Managerial Economics PDF (BBA Sem 1)

**Faculty of Commerce and Management, SGT University** **Managerial Economics** **BBA - Sem I** **Faculty : Dr. Nitesh Rawat** **Module -- II** **Returns to a factor** **It is a short -run concept. It has three situations namely** 1. 2. 3. **Returns to Scale** Long run production assume...

**Faculty of Commerce and Management, SGT University** **Managerial Economics** **BBA - Sem I** **Faculty : Dr. Nitesh Rawat** **Module -- II** **Returns to a factor** **It is a short -run concept. It has three situations namely** 1. 2. 3. **Returns to Scale** Long run production assumes there are no fixed factors. Long run production - In the long run, **all factors of production are variable** - How the output of a business responds to a change in factor inputs is called **returns to scale** **Numerical example of long run returns to scale** ---------------------------------------------------- --------------------- ------------------ ------------------------ ------------------------ ---------------------- **Units of Capital** **Units of Labour** **Total Output** **% Change in Inputs** **% Change in Output** **Returns to Scale** 20 150 3000 40 300 7500 100 150 Increasing 60 450 12000 50 60 Increasing 80 600 16000 33 33 Constant 100 750 18000 25 13 Decreasing Consider the table above that shows added capital and labour inputs: - When we double the factor inputs from (150L + 20K) to (300L + 40K) the % change in output is 150% - **increasing returns** - When the scale of production is changed from (600L + 80K0 to (750L + 100K) then the percentage change in output (13%) is less than the change in inputs (25%) i.e. **decreasing returns** 1. **Increasing returns** to scale occur when the % change in output \> % change in inputs 2. **Decreasing returns** to scale occur when the % change in output \< % change in inputs 3. **Constant returns** to scale occur when the % change in output = % change in inputs **Law of Variable Proportion** - **Constant State of Technology** - **Fixed Amount of Other Factors** - **Possibility of Varying the Factor proportions:** -- -- -- -- -- -- -- -- -- -- -- -- - An isoquant curve is a concave line plotted on a graph, showing all of the various combinations of two inputs that result in the same amount of output. - Most typically, an isoquant shows combinations of capital and labor and the technological trade-off between the two. [**Expansion Path**](https://theintactone.com/2019/10/19/be-u3-topic-3-expansion-path/) The expansion path is the locus of different points of firm\'s equilibrium when it changes its total outlay to expand output while relative factor prices remain constant. **Isocost Lines** These lines show how we can invest in two different factors to produce maximum profit.  **Producer's Equilibrium** An organization is under equilibrium if there is no increase or decrease in it's profits. This equilibrium bubble is when the company is gaining its maximum profit.   Producer's equilibrium is the output where the producer gets maximized profits. So a producer can reach a producer's equilibrium if his profits are at their highest levels. An organization is in equilibrium if there is no scope for either increasing the profit or reducing its loss by changing the quality of the output. Therefore, we have Profit  = Total Revenue - Total Cost Which is written as  P=  TR -- TC  Hence, the output level at which the total revenue minus the total cost is maximum is the equilibrium level of the output. There are two approaches to arrive at the producer's equilibrium: Total Revenue - Total Cost (TR-TC) Approach, Marginal Revenue - Marginal Cost (MR-MC) Approach **Economies and Diseconomies of Scale** When we talk about the scale of [production](https://www.toppr.com/guides/business-economics/theory-of-production-and-cost/meaning-of-production/) of a firm, we often hear about the fact that large-scale production, usually, helps in reducing the cost of production. Economies of scale refer to these reduced costs per unit arising due to an increase in the total output. Diseconomies of scale, on the other hand, occur when the output increases to such a great extent that the cost per unit starts increasing.  **Internal and External Economies** When a firm opts for large-scale production, the economies arising out of it are grouped into two categories: 1. 2. **Internal Economies and Economies of Scale** While studying returns to scale, we observed that they increase during the initial stages, remain constant for a while, and then start decreasing. The reason is simple -- initially, the firm enjoys internal economies of scale and after a certain limit, it suffers from internal diseconomies of scale. Let's look at the types of economies and diseconomies: **Technical Economies** Large-scale production is linked to technical economies. When a firm increases its scale of operations, it needs to use a more specialized and efficient form of [capital](https://www.toppr.com/guides/business-laws/companies-act-2013/classification-of-capital/) equipment and machinery. Such machinery helps to produce larger outputs at a lower unit cost. **Technical Diseconomies** However, beyond a certain point, the firm experiences diseconomies of scale. This happens because after reaching a large enough output, the firm utilizes almost all possibilities of the division of labour and [employment](https://www.toppr.com/guides/economics/employment/workers-and-employment/) of efficient machinery. **Managerial Economies** As the output increases, the firm can apply the division of labour to the management as well. For example, the production [manager](https://www.toppr.com/guides/business-management-and-entrepreneurship/nature-of-management-and-its-process/tasks-and-responsibilities-of-professional-managers/) can look after production, the sales manager can look after sales, etc. When the scale of production increases further, the firm divides each department into sub-departments like sales is divided into advertising, exports, and service. **Managerial Diseconomies** However, as the firm increases its scale of operations beyond a certain limit, the management finds it difficult to control and coordinate between departments. This leads to managerial diseconomies. **Commercial Economies** As a firm increases its volume of production, it requires large amounts of raw material and components. Hence, it places a bulk order for such material and components and enjoys discounted [pricing](https://www.toppr.com/guides/business-studies/marketing/pricing/) for them. **Commercial Diseconomies** Further, as the scale of production increases, the advertising cost per unit fall. Hence, the firm benefits from economies of [advertising](https://www.toppr.com/guides/civics/understanding-advertising/understanding-advertising/) too. After an optimum level, these economies start becoming diseconomies though. **Financial Economies** When a firm wants to raise finance, a large-scale firm has many benefits like: - - - **Financial Diseconomies** However, after the optimum scale of production, the financial costs rise faster due to the increased dependence on external finances. **Risk Bearing Economies** A firm enjoys the economies of risk-bearing if it has a large-scale operation with diverse and multi-production capabilities. **Risk Bearing Diseconomies** However, if the diversification increases the economic disturbances rather than covering them, then the risk increases. **External Diseconomies and Economies of Scale** External diseconomies and economies of scale are very important to a firm. These are a result of the expansion of output of the entire industry and not limited to an individual firm. They are available to one or more firms in the following forms: **Cheaper Raw materials and Capital Equipment** At times, the expansion of an [industry](https://www.toppr.com/guides/geography/industries/introduction-to-industry/) results in new and cheaper sources of raw material, machinery, and other capital equipment. It also results in an increased demand for the various types of materials and equipment required by the industry. **Technological External Economies** Usually, when an entire industry expands, new technical knowledge is discovered leading to new and improved machinery for the said industry. This changes the technological coefficient of production and enhances the productivity of the firms in the industry. Hence, the cost of production reduces. **Development of Skilled Labour** As the industry expands, the labour gets accustomed to managing various production processes and learns from the experience. This increases the number of skilled workers which in turn has a favourable effect on the levels of productivity. **Growth of Ancillary Industries** When a certain industry expands, many ancillary industries start specializing in the production of raw materials, tools, machinery, etc. These ancillary industries offer the materials/machinery at a low price. **Better Transportation and Marketing Facilities** An expanding industry, usually, results in better transportation and marketing networks. These aspects help reduce the cost of production in the firms from the industry. **TYPES OF COST** **Fixed Costs (FC)** The costs which don't vary with changing output. [[Fixed costs]](https://www.economicshelp.org/blog/glossary/fixed-costs/) might include the cost of building a factory, insurance and legal bills. Even if your output changes or you don't produce anything, your fixed costs stay the same. **Variable Costs (VC)** Costs which depend on the output produced. For example, if you produce more cars, you have to use more raw materials such as metal. This is a [[variable cost]](https://www.economicshelp.org/blog/glossary/variable-costs/). **Semi-Variable Cost.** Labour might be a semi-variable cost. If you produce more cars, you need to employ more workers; this is a variable cost. However, even if you didn't produce any cars, you may still need some workers to look after an empty factory. **Total Costs (TC)  = Fixed + Variable Costs** **Marginal Costs** -- Marginal cost is the cost of producing an extra unit. If the total cost of 3 units is 1550, and the total cost of 4 units is 1900. The marginal cost of the 4th unit is 350. **Opportunity Cost** -- Opportunity cost is the next best alternative foregone. If you invest rs1million in developing a cure for pancreatic cancer, the opportunity cost is that you can't use that money to invest in developing a cure for skin cancer. **Economic Cost**. Economic cost includes both the actual direct costs (accounting costs) plus the opportunity cost. For example, if you take time off work to a training scheme. You may lose a weeks pay of rs350, plus also have to pay the direct cost of 200. Thus the total economic cost = rs550. **Accounting Costs** -- this is the monetary outlay for producing a certain good. Accounting costs will include your variable and fixed costs you have to pay. [**Sunk Costs**](https://www.economicshelp.org/blog/glossary/sunk-costs/). These are costs that have been incurred and cannot be recouped. If you left the industry, you could not reclaim sunk costs. For example, if you spend money on advertising to enter an industry, you can never claim these costs back. If you buy a machine, you might be able to sell if you leave the industry. **Avoidable Costs- **Costs that can be avoided. If you stop producing cars, you don't have to pay for extra raw materials and electricity. Sometimes known as an escapable cost. [**Explicit costs**](https://www.economicshelp.org/microessays/costs/the-difference-between-implicit-and-explicit-costs/) -- these are costs that a firm directly pays for and can be seen on the accounting sheet. Explicit costs can be variable or fixed, just a clear amount. [**Implicit costs**](https://www.economicshelp.org/microessays/costs/the-difference-between-implicit-and-explicit-costs/) -- these are opportunity costs, which do not necessarily appear on its balance sheet but affect the firm. For example, if a firm used its assets, like a printing press to print leaflets for a charity, it means that it loses out on revenue from producing commercial leaflets. - **Social Costs**. This is the total cost to society. It will include the private costs plus also the external cost (cost incurred by a third party). May also be referred to as 'True costs' - **External Costs**. This is the cost imposed on a third party. For example, if you smoke, some people may suffer from passive smoking. That is the external cost. - **Private Costs**. The costs you pay. e.g. the private cost of a packet of milk is Rs.20-25. - **Social Marginal Cost**. The total cost to society of producing one extra unit. Social Marginal Cost (SMC) = Private marginal cost (PMC) + External marginal Cost (XMC) **Shapes of Long-Run Average Cost Curves** While in the short run firms are limited to operating on a single average cost curve (corresponding to the level of fixed costs they have chosen), in the long run when all costs are variable, they can choose to operate on any average cost curve. Thus, the long-run average cost (LRAC) curve is actually based on a group of short-run average cost (SRAC) curves, each of which represents one specific level of fixed costs. More precisely, the long-run average cost curve will be the least expensive average cost curve for any level of output.   **[Figure 7.10](https://openstax.org/books/principles-economics-3e/pages/7-5-costs-in-the-long-run#CNX_Econ_C07_005) **shows how we build the long-run average cost curve from a group of short-run average cost curves. Five short-run-average cost curves appear on the diagram. Each SRAC curve represents a different level of fixed costs. For example, you can imagine SRAC~1~ as a small factory, SRAC~2~ as a medium factory, SRAC~3~ as a large factory, and SRAC~4~ and SRAC~5~ as very large and ultra-large. Although this diagram shows only five SRAC curves, presumably there are an infinite number of other SRAC curves between the ones that we show.