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ECONOMICS
Economics is the study of how societies use scarce resources to produce valuable commodities
and distribute them among different people.
SCOPE OF ECONOMICS
1. Consumption: Satisfaction of human wants is called consumption which forms one of the
important branches of economics. This tells how people behave in consumption of goods and
services in order to maximize their satisfaction.
2. Production: Goods and services have to be produced with the help of factors of production.
So, production is another branch of economics. It concerned with how maximum goods are
produced with minimum cost or how the scarce factors could be utilized economically for better
results.
3. Exchange: Goods and services cannot be produced at one place or at one point of time.
Goods produced by one are exchanged for the goods produced by the others. So exchange forms
another branch of study in economics.
4. Distribution: Goods and services are produced with efforts, i.e., by combining the factors of
production. These efforts have to be paid for or rewarded. The land gets rent, the labor get
wages, the capital gets interest and the organizer gets profit. This branch of study is called
distribution in economics.
5. Public Finance: This branch of study in economics studies about the sources of revenue
to the government and the principles governing the expenditure for the benefit of the people. It
also studies about public debt and financial administration.
ECONOMICS IS A SCIENCE OR AN ART
Economics as a Science: A science is a systematized body of knowledge ascertainable
by observation experimentation. It is a body of generalizations, principles, theories or laws which
traces out a casual relationship between cause and effect. Economics is a systematized body of
knowledge in which economic facts are studied and analyzed in a systematic manner. For
instance, economics is divided into consumption, production, exchange, distribution and public
finance which have their laws are theories on whose basis these departments are studied and
analyzed in a systematic manner. Hence economics is a science like any other science
which has its own theories and laws which establish a relation between cause and effect.
Economics is also a science because its laws possess universal validity such as the law of
diminishing returns, the law of diminishing marginal utility the law of demand, Greshams law,
etc. Again, economics is a science because of its self corrective nature. It goes on revising its
conclusions in the light of new facts based on observations. Economic theories or principles are
being revised in the fields of macro economics, monetary economics, international economics,
public finance and economic development.
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CAPITALIST SYSTEM
Capitalism is that profit-oriented system which is characterized by private ownership of
objects of labor instruments of labor and means of labor. Production is mainly carried out with
the help of labor services rendered by the working class in return for wages and the class of
capitalists has the right to whatever output is produced within the system.
Characteristics of the capitalist system:
1. Private ownership of means of production: Under the capitalist system anything which
helps man in the production process like machinery, tools, land, raw-materials, etc. is owned by
the capitalist class.
2. Production for the market: Under capitalism business firms produce mainly with the aim of
selling the output in the market. Wherever any good is produced for the market it is termed as a
commodity and any economy in which production is undertaken with the sole object of
exchange is call a commodity economy.
3. Price mechanism: In a capitalist economy neither an individual nor any institution takes
decisions in a planned manner concerning its day-to-day functioning. That is, there is no
conscious effort to arrive at some kind of solution to its central problems.
4. Labor power as a commodity: In a capitalist economy, majority of the people own
only on thing viz., their capacity to work or their labor power.
5. Exploitation of labor: Workers are exploited under capitalism. Very often due to the freedom
granted to the workers at a formal level, many people are wrongly given to believe that
the workers by bargaining in the free market are able to get a fair price in return for their labor
power.
6. Growing wealth of the capitalists: In a capitalist economy the wealth of the capitalist class
increases in a sustained manner.
7. Emergence of the working class: Under capitalism the increasing use of machinery
leads to widespread unemployment and an increase in the rate of exploitation of workers
which implies a decline in the share of workers in the national income over time.
8. Class contradiction: Hence, the two major classes found in a capitalist society are those
of the capitalists and the workers. The clash of interests of the capitalists and the workers take
the form of the class conflict with the further development of capitalism.
SOCIALISM
Under socialism not only is there social ownership of the means of production but also
the functioning of the economy is such so as to maximize social benefit rather than private
benefit. Unlike capitalism in a socialist society the market mechanism does not play the all
dominating role of determining the type and quantity of various commodities produces their
priority sequence and the necessary allocation of resources.
Characteristics (or) Salient features of the socialist economic system:
1. Social ownership of the means of production: In a socialist society private
ownership of the means of production is abolished in the various sectors of the economy.
2. Predominance of public sector: An important precondition for the establishment of socialism
is the existence of the public sector which is founded on the principle of social ownership of the
means of production.
3. Decisive role of economic planning: Economic planning under socialism plays exactly the
same role as is played by the price mechanism in a capitalist economy.
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3. Production and Supply Analysis: Production analysis mainly deals with different production
function and their managerial uses. Supply analysis deals with various aspects of supply of a
commodity. Certain important aspects of supply analysis are: Supply schedule, curves and
function. Law of supply and its limitations, Elasticity of supply and Factors influencing supply.
4. Pricing Decisions, Policies and Practices: The important aspects dealt with under this area
are: Price Determination in various Market Forms, Pricing Methods, Differential Pricing,
Product-line Pricing and Price Forecasting.
5. Profit Management: Business firms are generally organized for the purpose of making
profits and, in the long run, profits provide the chief measure of success. In this connection, an
important point worth considering is the element of uncertainty existing about profits because of
variations in costs and revenues which, in turn, are caused by factors both internal and external to
the firm.
6. Capital Management: Capital management implies planning and control of capital
expenditure. The topics dealt with are: Cost of Capital, Rate of Return and Selection of projects.
BASIC ECONOMIC TOOLS IN MANAGERIAL ECONOMICS
1. Opportunity Cost Principle: By the opportunity cost of a decision is meant the
sacrifice of alternatives required by that decision. Thus, it should be clear that opportunity
costs require ascertainment of sacrifices. If a decision involves no sacrifice, its opportunity cost
is nil. For decision-making, opportunity costs are the only relevant costs. The opportunity cost
principle may be stated as under:
The cost involved in any decision consists of the
sacrifices of alternatives required by that decision. If there are no sacrifices, there is no cost.
2. Incremental Principle: Incremental concept involves estimating the impact of decision
alternatives on costs and revenues, emphasizing the changes in total cost and total revenue
resulting from changes in prices, products, procedures, investments or whatever may be at
stake in the decision. The two basic components of incremental reasoning are: Incremental cost
and incremental revenue. Incremental cost may be defined as the change in total cost resulting
from a particular decision. Incremental revenue is the change in total revenue resulting from a
particular decision.
3. Principle of Time Perspective: The economic concepts of the long run and the short
run have become part of everyday language. Managerial economics are also concerned with the
short-run and long-run effects of decisions on revenues as well as costs. The really important
problem in decision-making is to maintain the right balance between the long-run and the
short-run considerations. A decision may be made on the basis of short-run considerations, but
may as time elapses have long-run repercussions which make it more or less profitable than it at
first appeared.
4. Discounting Principle: One of the fundamental ideas in economics is that a rupee
tomorrow is worth less than a rupee today. This seems similar to saying that a bird in hand is
worth two in the bush. If a decision affects costs and revenues at future dates, it is necessary to
discount those costs and revenues to present values before a valid comparison of alternatives is
possible.
5. Equi-marginal Principle: This principle deals with the allocation of the available resources
among the alternative activities. According to this principle, an input should be so allocated that
the value added by the last unit is the same in all cases. This generalization is called the equimarginal principle.
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economic theory and then attempts to solve the real-life, complex business problems with
the aid of tool subjects, e.g., mathematics, statistics, econometrics, accounting, operations
research, marketing research and so on.
and the information about consequences is not available. In this state, nothing is known for sure
and the risk of failure is quite high.
PROFIT MAXIMIZATION AS BUSINESS OBJECTIVE
Profit maximization objective of the firm has been the traditional approach to the study of a firm
in equilibrium analysis. Profit maximization means the largest absolute amount of profits over a
time period, both short-term. And long term. The short run is a period where adjustments cannot
be made quickly in matters of supply and demand. Long run however enables adjustment to
changed conditions. Profit can be defined as the difference between total revenue (TR) and
total cost (TC).
Profit=TR-TC
CRITISIMS OF PROFIT-MAXIMISING THEORIES
1. Separation of Ownership from Control: The rise of corporate firm of organization has
resulted in a separation of ownership and control. Ownership is vested with the shareholders and
control is wielded by the managers. It has not been empirically proved that shareholders are
more concerned with profitability than anything else.
2. Difficulties in Pursuing Profit Maximization: The modern firm faces lot uncertainties. As a
result, short run profit maximizing behavior is subordinated to the more important objective
of long-run survival of the firm, for example, the firms objective to pursue good-will in the
long-run may clash with short-run profit objective.
3. Problems in the Measurement of Profit: There are some problems about the measurement
of profit as a measure of firms efficiency. Profit may be the result of imperfection in the market
and profits may be the reward of monopolistic exploitation. Worse still, profit measurement
process itself is dubious.
4. Social responsibility of the firm: The firm is now-a-days not just an economic entity
concerned with production or sales alone. The firm owes a responsibility to offer good, well
paid jobs for employees, to provide efficient services to customers. In short the firm has a
social responsibility beyond profit maximization.
5. Deliberate limitation of profits: Firms may deliberately show lesser profits in the
short run in order to discourage laborers from asking for higher wages or to discourage
entry of new firms. Limited profits may be shown to prevent the government from taking over
the business.
6. Aversion for business expansion: Profit maximization requires business expansion and it
means additional risk and responsibility. Businessmen may be satisfied with the prevent level of
profit and may not expand.
ARGUMENTS IN FAVOUR OF PROFIT MAXIMIZATION
1. Profit is indispensable for firms survival: The survival of all the profit-oriented
firms in the long run depends on their ability to make a reasonable profit depending on the
business conditions and the level of competition.
2. Achieving other objectives depends on firms ability to make profit: Many other objectives
of business firms have been cited in economic literature, e.g., maximization of managerial utility
function, maximization of long-run growth, maximization of sales revenue, satisfying all the
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concerned parties, increasing and retaining market share, etc. the achievement of such alternative
objectives depends wholly or partly on the primary objective of making profit.
3. Evidence against profit maximization objective not conclusive: Profit maximization is a
time-honored objective of business firms. Although this objective has been questioned by many
researchers, the evidence against it is not conclusive or unambiguous.
4. Profit maximization objective has a greater predicting power: Compared to other business
objectives, profit maximization assumption has been found to be a much more powerful premise
in predicting certain aspects of firms behaviour.
5. Profit is a more reliable measure of firms efficiency: Thought not perfect, profit is the most
efficient and reliable measure of the efficiency of a firm.
ALTERNATIVE OBJECTIVE OF FIRMS
Baumols Theory of Sales Revenue Maximization
Prof. J. Baumol has postulated seller revenue maximization approach as an alternative to profit
maximization objective. The factors which explain the pursuance of this objective are following:
1. Financial institutions evaluate the success and strength of the firm in terms of rate of growth of
its sales revenue.
2. Empirical evidence shows that the stock earnings and salaries of top management are
correlated more closely with sales than with profits.
3. Increasing sales revenue over a period of time gives prestige to the top management, but
profits are enjoyed only by the shareholders.
4. Growing sales means higher salaries and better terms. Hence sales revenue maximizations
results in a healthy personnel policy.
5. It is seen that managers prefer a steady performance with satisfactory profits than
spectacular profits year after year. They will be criticized if spectacular profits decline. Hence
they may prefer a safe and steady performance with satisfactory profits but good sales.
6. Large and increasing sales help the firm to obtain a bigger market share which gives it a
greater competitive power.
ASSUMPTIONS OF BAUMOLS SALE MAXIMIZATION MODEL
i. Sales maximization goal is subject to a minimum profit constrain.
ii. Advertisement is a major instrument of sales maximization i.e., advertisement will shift the
demand curve to the right.
iii. Advertisement costs are independent of production costs.
iv. Price of the product is assumed to be constant.
IMPLICATIONS OF BAUMOLS THEORY
i. His theory is more consistent with observed behavior. In the traditional theory changes in
fixed costs do not influence output or prices except for fixing the breakeven point. But
according to Baumol a firm which experiences any increase in fixed costs will try to reduce
them or pass them on to the consumer in the form of higher prices, through large scales.
ii. This theory also establishes that businessmen may consider non-price competition through
sales maximization to be the more advantageous alternative.
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iii. However, Baumols theory does not explain how the firms maximize their sales
volume within a profit constraint. Further it explains business behavior, without elaborating the
mechanism by which they try to find new alternative.
MARRIS THEORY OF MAXIMISATION OF FIRMS GROWTH RATE
According to Robin Marris, managers maximize firms balanced growth rate subject to
managerial and financial constraints. He defines firms balanced growth rate (G) as, G= GD=GC
Where GD=growth rate of demand for firms product and GC=growth rate of capital supply
to the firm. In simple words, a firms growth rate is balance when demand for its product and
supply of capital to the firm increase at the same rate. The two growth rates are according to
Marris, translated into utility functions:
(i) Managers utility function: The managers utility function (Um) and owners utility(Uo)
may be satisfied as follows. Um=f(salary, power, job security, prestige, status).
(ii) Owners utility function Owners utility function (Uo): Uo=f (output, capital, marketshare, profit, public esteem), implies growth of demand for firms product and supply of capital.
Therefore, maximization of Uo means maximization of demand for firms product or
growth of capital supply. According to Marris, by maximizing these variables, managers
maximize both their own utility function and that of the owners. The managers can do so
because most of the variables (e.g., salaries, status, job security, power, etc) appearing in their
own utility function and those appearing in the utility function of the owners (e.g., profit, capital
market, share, etc) are positively and strongly correlated with a single variable, i.e., size of the
firm. Maximization of these variables depends on the maximization of the growth rate of the
firms. The managers, therefore, seek to maximize a steady growth rate.
Marriss theory, though more rigorous and sophisticated than Baumols sales revenue
maximization, has its own weaknesses. It fails to deal to deal satisfactorily with oligopolistic
interdependence & it ignores price determination which is the main concern of profit
maximization hypothesis.
Williamsons Theory of Maximization of Managerial Utility Function
Like Baumol and Marris, Willamson argues that managers have discretion to pursue objectives
other than profit maximization. The managers seek to maximize their own utility function subject
to a minimum level of profit. Managers utility function (U) is expresses as:
U = f(S, M, ID)
where S= additional expenditure on staff, M= managerial emoluments, ID = discretionary
investments.
According to Williamsons theory managers maximize their utility function subject to a
satisfactory profit. A minimum profit is necessary to satisfy the shareholders or else managers
job security is endangered. The utility functions which managers seek to maximize include both
quantifiable variables like salary and slack earnings, and non-quantitative variable such as
prestige power, status, job security, professional excellence, etc. The non-quantifiable variables
are expresses, in order to make them operational, in terms of expense preference defined as
satisfaction derived out of certain types of expenditures (such as slack payments), and ready
availability of funds for discretionary investments.
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Williamsons theory suffers from certain weakness. His model fails to deal with problem of
oligopolistic interdependence. Williamsons theory is said to hold only where rivalry between
firms is not strong. In case of strong rivalry, profit maximization is claimed to be a more
appropriate hypothesis. Thus, Williamsons managerial utility function too does not offer a more
satisfactory hypothesis than profit maximization.
CYERT-MARCH THEORY OF SATISFICING BEHAVIOUR
Cyert-March theory is an extension of Simons theory or firms. Satisfying behaviour or
satisfying behaviour. Simon had argued that the real business world is full of uncertainly;
accurate and adequate data are not readily available; where data are available managers have
little time and ability to process them; and managers work under a number of terms of rationality
postulated under profit maximization hypothesis. Nor do the firms seek to maximize sales,
growth or anything else. Instead they seek to achieve a satisfactory profit a satisfactory
growth, and so on. This behaviour of firms is termed as Satisfaction Behaviour. Cyert and
March added that, apart from dealing with an uncertain business world, managers have to satisfy
a variety of groups of people-managerial staff, labour, shareholders, customers, financiers, input
suppliers, accountants, lawyers, authorities etc. All these groups have their interest in the firmsoften conflicting. The managers responsibility is to satisfy them all. Thus, according to the
Cyert-March, firms behavior is satisfying behaviour. The satisfying behaviour implies
satisfying various interest groups by sacrificing firms interest or objective. The
underlying assumption of Satisfying Behaviour is that a firm is a coalition of different groups
connected with various activities of the firms, e.g., shareholders, managers, workers, input
supplier, customers, bankers, tax authorities, and so on. All these groups have some kind of
expectations-high and low-from the firm, and the firm seeks to satisfy all of them in one way or
another in sacrificing some of its interest.
In order to reconcile between the conflicting interests and goals, managers form an aspiration
level of the firm combining the following goals:
(a) Production goal
(b) Sales and market share goals
(c) Inventory goal
(d) Profit goal.
These goals and aspiration level are set on the basis of the managers past experience and
their assessment of the future market conditions. The aspiration levels are modified and
revised on the basis of achievements and changing business environment. The behavioural
theory has, however, been criticized on the following grounds. First, though the behavioural
theory deals realistically with the firms activity, it does not explain the firms behaviour under
dynamic conditions in the long run. Secondly, it cannot be used to predict exactly the future
course of firms activities; thirdly, this theory does not deal with the equilibrium of the
industry. Fourthly, like other alternative hypotheses, this theory too fails to deal with
interdependence of the firms and its impact on firms behaviour.
SOURCES OF BUSINESS RISK
1. Risk of Market Fluctuation: General economic conditions are rarely stable. Firms face
booms and depressions. Though with the help of certain forecasting techniques the firm can
somewhat hedge itself against cyclical fluctuation, but there is no way the firm can
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generally know with certainty the timing and volatility of changes. The firm is, therefore,
unstable to completely prepare itself for these changes.
2. Risk of Industry Fluctuations: There may be fluctuations specific to the industry, which are
least as uncertain and may not always coincide with those of the overall market.
3. Competition risks: These are the risk arising from the policy changes of the rivals, which
include things like changes in prices, product line, advertisement expenditure, etc.
4. Risk of technological change: This is also called the risk of obsolescence, which grows with
advancement of an economy. These risks arise from the possibility of newly installed machinery
becoming obsolete with the discovery of new and more economical process of production.
5. Risk of taste fluctuation: In many cases, vagaries of consumer demand create uncertain
conditions. Successful product of one season may become discarded in the next season. These
risks are most common in fashion and entertainment industries.
6. Risk of cost fluctuation: Unless contractually agreed upon, the future prices of labour,
material etc. may change. Thus estimates of future expenditure are subject to uncertainty.
7. Risk of public policy: Government policy regarding business undergoes a change over
time, some of which cannot be precisely predicted. These relate to price control, foreign trade
policy, corporate taxation etc.
THE THREE CATEGORIES OF DECISION-MAKERS
1. Risk-neutral: A decision-maker is risk-neutral if each added rupee of wealth gives him the
same additional utility.
2. Risk-averse: A decision-maker is considered risk-averse if addition of each successive rupee
to his wealth gives him lesser utility than the earlier rupee.
3. Risk-preferer: A decision-maker is considered as risk-preferer when addition of each
successive rupee to decision-makers wealth gives him greater utility each time.
DECISION MAKING
Decision making is the process of selection from a set of alternative courses of action
which is thought to fulfill the objective of the decision problem more satisfactorily than other.
FEATURES OF DECISION MAKING
1. Selection process: Decision making is a selection process. The best alternative is selected out
of many available alternatives.
2. Goal-oriented process: Decision making is goal-oriented process. Decisions are made to
achieve some goal or objective.
3. End process: Decision making is the end process. It is preceded by detailed discussion and
selection of alternatives.
4. Human and Rational process: Decision making is a human and rational process involving
the application of intellectual abilities. It involves deep thinking and foreseeing things.
5. Dynamic process: Decision making is a dynamic process. An individual takes a number of
decisions each day.
6. Situational: Decision making is situational: A particular problem may have different
decisions at different times, depending upon the situation.
7. Continues or Ongoing process: Decision making is a continuous or ongoing process.
Managers have to take a series of decisions on particular problems.
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8. Freedom to the decision makers: Decision making implies freedom to the decision makers
regarding the final choice. It also involves the using of resources in specified ways.
9. Positive or Negative: Decision may be positive or negative. A decision may direct others to
do or not to do.
10. Gives happiness to an Endeavour: Decision making gives happiness to an Endeavour who
takes various steps to collect all the information which is likely to affect decisions.
STEPS IN DECISION MAKING PROCESS IN AN ORGANIZATION
1. Identification of problem: Decision making process begins with the identification of problem
that means recognition of a problem. The managers have to use imagination, experience, and
judgment in order to identify the real nature of the problem.
2. Diagnosis and analysis of the problem: In order to diagnose the problem correctly, a
manager must obtain all pertinent facts and analyze them correctly. The most important part of
the diagnosing problem is to find out the real cause or source of the problem. After
analyzing the problem next phase of the decision making is to analyze problem. This process
involves classifying the problem and gathering information.
3. Search for alternatives: A problem can be solved in many ways. All possible ways cannot be
equally satisfying. Managers are advice to limit him to the discovery of the alternatives
which are strategic or critical to the problem. The principle of limiting factor is given as By
recognizing and overcoming that factor that stand critically in the way of a goal, the best
alternative course of action can be selected. Creative thinking is necessary to develop
alternatives such as decision makers past experience, practices followed by others, and using
creative techniques.
4. Evaluation of alternatives: Evaluation is the process of measuring the positive and
negative consequences of each alternative. Some alternatives offer maximum benefit than
others. An alternative is compared with the others. Management must set some criteria against
which the alternatives can be evaluated. Criteria to weigh the alternative courses of action
includes Risk-Degree of risk involved in each alternative, Economy of effort- Cost, time and
effort involved in each alternative, Timing or Situation- Whether the problem is urgent &
Limitation of resources- Physical, financial and human resources available with the organization.
5. Selecting an alternative: In this stage, decision makers can select the best alternatives.
Optimum alternative is one which maximizes the results under given conditions.
6. Implementation and follow-up: Once an alternative is selected, it is put into action in
systematic way. The future course of action is scheduled on the basis of selected alternatives.
When a decision is put into action, it may yield certain results. These results provide the
indication whether decision making and its implementation is proper. The follow-up action
should be in the light of feedback received from the results.
RATIONAL DECISION MAKING
Decision making is the process of selection from a set of alternative courses of action
which is thought to fulfill the objective of the decision problem more satisfactorily than other.
The concept of rationality is defined in terms of objective and intelligent action.
TYPES OF DECISION MAKING DEPENDING UPON RATIONALITY
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