are the differences between command economies, free market economies, and mixed economies in terms of the ways they address the 3 basic economic questions? </li></ul>
  12. 12. Opportunity Cost - Components <ul><li>Direct money cost of a choice may only be a part of the cost of that choice </li></ul><ul><li>Cost of a choice </li></ul><ul><li>= explicit costs + implicit costs </li></ul><ul><ul><li>Explicit cost—dollars actually paid out for a choice </li></ul></ul><ul><ul><ul><li>Accounting cost </li></ul></ul></ul><ul><ul><li>Implicit cost—value of something sacrificed when no direct payment is made </li></ul></ul>
  13. 13. Opportunity Cost and Society <ul><li>Resources in whole society are limited. </li></ul><ul><li>All production carries an opportunity cost </li></ul><ul><ul><li>To produce more of one thing </li></ul></ul><ul><ul><ul><li>Must shift resources away from producing something else </li></ul></ul></ul><ul><li>No free lunch! </li></ul>
  14. 14. Increasing Opportunity Cost <ul><li>According to law of increasing opportunity cost </li></ul><ul><ul><li>The more of something we produce </li></ul></ul><ul><ul><ul><li>The greater the opportunity cost of producing even more of it </li></ul></ul></ul><ul><li>This principle applies to all of society’s production choices </li></ul>
  15. 15. Production Possibilities Frontiers <ul><li>Production Possibilities Frontiers (PPF) shows the combinations of two goods that can be produced with resources and technology available </li></ul>
  16. 16. Opportunity cost <ul><ul><li>Opp. cost of X = </li></ul></ul><ul><ul><li>Amount of Y to be compensated for one more unit of X </li></ul></ul><ul><ul><li>Opp. cost of X increases as you produce more of X </li></ul></ul>Situation X Y 1 0 20 2 1 18 3 2 15 4 3 11 5 4 6 6 5 0
  17. 17. Opportunity Cost - Illustrated <ul><li>Sacrifice of alternatives in production/consumption of a good </li></ul><ul><li>Eg. Let a farm produce 1000 tonnes of wheat or 2000 tonnes of sugar </li></ul><ul><li>Opportunity Cost of producing 1 ton wheat = 2 tonnes of sugar foregone. </li></ul>
  18. 18. Production Possibility Curve <ul><li>Enclosed region – unemployment </li></ul><ul><li>Outside graph – not feasible </li></ul><ul><li>Various combinations of 2 classes of goods produced provided resources in the economy are fully employed </li></ul>
  19. 19. Production Possibility Frontier <ul><li>Curve shows all possible 2-goods combination that an economy can produce </li></ul><ul><li>Specified time period </li></ul><ul><li>Resources fully & efficiently employed </li></ul><ul><li>Issues of choice & opportunity cost </li></ul><ul><li>Concave to origin – increasing opportunity cost </li></ul><ul><li>Region interior to PPF – economy has not attained Productive Efficiency - unemployment </li></ul>
  20. 20. Economic Growth Improvement in skills Improved Technology Increase in factors of production
  21. 21. <ul><li>Economic Activity is transformation of inputs into output </li></ul><ul><li>What to produce? </li></ul><ul><li>How to produce? </li></ul><ul><li>For whom to produce? </li></ul><ul><li>Economics is concerned with identification, explanation and solution of these problems </li></ul>
  22. 22. Resource Allocation <ul><li>Problem of resource allocation </li></ul><ul><ul><li>Which goods and services should be produced with society’s resources? </li></ul></ul><ul><ul><ul><li>Where on the PPF should economy operate? </li></ul></ul></ul><ul><ul><li>How should they be produced? </li></ul></ul><ul><ul><ul><li>No capital at all </li></ul></ul></ul><ul><ul><ul><li>Small amount of capital </li></ul></ul></ul><ul><ul><ul><li>More capital </li></ul></ul></ul><ul><ul><li>Who should get them? </li></ul></ul><ul><ul><ul><li>How do we distribute these products among the different groups and individuals in our society? </li></ul></ul></ul>
  23. 23. The Three Methods of Resources Allocation <ul><li>Market Economy </li></ul><ul><ul><li>Resources are allocated through individual decision making </li></ul></ul><ul><ul><li>Dominant method </li></ul></ul><ul><li>Command Economy (Centrally-Planned) </li></ul><ul><ul><li>Resources are allocated according to explicit instructions from a central authority. </li></ul></ul><ul><ul><li>Mixed economy- a combination of markets and state </li></ul></ul>
  24. 24. The Nature of Markets <ul><li>A market is a group of buyers and sellers with the potential to trade with each other </li></ul><ul><ul><li>Global markets </li></ul></ul><ul><ul><ul><li>Buyers and sellers spread across the globe </li></ul></ul></ul><ul><ul><li>Local markets </li></ul></ul><ul><ul><ul><li>Buyers and sellers within a narrowly defined area </li></ul></ul></ul>
  25. 25. INVISIBLE HAND <ul><li>In trying to maximize his own welfare an individual is led by an invisible hand to achieve the best for all. </li></ul><ul><li>A competitive market economy will provide an efficient allocation of resources through the price mechanism </li></ul>
  26. 26. The Importance of Prices <ul><li>A price is the amount of money that must be paid to a seller to obtain a good or service </li></ul><ul><li>When people pay for resources allocated by the market </li></ul><ul><ul><li>They must consider opportunity cost to society of their individual actions </li></ul></ul><ul><li>Markets can create a sensible allocation of resources </li></ul>
  27. 27. <ul><li>Objective – maximum possible ends by sacrificing the minimum possible resources </li></ul><ul><li>Ends are unlimited but can be graded in priority </li></ul><ul><li>Means are limited and they have alternative uses </li></ul><ul><li>This leads to the twin issues of efficiency and choice </li></ul>
  28. 28. Types of Economic Systems <ul><li>An economic system is composed of two features </li></ul><ul><ul><li>Mechanism for allocating resources </li></ul></ul><ul><ul><ul><li>Market </li></ul></ul></ul><ul><ul><ul><li>Command </li></ul></ul></ul><ul><ul><li>Mode of resource ownership </li></ul></ul><ul><ul><ul><li>Private </li></ul></ul></ul><ul><ul><ul><li>State </li></ul></ul></ul>
  29. 29. Figure 4: Types of Economic Systems Resource Allocation Market Command Private State Resource Ownership Market Capitalism Centrally Planned Capitalism Centrally Planned Socialism Market Socialism
  30. 30. Role of Government <ul><li>Increasing efficiency by: </li></ul><ul><li>a. Increasing competition </li></ul><ul><li>b. control of externalities </li></ul><ul><li>c. public goods </li></ul><ul><li>Equity: redistribution of income by taxes and public expenditure </li></ul><ul><li>Macro-stability : control inflation, ensure growth, reduce unemployment and stabilize exchange rates </li></ul>
  31. 31. Externalities <ul><li>Externalities can occur in production or consumption. </li></ul><ul><li>External costs : pollution due to industries, traffic congestion etc </li></ul><ul><li>External benefits: research, ancilliary industries, reducing pollution </li></ul><ul><li>External costs in consumption – passive smoking </li></ul>
  32. 32. Public Goods <ul><li>Private goods are depletable and excludable. </li></ul><ul><li>Hence there is no extra cost for serving an additional user. This makes pricing of such goods difficult. </li></ul><ul><li>It is difficult to collect fees for public goods thus discouraging private enterprise. </li></ul>
  33. 33. Mixed economy <ul><li>The government and the private sector interact in solving economic problems. </li></ul><ul><li>Government controls a significant share of the output through taxation, transfers, provision of public goods and also regulates the extent to which individuals pursue their self interest. </li></ul>