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Managerial Economics

Module 1:
Introduction to managerial economics
Meaning and defnition economics- economic theory and managerial
economics-nature and scope of managerial economics-relationship
to other branches of learning-usefulness of managerial economics
Defnition and scope of managerial economics:
Manageríaí economícs ís economícs appííed ín decísíon-makíng. It ís that
branch of economícs whích íínks abstract theory wíth manageríaí practíce.
Economícs ís a scíence concerned wíth the probíem of aííocatíng scarce
resources wíth competíng ends. Manageríaí economícs may aíso be taken as
economícs appííed to probíems of choíce of aíternatíves and aííocatíon of
scarce resources by the ñrms. Manageríaí economícs ís goaí oríented and
aíms at maxímum achíevement of ob|ectíves.
Manageríaí economícs emerged oníy ín the earíy part of 1950´s. Manageríaí
economícs generaííy refers to the íntegratíon of economíc theory wíth
busíness practíce. Economícs provídes the tooís whích expíaín the varíous
aspects such as demand, suppíy, príce, competítíon etc. Economíc príncípíes
by themseíves do not oher ready-made soíutíons appíícabíe ín the changíng
busíness woríd. After the Second Woríd War and partícuíaríy after 1950, wíth
the expansíon of busíness aíí over the woríd, the busíness manager was
faced wíth many probíems due to changíng busíness envíronment. The príme
functíon of a management executíve ín a busíness organízatíon ís decísíon-
makíng and forward píanníng.
The decísíons and forward píanníng ís for the future, whích ís uncertaín. In
the reaí woríd, the busíness manager rareíy has compíete ínformatíon as to
future saíes, costs, proñts, capítaí etc.
Hence decísíons are made and píans formuíated on the basís of past data,
current ínformatíon and the estímates about future predícted as best as
possíbíe. As píans are ímpíemented over tíme, therefore, píans may have to
be revísed and díherent courses of actíon adopted. Managers are thus
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engaged ín a contínuous process of decísíon-makíng through an uncertaín
future and the overaíí probíem confrontíng them ís one of ad|ustíng to
uncertaínty.
In fuíñíííng the functíon of decísíon-makíng ín an uncertaínty frame-work,
economíc theory can be pressed ínto servíce wíth consíderabíe advantage.
Economíc theory deaís wíth a number of concepts and príncípíes reíatíng to
proñt, demand, c0st, prícíng etc. Whích aíded by aíííed díscípíínes ííke
accountíng, statístícs and mathematícs can be used to soíve the probíems of
busíness management.
Defnition of managerial economics:
Accordíng to Mcnaír and Meríam," Manageríaí economícs ís the use of
economíc modes of thoughts to anaíyse busíness sítuatíon".
Accordíng to Prof. Watson," Príce theory ín the servíce of busíness executíves,
ís known as manageríaí economícs".
Prof. D.C.Haque deñnes manageríaí economícs as," a fundamentaííy an
academíc sub|ect whích seeks to understand and to anaíyse the probíems of
busíness decísíon-takíng".
Accordíng to W.W.Haynes, manageríaí economícs ís the study of the
aííocatíon of resources avaííabíe to a ñrm or other unít of management
among the actívítíes of that unít".
Spencer has deñned manageríaí economícs as," manageríaí economícs ís the
íntegratíon of economíc theory wíth busíness practíce for the purpose of
facííítatíng decísíon-makíng and forward -píanníng by the management."
"Manageríaí economícs ís concerned wíth busíness emcíency". Prof. Smaíí.
"Manageríaí economícs ís the appíícatíon of economíc theory and
methodoíogy to busíness admínístratíon and practíce". Brígham and Pappas.
Dougías has deñned manageríaí economícs as," manageríaí economícs ís
concerned wíth the appíícatíon of economíc príncípíes and methodoíogíes to
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the decísíon makíng process wíth the ñrm or organízatíon under condítíons of
uncertaínty. It seeks to estabíísh ruíes and príncípíes to facííítate the
attaínment of the desíred economíc goaís reíate to costs, revenues and
proñts and are ímportant wíthín both the busíness and the non-busíness
ínstítutíons".
It ís cíear from the above deñnítíons; díherent economísts try to pro|ect the
sub|ect matter of manageríaí economícs díherentíy. However, theír víew-
poínts have the foííowíng features ín common:
1. Manageríaí economícs ís concerned wíth decísíon makíng of economíc
nature. It deaís wíth ídentífyíng díherent choíces and aííocatíng íímíted
resources.
2. Manageríaí economícs ís goaí oríented, ít aíms at maxímum achíevement
of ob|ectíves and how decísíons shouíd be made by the manager to achíeve
the foaí.
3. Manageríaí economícs ís pragmatíc as ít deaís wíth matters accordíng to
theír practícaí sígníñcance.
4. Manageríaí economícs appííes quantítatíve techníques to busíness. Whííe
measurement wíthout theory can oníy íead to fauíty concíusíons. Precísíon
theory wíthout measurement cannot be operatíonaííy usefuí.
Manageríaí economícs ís pragmatíc and reaíístíc ín nature. It ís appííed to
soíve probíems faced by the busíness ñrms. These probíems are reíated to
choíce and aííocatíon of resources whích are economíc ín character. It shouíd
be remembered that decísíon-makíng ín busíness ís ínñuenced not oníy by
economíc factors, but, aíso by many other factors such as,
1. Human
2. Behavíoraí
3. Technoíogícaí and
4. Envíronmentaí
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Scope of managerial economics:
Sínce manageríaí economícs ís a newíy formed díscípííne, no uníform pattern
ís adopted and díherent authors treat the sub|ect ín díherent ways. However,
the foííowíng topícs have been regarded as the scope of the sub|ect,
manageríaí economícs:
I. Whether manageríaí economícs ís normatíve or posítíve economícs
II. Area of study
III. Proñts- the centraí concept of manageríaí economícs
IV. Optímízatíon
V. Reíatíonshíp of manageríaí economícs wíth other díscípíínes.
I. Managerial economics- Is it positive or normative:
Posítíve economícs ís descríptíve ín character. It descríbes economíc
actívítíes as they are. Accordíng to Prof. Líoneí Robbíns economícs ís a
posítíve scíence and he beííeved that economíst, shouíd be ´neutraí´´
between ´ends´ and he cannot pronounce on the vaíídíty o uítímate
|udgments of vaíue.
Whííe normatíve economícs passes |udgments of vaíue. Manageríaí
economícs draws from descríptíve economícs and tríes to pass |udgments of
vaíue ín the context of the ñrm. Manageríaí economícs ís maíníy normatíve ín
nature.
II. rea of study:
Broadíy speakíng, manageríaí economícs deaís wíth the foííowíng topícs:
1. Demand anaíysís and forecastíng
2. Cost and productíon anaíysís
3. Prícíng decísíons, poíícíes and practíces
4. Proñt management
5. Capítaí management
6. Línear programmíng and theory of games.
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1. Demand analysis and forecasting:
Accurate estímatíon of demand by anaíyzíng the forces actíng on demand of
the product produced by the ñrm forms the vítaí íssue ín takíng ehectíve
decísíons at the ñrm íeveí. Demand anaíysís attempts at ñndíng out the
forces of determíníng saíes. Thís has two maín manageríaí purposes.
1. Forecastíng saíes and 2. Manípuíatíng demand.
The demand anaíysís covers the topícs ííke demand determínants, demand
dístínctíons and demand forecastíng.
!. "ost and production analysis:
In decísíon-makíng, cost estímates are very essentíaí. Productíon píanníng,
proñt píanníng etc depends upon sound prícíng practíces and accurate cost
anaíysís. Productíon anaíysís deaís wíth physícaí terms of the product, whííe
cost anaíysís deaís wíth the monetary terms. Cost anaíysís ís concerned wíth
cost concepts, cost-output reíatíons, economíes of scaíe, productíon functíon
and cost controí.
#. $ricing decisions% policies and practices:
Prícíng forms the core of manageríaí economícs. The success or faííure of a
ñrm maíníy depends on accurate príce decísíons to ehectíveíy compete ín the
market. The ímportant aspects of the study under thís are príce
determínatíon under díherent market condítíons, prícíng methods and poííce
product ííne prícíng and príce forecastíng.
&. $roft management:
Aíí busíness enterpríses are proñt makíng ínstítutíons. The success or faííure
of a ñrm ís measured oníy ín terms of proñt ít has made and the percentage
of dívídend ít has decíared. Hence, proñt management, proñt poíícíes and
techníques. Proñt píanníng ííke break-even anaíysís ís studíed under thís
category.
'. "apital management:
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Capítaí management ís the most troubíesome probíem for the management
of busíness ínvoívíng hígh-íeveí decísíons. Capítaí management deaís wíth
píanníng and controí of capítaí expendíture. Cost of capítaí, rate of return
and seíectíon of pro|ect etc.
(. )inear programming and theory of games:
Línear programmíng and theory of games have come to be regarded as part
of manageríaí economícs, as there ís a trend towards íntegratíon of
manageríaí economícs and operatíons research.
III. $roft: *he central concept in managerial economics:
Generaííy, proñts are the prímary measure of the success of any busíness. It
ís the acíd test of the economíc strength of the ñrm. Economíc theory makes
a fundamentaí assumptíon that maxímízíng proñt ís the basíc aím of every
ñrm. Thís assumptíon ís by and íarge true, though ín modern socíety thís
may not aíways hoíd good. Modern ñrms pursue muítípíe ob|ectíves such as
weífare, obíígatíons to socíety and consumers etc. However, proñt
maxímízatíon receíves top príoríty, íf not soíe ob|ectíve. Consequentíy, proñt
maxímízatíon contínues to be the ob|ectíve of the ñrm and the study of ñrm
ín manageríaí economícs has centered on the concept of proñt.
The maxímízatíon of proñts ís the maín ob|ectíve of any ñrm and the survívaí
of the ñrm depends on the proñts ít earns. Proñts are the maín índícator of a
ñrm´s success. It ís the índex of busíness emcíency. Further, the concept of
proñt maxímízatíon ís very much usefuí ín seíectíng the aíternatíves ín
makíng a decísíon at the ñrm-íeveí.
I+. ,ptimi-ation:
Another ímportant concept used ín manageríaí economícs ís ´optímízatíon´.
Thís aíms at optímízíng a gíven ob|ectíve. The aím of íínear programmíng ís
to aíd the process of optímízatíon and choíce. It ohers numerícaí soíutíons to
the probíem of makíng of optímum choíces. Thís poínt of optímízatíon
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emerges when they are constraínts optímízatíon ís basíc to manageríaí
economícs ín decísíon-makíng.
+. .elationship of managerial economics /ith other disciplines:
Manageríaí economícs ís cíoseíy reíated to other sub|ects ííke mícro economíc
theory, macro economíc theory, mathematícs, statístícs, accountíng and
operatíons research. Manageríaí economícs," as usíng the íogíc of
economícs, mathematícs and statístícs to províde ehectíve ways of thínkíng
about busíness decísíon probíems".
Managerial economics and micro economics:
Manageríaí economícs ís maíníy mícro economíc ín character, makíng use of
many of the concepts and tooís províded by mícro-economíc theory. The
concept of eíastícíty of demand, margínaí cost, market structures, the theory
of the ñrm and the theory of prícíng of mícro-economícs are fuííy made use of
by manageríaí economícs. Hence the study of mícro economícs ís essentíaí
for the better understandíng of manageríaí economícs. Aíí mícro economíc
theoríes whích can be appííed ín busíness are made use of ín manageríaí
economícs.
Managerial economics and macro economics:
Macro economícs ís concerned wíth aggregates and macro economícs
concepts are used ín manageríaí economícs ín the area of forecastíng generaí
busíness condítíons. The theory of the ñrm, prícíng poíícíes etc have to be
víewed ín the broad frame work of the economíc system and ít ís essentíaí
that the busíness executíves shouíd have some knowíedge of the entíre
economíc system. Macro economíc concepts ííke natíonaí íncome, socíaí
accountíng, manageríaí emcíency of capítaí, muítípííer, busíness cycíes, ñscaí
poíícíes etc have to be studíed ín manageríaí economícs for forecastíng the
busíness condítíons.
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Both mícro and macro economícs are cíoseíy reíated to manageríaí
economícs. Manageríaí economícs draws from mícro and macro economícs,
so that ít can appíy these príncípíes to soíve the day-to-day probíems faced
by busínessmen.
Managerial economics and mathematics:
Manageríaí economícs ís becomíng íncreasíngíy mathematícaí ín character.
Busínessmen deaí wíth varíous concepts whích are measurabíe. The use of
mathematícaí íogíc provídes cíaríty of concepts. It aíso gíves a systematíc
frame-work wíthín whích quantítatíve reíatíonshíp maybe anaíyzed.
Mathematícs, therefore, ís of great heíp to manageríaí economícs. The ma|or
probíem confrontíng busínessmen ís to mínímíze cost or maxímíze proñt or
optímíze saíes. To ñnd out the soíutíon for the overaíí probíems,
mathematícaí concepts and techníques are wídeíy used. Mathematícaí
techníques ííke íínear programmíng, games theory etc heíp manageríaí
economísts to soíve many of theír probíems.
Managerial economics and statistics:
Statístícs ís a scíence concerned wíth coííectíon, cíassíñcatíon, tabuíatíon and
anaíysís of data for some specíñed purpose. Manageríaí economícs and
statístícs are cíoseíy reíated as busínessmen deaí maíníy wíth concepts that
are quantíñabíe for exampíe: demand, príce, cost of operatíon etc.
Statístícs ís usefuí to manageríaí economícs ín many ways:
a. Manageríaí economícs requíres marshaíííng of quantítatíve data to ñnd out
functíonaí reíatíonshíp ínvoíved ín decísíon-makíng. Thís ís done wíth the
heíp of statístícs.
b. Statístícaí methods are used for empírícaí testíng ín manageríaí economícs.
c. The busíness executíves have to work and take decísíons ín an uncertaínty
frame-work. The theory of probabíííty evoíved by statístícs heíps manageríaí
economísts for takíng a íogícaí decísíon.
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Thus statístícaí methods provídes sound base for decísíon-makíng and heíp
the busínessmen to achíeve the ob|ectíve wíthout much dímcuíty. Statístícaí
tooís are extensíveíy used ín the soíutíon of manageríaí probíems.
Manageríaí economísts make use of varíous statístícaí techníques ííke the
theory of probabíííty, co-reíatíon techníques, regressíon anaíysís etc. ín
varíous busíness sítuatíons.
Managerial economics and accounting:
Accountíng ís concerned wíth recordíng the ñnancíaí operatíons of a busíness
ñrm. Accountíng ínformatíon ís one of the prímary sources of data requíred
for manageríaí economísts for the decísíon-makíng purpose. The ínformatíon
ít contaíns can be used by the manageríaí economíst to throw some ííght on
the future course of actíon.
Managerial economics and operations research:
Operatíons research ís the," appíícatíon of mathematícaí techníques ín
soívíng busíness probíems". It deaís wíth modeí buíídíng that ís constructíon
of theoretícaí-modeís that heíp the decísíon-makíng process. Though the
roots of operatíons research ííe ín mííítary studíes, ít ís now íargeíy used ín
busíness admínístratíon, píanníng and controí. Línear programmíng and
aíííed concepts of operatíons research are used ín manageríaí economícs.
0undamental concept of managerial economics:
Economíc theoríes, concepts, and anaíytícaí tooís are of great heíp to a
busínessman ín arrívíng at better decísíons ín actuaí busíness íífe. The
foííowíng economíc concepts are fundamentaí to economíc concepts are
fundamentaí to busíness anaíysís and decísíon-makíng
1. Opportuníty cost príncípíe
2. Incrementaí cost and revenue príncípíe
3. Tíme perspectíve
4. Equí-margínaí príncípíe
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1. ,pportunity "ost:
Decísíons ímpíy makíng a choíce from the varíous aíternatíves. The
opportuníty cost of a decísíon ís the sacríñce of the next best aíternatíve
course of actíon avaííabíe. A decísíon ís cost free íf ít ínvoíves no sacríñce.
Thís can be best understood wíth the heíp of a few íííustratíons:
1. The opportuníty cost of the funds empíoyed ín one´s own busíness ís the
ínterest that couíd be earned on those funds had they been empíoyed ín
other ventures.
2. The opportuníty cost of the tíme an entrepreneur devotes to hís own
busíness ís the saíary he couíd earn by seekíng empíoyment eísewhere.
3. The opportuníty cost of usíng a machíne to produce one product ís the
earníngs foregone whích wouíd have been possíbíe from other products.
4. The opportuníty cost of hoídíng Rs. 500 as cash ín hand for one year ís the
10% rate of ínterest, whích wouíd have been earned had the money been
kept as ñxed deposít ín a bank.
Thus, ít shouíd be cíear that opportuníty costs requíre ascertaínment of
sacríñces, íf a decísíon ínvoíves no sacríñces, the opportuníty cost ís níí. For
decísíon-makíng, opportuníty costs are the oníy reíevant costs.
!. Incremental cost and revenue principle:
Incrementaí concept ís cíoseíy reíated to the margínaí costs and margínaí
revenues. Incrementaí concept ínvoíves estímatíng the ímpact of decísíon
aíternatíves on costs and revenues, emphasízíng the changes ín totaí cost
and totaí revenue resuítíng from changes ín príces products, procedures,
ínvestments or whatever may be at stake ín the decísíon.
The two basíc components of íncrementaí reasoníng are: íncrementaí cost
and íncrementaí revenue. Incrementaí cost may be deñned as the change ín
totaí cost resuítíng from a partícuíar decísíon. Incrementaí revenue ís the
change ín totaí revenue resuítíng from a partícuíar decísíon. For exampíe: íf a
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ñrm decídes to go for computerízatíon of market ínformatíon, the addítíonaí
revenue ít earns wííí be termed ´íncrementaí revenue´ and the extra cost of
settíng up computer facííítíes wííí be termed íncrementaí cost. Thus when the
íncrementaí revenue exceeds íncrementaí cost resuítíng from a partícuíar
decísíon ít ís regarded proñtabíe. Thís certaíníy heíps ín arrívíng at a better
decísíon by comparíng íncrementaí costs and revenues of aíternatíve
decísíons.
#. *ime perspective:
In the ñeíd of prícíng tíme has a crucíaí roíe to píay. The credít goes to
Marshaíí for takíng cognízance of tíme eíement ín the theory of vaíue. He
studíed the market on the basís of tíme nameíy very short períod, short
períod, íong períod etc. In manageríaí economícs, the anaíysís and decísíons
are cíassíñed ínto short and íong períod. That ís why short and íong períod.
That ís why short and íong run tíme períods are wídeíy known and popuíaríy
used ín manageríaí economícs. Margínaí economísts are concerned wíth
short-run and íong-run ehects of decísíons on revenues and costs. The
crucíaí probíem ín decísíon-makíng ís to maíntaín the ríght baíance between
the short and íong run busíness perspectíves. In other words, the manageríaí
shouíd take a íong-range víew of ehects on costs and revenues rather than
mereíy a short-síghted víew. A decísíon may be made on the basís of short-
run consíderatíons, but may, as tíme passes, have íong-run repercussíons
that make ít more or íess proñtabíe than at ñrst seemed. In the uítímate
anaíysís, a proper baíance between the short-term consíderatíons and íong-
term ímpíícatíons ís ínñuenced by the sensítívíty of the customers.
&. *he e1ui-marginal principle:
An ímportant proposítíon of economícs ís that an ínput shouíd be aííocated ín
such a way that the vaíue added by the íast unít ís the same ín aíí uses. Thís
proposítíon ís popuíaríy known as the equí-margínaí príncípíe. Let us consíder
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a case ín whích the ñrm ís ínvoíved ín four actívítíes víz actívíty, actívíty b,
actívíty c, actívíty d. Aíí these actívítíes requíre the servíces of íabour. The
ñrm can íncrease any one of the actívítíes by empíoyíng more íabour, but
oníy at the cost of other actívítíes. In thís case, the ñrm aííocates íabour for
each of the actívíty ín such a manner that the vaíue of the margínaí product
ís equaí ín aíí actívítíes.
VMP = VMP = VMP = VMP
Where ´L´ índícates íabour and a, b, c, d, represent the actívítíes, that ís, the
vaíue of the margínaí product of íabour empíoyed ín a ís equaí to the vaíue of
the margínaí product of the íabour empíoyed ín b, and so on.
If the ñrm funds that the vaíue of the margínaí product ís greater ín one
actívíty than another, the ñrm must reaííze the fact that an optímum has not
been achíeved.
Importance2 usefulness of managerial economics:
1. Manageríaí enabíes the use of economíc íogíc and príncípíes to aíd
management decísíon-makíng. Managers are decísíon-makers and
economícs shouíd be reíevant to gíve practícaí guídance ín arrívíng at ríght
decísíons. Every manager has to take ímportant decísíons about usíng hís
íímíted resources ííke íand, capítaí, íabour, ñnance etc. to get the maxímum
returns, therefore, manageríaí economícs, concentrates on those practícaí
aspects of mícro-economícs whích heíp ín decísíon-makíng.
2. Manageríaí economícs focuses on the most proñtabíe use of scarce
resources rather than on the achíevement of equíííbríum príces and
quantítíes as pure theory of economícs does. Víewed thís way ít ís more
practícaí and pragmatíc than mícro economícs. Manageríaí economícs
equípped wíth theoretícaí background provídes an answer to practícaí
probíems faced by a busíness ñrm.
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3. Manageríaí economícs has íntroduced dynamísm ín the woríd of decísíon-
makíng and busíness envíronment. In a free market economy, success ín
busíness depends upon how quíckíy busíness antícípates and responds to the
changíng nature of the market píace. Busíness managers, forever, face a
need to adapt to changes ín the busíness envíronment. The busíness woríd
has to be dynamíc to face the changíng trends ín demand. Thís dynamísm
pervades decísíon-makíng and necessítates the íntegratíon of manageríaí
economícs ínto the busíness envíronment.
4. Manageríaí economícs has gíven ríse to the emergence of a new approach
ín decísíon-makíng known as corporate strategy. Busíness Corporatíon´s work
wíth a gíven set of corporate goaís and ob|ectíves agaínst the background of
a set of assumptíons about the company´s economíc, competítíve, reguíatory,
factor-suppíy, technoíogícaí and ínternatíonaí envíronment. Strategíc
píanníng ís a three-foíd probíem víz a portfoíío probíem, an ínvestment
probíem and a strategy seíectíon probíem and a strategy seíectíon probíem.
The portfoíío probíem pertaíns to whích busíness shouíd the company adopt.
The ínvestment probíem pertaíns to the íeveí of ínvestment to be made by
each busíness. The strategy seíectíon probíem pertaíns to the specíñc
ñnancíaí, marketíng and productíon strategíes to be foííowed by each
busíness ñrm. Thus the íntegratíon of manageríaí economícs ín decísíon-
makíng has gíven ríse to corporate economícs.
5. Manageríaí economícs sharpens the busíness acumen. An abíííty to
anaíyse probíems íogícaííy and cíearíy heíps to make good decísíons.
Manageríaí economícs provídes necessary tooís to the management ín íts
decísíon-makíng process.
6. Manageríaí economícs has emerged as a specíaí branch of knowíedge
aíííed to economícs to enrích the decísíon makers at varíous íeveís of ñrms
operatíons. Concepts ín the area of demand, costs, saíes etc heíp to appíy
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theoríes to the soíutíon of probíems ín day-to-day busíness actívíty.
Manageríaí economícs wíth the knowíedge of operatíons research provídes
the professíonaí managers wíth the requíred tooís and modeís to soíve
probíems ín a more scíentíñc way.
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