Unit 1 Introduction to Managerial Economics PDF

UNIT 1: INTRODUCTION TO MANAGERIAL ECONOMICS What is Economics? Economics comes from the ancient Greek “oikonomikos” or word “oikonomia” which literally translates to “the task of managing a household.” “An inqu...

UNIT 1: INTRODUCTION TO MANAGERIAL ECONOMICS What is Economics? Economics comes from the ancient Greek “oikonomikos” or word “oikonomia” which literally translates to “the task of managing a household.” “An inquiry into the nature and causes of the wealth of nations” – Adam Smith (1776) “A study of man's actions in the ordinary business of life, it inquires how he gets his income and how he uses it” – Alfred Marshall (1922) “The science which studies human behavior as a relationship between ends and scarce means which have alternative uses” – Lionel Robbins (1935) Economics can, thus be defined as a social science that studies economic behavior of the people, the individuals, households, firms, and the government. Why do people economize? ECONOMIC BEHAVIOUR ECONOMIZING BEHAVIOUR  Endless human wants, desires and aspirations  Scarcity of available resources  Tendency to economize is inherent in human nature Economics studies how people allocate their limited resources to their alternative with the objective of deriving maximum possible gains from the use of their resources What are the Basic or Fundamental Problems faced by an Economy?  What to produce?  How to produce?  For whom to produce?  Are resources used economically?  Are resources fully employed?  Is the economy growing?  Microeconomics & Macroeconomics Microeconomics (“micro” meaning small) looks at the smaller picture of the economy and is the study of the behaviour of small economic units. Microeconomics analyses the market behaviour of individual consumers and firms, in an attempt to understand their decision- making processes. Macroeconomics (“macro” meaning large) is that branch of economic analysis that deals with the study of aggregates. Macroeconomics deals with the economy level and takes into consideration the impact of government policies on the aggregates like national income and employment “…if you read one branch of economics carefully, but ignore the other, you will be half-educated” – Paul Samuelson What is Managerial Economics?  “Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.” Salvatore  “Managerial economics applies economic theory and methods to business and administrative decision making.” Pappas and Hirschey  “We define managerial economics as the integration of economic theory and methodology with analytical tools for applications to decision-making about the allocation of scarce resource in public and private institution.” Seo and Winger Managerial economics is a means to an end to managers in any business, in terms of finding the most efficient way of allocating scarce organisational resources and reaching stated objectives  How Economics contributes to Business Decisions Managerial Decision Areas Choice of business area given the resources Choice of product Determining optimum output Choice of technology- factor combination Acquisition of inputs- labour & capital Determining price of the product Assessing economic environment & business scope Economic Science Quantitative Methods Microeconomics & Macroeconomics: Mathematical tools, Statistical tools, Game Economic principles, theories, concepts & theory, Econometrics tools of analysis Managerial Economics Application of Economic theories & Quantitative methods to find solution to Business problems Consumer Choice : A few basic concepts Effective Demand : Total utility : TUx = U1 + U2 + U3 + U4 Depends on desire to buy, ability to pay and willingness to pay Marginal utility : MUx = TUn – TU(n-1) Utility: Cardinal Utility: Fromproduct angle, Utility is want satisfying property of a Utility is measurable; unit of commodity from product angle measurement is ‘util’ Ordinal Utility: From consumer angle, utility is Utilityis not measurable; can be satisfaction a consumer derives from possession or consumption expressed in ‘less than’ or ‘more than’ form, i.e., ordering or ranking of of a commodity preference is possible Analysis of Consumer Behaviour: Law of Diminishing Marginal Utility The law states “as the quantity consumed of a commodity goes on increasing, the utility derived from each successive unit consumed goes on decreasing, consumption of all other commodities remaining constant” Units of TUx MUx commodity X TU and MU of Commodity X 65 1 30 30 60 60 50 45 2 50 20 30 3 60 10 20 10 4 65 5 5 1 2 3 4 -5 5 6 5 60 -5 -15 6 45 -15 TU MU Assumptions of Law of Diminishing MU The Unit of Consumption must be a Standard One Consumption must be Continuous TheTastes and Preferences of the Consumer should Remain Unchanged during the Course of Consumption The Good should be Normal and Not Addictive in Nature  Analysis of Consumer Behaviour: The Indifference Curve Theory Hicks& Allen developed the ordinal utility theory or the indifference curve theory Based on the concept of ordinal utility, i.e., utility cannot be numerically be measured, but can only be expressed comparatively. Anindifference curve (IC) is the locus of points which show the different combinations of two commodities a consumer is indifferent about. Indifference curve Combinatio No. of No. of ns sandwich glasses of 7 es cold coffee 6 5 Cold coffee A 1 6 4 3 B 3 3 2 1 C 4 2 0 0 1 2 3 4 5 6 7 8 D 7 1 Sandwich Assumption of Indifference Curve Analysis At any given point of time, the consumer has only two goods in his/her consumption basket. Consumer is able to rank his/her preferences on a scale, and not quantify. The consumer is never completely satisfied The consumer is consistent in his choices. The two goods under consideration are perfectly divisible in small units. Properties of Indifference Curve Indifference curve slopes downward to the right Higher Indifference curve represents higher level of utility Indifference curves cannot intersect each other Indifference curves are convex to origin – imperfect substitutability and diminishing marginal rate of substitution (MRS)  Marginal Rate of Substitution (MRS) Marginal rate of substitution is the rate at which one commodity is substituted for the other in order to maintain same level of total utility Combinati No. of No. of Change Change MRSxy on Sandwich glasses of in in =- es (X) cold Commodi Commodi ΔY/ΔX coffee (Y) ty X ty Y A 1 6 - - B 3 3 2 -3 1.5 C 4 2 1 -1 1 D 7 1 3 2 0.3 Why MRS has a negative sign or is diminishing? Exercise 1 Suppose Aditi and Akash each have Rs. 500 at their disposal. Both of them enjoy having ice cream and gulab jamun. However, they differ substantially in their preferences for these two types of desserts. Aditi prefers ice cream to gulab jamun and it’s the vice versa in case of Akash. 1. How will the indifference curves of Aditi and Akash look like? 2. Explain why the two sets of curves are different from each other using MRS principle.  Answer Akash: Aditi: 1. Prefer gulab jamun (X) to ice cream (Y) 1. Prefers ice cream over gulab jamun 2. Sacrificing of one unit of gulab jamun will lead to 2. Sacrificing one unit of gulab jamun will lead to gaining higher no. of ice creams gaining of smaller no. of ice creams 3. Steeper Indifference curve with higher MRS 3. Flatter Indifference curve with smaller MRS value value Special types of Indifference Curves Particula Panel a Panel b Panel c Panel d rs Type of IC Downward Right Concave Upward sloping angled or L sloping straight shaped line Type of Perfect Perfect Both the One good goods substitutes complemen commodities and one ts are of dislike bad Example Drinking A pair of Combination Industrial water shoes of two allergic developme bottle of seafood, e.g., nt and Bislery and crab and pollution Kinley prawn Reference Books: Managerial Economics, 8th ed. By D.N. Dwivedi; Managerial Economics, 3rd ed. By Geetika, Ghosh & Roy Chowdhury