Managerial Economics

Meaning ,Scope & Methods:

 Why Study Managerial Economics ?

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Sound Economic Business Decision: Factors Influencing:

Managerial economics tells managers how things should be done to achieve objectives efficiently, and helps them recognize how economic forces affect organizations.* Definition: Economics is a social science, which studies human behavior in relation to optimizing allocation of available resources to achieve the given ends.

Meaning :
Is a Discipline that deals with the application of Economic Concepts ,Theories and methods to the practical problem of the Business to formulate rational Management decision.

Problems may be relating to costs,prices,forecasting the future market,human resource management, profits etc.

It is the attempt to optimize business decisions given the firm's objectives and given constraints imposed by scarcity .

Scope:

Wherever there are scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning customers, suppliers, competitors as well as within an organization.

Helps in the following : Demand Analysis and Forecasting : Cost Analysis : Production And Supply Analysis: Pricing Decisions

Difference B\W Accounting Profit & Economic Profit:

Accounting Profit

Economic Profit :

Revenue - Cost.

Opportunity Cost - Revenue

Significant in Number

Less

Why Do Profits among Firms Vary ?

Disequilibrium Profit Theories: Markets are sometimes in disequilibrium because of unanticipated changes in demand or cost conditions.

Profits are sometimes above or below normal because of factors that prevent instantaneous adjustment to new market conditions. Monopoly profits exist when firms are sheltered from competition by high barriers to entry. Economies of scale, high capital requirements, patents, or import protection, among other factors, enable some firms to build monopoly positions that allow above-normal profits for extended periods.

Compensatory Profit Theories: Innovation profit theory, describes the above-normal profits that arise following successful invention or modernization.

As in the case of frictional or disequilibrium profits, innovation profits are susceptible to the onslaught of competition from new and established competitors. Compensatory profit theory describes above-normal rates of return that reward firms.

Superior firms provide goods and services that are better, faster or cheaper than the competition.

ROLE OF BUSINESS IN SOCIETY : Why Firms Exist ?

Business contributes significantly to social welfare. These contributions stem directly from the efficiency of business in serving the economic needs of customers.

Social Responsibility of Business:

The firm can be viewed as a collaborative effort on the part of management, workers, suppliers, and investors on behalf of consumers. Taxes and restrictions on firms are taxes and restrictions on people associated with the firm.

Economic Concepts

Text Books
Managerial Economics: Joel Dean.
Managerial Economics: Mote Paul & Gupta. Managerial Economics: James pappas & Mark

Hershey. Managerial Economics: Milton Spencer & Louis Siegleman. Economics : Samuelson

Economic Concepts
Demand:

Refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between Price and quantity demanded is called as Demand Relationship.

Supply:

Represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship.

The Law of Demand

The law of demand states that, if all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good. As a result, people will naturally avoid buying a product that will force them to forgo the consumption of something else they value more.

Types of Demand:
Individual demand: Market demand:

Joint demand:
Composite demand: Number of Uses. Competitive demand: close substitutes .

Derived demand:
Variation in demand: Direct demand:

Exceptions to the Law of Demand:

Speculative Market: Inferior goods: Increase in Purchasing Power. Prestige goods: Status Attached ( Veblen effect) Price Illusions: Quality related to price.

Demonstration effect:
Snob Effect:

In the Above cases the Demand curve is Upward showing a positive relationship between Price and demand.

Chief Characteristics Of Demand:

Inverse Relationship: Price ,an Independent while Demand is Dependant Variable: Other Things remaining Constant: Determinants of Demand: Income: Price: Weather Conditions: Fashion: Money Circulation: Advertisement and salesmanship:

Price Elasticity of Demand

Meaning: Definition: (PED or Ed)

The degree of responsiveness of quantity demanded to a change in price Formula :

Proportionate change in quantity demanded _______________________________________________ Proportionate change in Price

Types of Elasticity of Demand

Income Elasticity:

Demand for a good is the ratio of the percentage change in the amount spent on the commodity to a percentage change in the consumers income.

Proportionate change in the quantity purchased _____________________________________________ Proportionate change in Income

 Cross Elasticity :

A change in the price of one good causes a change in the demand for another. Proportionate change in purchases of commodity X ----------------------------------------------------------------------

Proportionate change in the price of commodity Y

Complementary Goods: Substitutes:

Perfectly Elastic Demand: Where No Reduction In price is Needed to Increase Demand. Perfectly Inelastic Demand: Where Change in Demand results in no change in price .
Demand with Unity Elasticity: Equal Change Relatively Elastic Demand: Reduction in price leads to relatively more change in demand. Relatively inelastic Demand: Where reduction in price leads to less change in demand.

Determinants Of PED

Availability of substitute goods:

Income: Necessity: Brand loyalty: Who pays: Proportionate of Income spend:

Opportunity Cost: Is meant the sacrifice of alternatives required by that decision. Ex: Funds, Time. Production function Is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs Q = f(X1,X2,X3,...,Xn) where: Q = quantity of output X1,X2,X3,...,Xn = quantities of factor inputs (such as capital, labour, land or raw materials)

The law of supply

This Law demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied. Producers supply more at a higher price because selling a higher quantity at a higher price increases revenue. Factors Effecting Supply:

Input prices Technology Expectations -

Law of Demand

The Law of Demand

A, B and C are points on the demand curve. Each point on the curve reflects a direct correlation between quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and quantity demanded. The higher the price of a good the lower the quantity demanded (A), and the lower the price, the more the good will be in demand (C)

Law of Supply

Supply (s)

P3
Supply Relationship

P2

P1

Q1

Q2

Q3

A, B and C are points on the supply curve. Each point on the curve reflects a direct correlation between quantity supplied (Q) and price (P). At point B, the quantity supplied will be Q2 and the price will be P2, and so on

Demand Forecast
Meaning:

Length of Forecast: Short term Forecasting: up to 12 months used for inventory control, productions plans etc
Medium term forecasting: 1- 2 years used for rate of

maintenance, schedule of operations etc

Long term forecasting: 3 10 years used for manpower

planning, capital expenditure etc

Levels : Macro Level : National Income ?& Expenditure. Industry Level : Firm Level:

Purposes of Short term Forecasting

Appropriate Production:
Reducing Costs: Determining appropriate Pricing Policy : Setting Sales targets: Advertising Decision: Financial Requirement:

Purposes of Long term Forecasting

Expansion Plans:
Long term financial requirement: Planning Man Power:

Classification of Forecasting Passive Forecasting Active Forecasting

Demand Distinctions:
Producers Goods Consumable : Coal , Oil etc.. Durable Goods : Machines etc Consumers goods Durable Goods: Characteristics Non - durable goods: Single Usage

 Durable Goods :
Derived Demand : Automous Demand :Independent Industry Demand: Company Goods:

 Market Share Concept :

Factors Determining Market Share : Price Charged & Price Differentiated: Promotional expenditure: Product Improvement:

Criteria for a good forecasting Method:

Accuracy:
Simplicity and ease of comprehensions: Economy: Availability: Maintenance of Timeliness:

Presentations of forecast to management

Ease to understand.
Avoid using vague generalities. Always pin-point major assumptions and sources. Give possible margin of error. Avoid making undue qualifications. Omit details about methods and calculations. Charts and graphs .

Steps in Demand Forecasting

Setting the Objectives.
Selection and Classification of Goods. Selection of Methods. Interpreting the result.

Qualitative Sources of Data:

Consumer Survey Method

Market Experiments Expert Opinion Methods

Complete Enumeration

Sales Force Method Sample Survey

 Consumer Survey Method:

Delphi Method:

 Advantages:
It Facilitates the Anonymity of the respondents. This is nearly as good as having the panelist physically

pooled.
Conditions: Panelist Knowledge :

Expert Opinion:

Monopoly :
Meaning: Characteristics : Market Power: Single Seller :
Sources of Monopoly Power:

Economic Barriers:
Capital Requirement: Technology Superiority:

Costs and Classification of Costs

Meaning: Basis of Identity:

Materials, Labor and Expenses . Basis of Function: Production, Administration, Selling & Distribution Basis of Variability: Fixed Costs , Variable Costs & Semi - variable Costs

 Basis of controllability :

Controllable Costs & Uncontrollable Costs.

Basis of Time:

Historical Costs, Replacement Costs & Predetermined Costs.

Sunk Costs: Shut Down Costs: Abandoned Costs: Incremental Costs: Common production Costs:

 Avg Costs:
Marginal Costs: Total Costs:

Costs Determinants: Level of Output: Prices and Input factors: Productivity: Size of the plant: Lot of size: Level of capacity utilization: Technology : Learning Curve: Breath of product range: Geography: Degree of vertical Integration:

Vertical Integration
Types:
Backward vertical integration : Forward vertical integration

Economies of Scale
Cost advantages
Expansion. Average cost per unit to fall as the scale of output is

increased. "Economies of scale" is a long run concept and refers to reductions in unit cost as the size of a facility . Marketing Costs, Purchasing Costs etc

Market Analysis
Meaning:
Elements : Market size : Sum of Revenue of the market. Market profitability: Market growth rate : Distribution channels : Success Factors : Importance Of Market Analysis:

Steps in Market Analysis :

Defining the problem Analysis of the situation Obtaining data that is specific to the problem Analysis and interpreting the data Fostering ideas and problem solving Designing a plan

1 ) Defining the problem

Are we trying to market our entire product or service

line? Or, are we trying to hone in on a new product or a new service? What specific marketing strategies ? How much money is allocated to marketing? When making a sale, do we survey our customers to determine a referral source? Who are our customers?

2 ) Analysis Of The Situation:

Primary & secondary market research:

3 ) Obtaining Data Specific To The Problem : 4 ) Data Analysis and Interpretation : 5 ) Fostering Ideas And Problem Solving: 6 ) Marketing Plan:

3.Obtaining Data Specific To The Problem

Qualitative & Quantitative Questionnaires:

Ex: Excellent=4Good=3Fair=2Poor=1. Ways to Conduct Surveys: Mail Surveys : 25 % RR. Telephone Surveys : Personal Interview Questions: Observations:

4 Data Analysis and Interpretation

Poor Sampling :
Misinterpretation:

5. Fostering Ideas And Problem Solving 6. Marketing Plan

Price Discrimination
Degrees of Price Discrimination: First Degree Discrimination: Seller charges diff price to same buyer for each unit bought. Second Degree Discrimination: Seller charges diff prices for block of units instead of individual units. Third Degree Discrimination: Segregation , Elasticity prevails.

Conditions for price Discrimination:

Multiple Elasticity: Market Segmentation: Market sealing:

Objectives of Price Discrimination:

To dispose of occasional surplus: To develop a new market: To earn monopoly Profits: To enter into or retail export markets: To raise future sales:

Monopoly V/S Price Discrimination

Monopoly: Same Price to Buyers . Monopolistic Decision. Under utilization of Price discrimination: Different Prices to Diff

resources.

Buyers . Buyers are charged acc to their ability to pay . Better utilization of capacity.

Pricing Policies:
Introduction:
Consideration for formulation Pricing Policies: Objectives of Business: Competition situation: Product and promotional Activities: Interest of Manufactures and Middlemen:

Objectives of Pricing Policies:

Maximization of profits for entire Product line:
Promotional: Discouraging the entry of new firms. Adaption of Prices: Flexibility:

Kotler additional Objectives: Market Penetration: Market Skimming: Early cash Recovery:

 Role of Cost in Pricing: Demand Factor In pricing : Consumer Psychology & Pricing:

Price as an Indicator of Quality : Ease in measurement: Expenditure of Money : Snob Appeal:

Q u a l i t y

 Reduction In Prices: Offset possible Loses : Expansion : Competition: Technological Development: Increase in Prices:

Pricing Methods:
Cost-plus pricing: Advantages: Easy to calculate Minimal information requirements Easy to administer Disadvantages: It Ignores Demand: Ignores Competition: Ignores opportunity Costs : Ignores Customers:

2.Target rate of return pricing : 3. Value-based pricing: Important concepts: Customers are value conscious rather than price conscious e.g. some customers will pay extra for prompt delivery. Customers assign a personal value to a product or service e.g. a teenager is willing to pay a premium price for a concert performed by his idol. The selling price is based on customers perceived value rather than on the vendors costs.

4. Everyday low price: 5. Marginal Cost Pricing: MC pricing allows flexibility Particularly relevant in transport where fixed costs may be relatively high. 6. Going Rate Pricing: 7. Customary Prices: 8. Sealed Bid Pricing:

Pricing in relation to Established Goods

Meaning:

Pricing below the Market Price: Conditions: Product Mix: Competition: If the existing Brand has gained Popularity ( Incentive Should over weight the Loyalty ) : Benefits :
Popularity (Cross Elasticity): Gradually Increase Price :

Pricing at Market Price :

Goods can be sold at any quantity at Prevailing price: Seller is a Price Taker :

Pricing Above the Market Price : Skimming Pricing

Product Life Cycle

Pricing in Life Cycle of a Product

Introduction or Initial Stage:

Trial Period Growth : Sales Increase due to Advertisements Maturity: Sales Increase at a Lower Rate and Eventually Become Constant Saturation: No Increase or Decrease in Sales Decline : Reasons : Availability of Substitutes. The Loss Of Distinctiveness Of the Product

Pricing a New Product :

Degree of Difficulty:

Pricing Strategies :
Skimming Price Policy : Penetration Pricing Policy :

Skimming Price Policy :

Reasons : No Substitutes Available: Consumers Want for Distinctiveness of the Product: Cross Elasticity is Very Low: Step By Step Price cut the Product is later available to Lower

Segments : High Price Initially Helps in Recouping the Development Costs :

 Post Skimming Strategy :

Penetration Pricing Strategy :

Reasons: Economies of Scale should be available Market Has to be Large : High Cross Elasticity should Prevail: Easily acceptable :
Choosing Between the 2 Pricing : Rate of the Market Growth : Erosion of Distinctiveness:

 Pricing In Maturity Period:

Pricing in Decline Period :

Profit Planning:
Meaning:

The Profit Planning is used for the following ways:

Evaluating Operations:

Determining the need of additional resources

Planning Purchasing Requirements: Anticipating any additional Financing needs

Advantages of Profit Planning :

Performance Evaluation: Awareness of Responsibilities: Cost Consciousness: Disciplined approach to problem solving: Thinking about the future: Financial Planning :

Limitation of Profit Planning :

Responsibilities :

Forecasted Figures :
Monitoring:

Capital Budgeting :
Meaning:
Capital Budgeting Tools Payback Period Accounting Rate of Return Net Present Value

 Payback Period:
Payback Reciprocal Rate :

Reciprocal of payback period = [1/payback period] x 100

Accounting rate of return :

ARR =

Avg Net Income _________________________ Avg Investment Net Present Value:

Cost of capital:

Cost of capital
Meaning :
Importance of Cost of Capital :
Capital Budgeting Decision:

Designing the Corporate Financial Structure:

Deciding about the Method of Financing: Performance of Top Management:

Other Areas:

Importance of capital budgeting Strategic direction Long term decision and effects last long Time It might have serious financial Consequences

Steps for capital budgeting process:

Step 1:
Identification involved in capital budgeting proposals:

Step 2 : Screening the proposal: Step 3 : Evaluation of various proposals:

Step 4: Fixing the priorities Financially :

Step 5 : Analyze alternatives ad identify Feasibility :

Step 6 : Choose the Project to be undertaken : Step 7 : Monitor Project with the rest of Org: Step 8 : Carry out post completion Audit :