UNIT I

Origin of Economics
Economics is originated from a Greek term ‘Oikonomikos’ which means ‘house management’,
economics explains how different individuals behave while managing their economic activities.

Introduction
Human wants are unlimited. As the social conditions improve, human beings not only satisfy the
basic needs but also raise their standard of living. Man continuously tries to make his life
comfortable. It is in this background a new want crops up when one wanted is satisfied. But, the
means or resources to satisfy the wants are limited. Economics describes how the consumers,
producers, and the government in other words, the economic agents try to satisfy the unlimited
wants with the Limited means which have alternative uses. The behavior of economic agents in the
process of using limited resources to satisfy unlimited wants is studied by economics. Economic
agents undertake various economic activities to earn the required income in order to satisfy their
wants. When I want arises, it is satisfied by making an efforts. As soon as one want is satisfied
another want arises. Effort is made again to satisfy this want. So the process of wants efforts
satisfaction continuous.

Economic problem
From the point of view of individuals or the point of the economy, the resources viz., land labour
capital and enterprise, are always limited and have alternative uses. If more of a factor is devoted for
one use, less of it is available for the other use. Individual are required to satisfy their unlimited
needs with their limited means. The economy requires the resources for management of various
economic activities. The individuals and the economic system may find that the available resources
are not sufficient to meet all the requirements. The economic problem arises because the unlimited
ends are to be satisfied with the limited means. It is noted that not only the resources are limited
but also they have alternative uses. The individuals firms and governments are required to list their
needs according to their importance and urgency in order to allocate the scares resources optimally.
This is a problem of choice. scarcity of resources is the basic economic problem economic problem is
concerned with economizing scarce resources. They would not have been an economic problem if
resources were not scarce.

Introduction to managerial economics (meaning and definitions)

Man is a bundle of desires. To satisfy these desires, goods and services are to be produced. Thus
production is the starting point of all economic activity, which is undertaken by individuals or firms
or business units. These producers have to use the resources like land, labour, capital and
organization which are limited in supply. As these agents of production can be employed in
alternative ways, a firm or a business unit is faced with the problem of choice or selection among
several alternatives. Economics is a science of choice.

Thus decision making is an important aspects of every business unit right from the point of
production till the commodity is marketed. keeping in view the social, political, economic and legal
framework in which the production unit operates, decisions have to be taken at different levels of
economic activities like production, consumption, marketing etc.

The success in business depends upon the right decisions by the production units. Hence these
decisions have to be taken after careful analysis and understanding of alternative courses of action.
Business management emphasis making rational choices to yield maximum benefits in accordance
with the varied goals of business units or firms. For such decision making a professional managerial
economist has to integrate concepts and methods from different disciplines like economic theory,
statistics, mathematics etc. economics provides a number of sophisticated concepts and analytical
tools in the art of rational decision making. Managerial Economics is concerned with analytical tools
that are useful in decision making by various business units or forms. It deals with how decisions
should be made by managers to achieve the goals of the forms. It seeks to understand and analyses
the problems of business decisions making within the broad framework of economic and non-
economic environment which the firm operates.

Business Economics is also called managerial economics these days according to MC Nair and
Meriam, “Managerial Economics deals with the use of economic modes of thought to analyse
business situation”. In other words Business Economics is applied branch of economics which
analyse business situations. Economics has developed some well-known 'principles' or 'modes of
thought' these principles are utilized to solve business problems of an economic nature. In business,
a management executive has the prime function of a business executive in decision making and
forward planning.

a) Decision making means the process of choosing one action from two or more alternative
available to the business executive.
b) Forward planning means establishing plans for the future. These plans relate to the future
programme of action by the business units the problem of choice arises because resources
at the disposal of a business units (land, labour, capital and managerial capacity) are limited
and the firm has to make the most profitable use of these resources. The decision-making
function is that of the business executive. Hi-Tech decisions which will ensure the most
efficient means of attaining a desired objective, say profit maximization. After taking the
decision about the particular goal and the targets to be achieved over a period of time,
plants regarding output, pricing, capital, raw materials and power etc. are prepared.
Forward planning and decision making thus go on at the same time.

A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict accurately the future course of business conditions and the
most, a business executive can make an intelligent guess of likely conditions in the future. Is
knowledge of the future where perfect, plants could be formulated without error? They would
not arise any need for subsequent revision of the plans after their formulation. A business
manager has therefore to contend with some uncertainty attaching to his plans about sales, cost
capital conditions and profit. He prepares the best possible plans for the future depending on
past experience and future Outlook and yet he has to go on revising his plans in the light of new
 experience. The business manager has to continuously take decisions about his outputs and
sales in order to adjust the uncertainty of the future as it unfolds to him. Business Economics is
the discipline which helps a business manager in decision-making for achieving the desired
results.

Therefore Spencer and Siegel man have defined Managerial Economics as “the integration of
economic theory with business practice for the purpose of facilitating decision making and
forward planning by management".

We can define business economics as a discipline which deals with the application of economic
theory to business management.

1. Managerial Economics is a combination of management and economics.

2. In management skills we use economic tools and ultimately take with business decisions.

3. Managerial Economics is a process of decision making with the help of economic theory/ tools.

Objectives of managerial economics

1. It helps in profit maximization.

2. It helps to analyse the business situation with the help of economic tools.

3. It facilitates the demand analysis and demand forecasting.

4. It helps to take decisions for the effective utilization of resources.

Nature of managerial economics.

1. Managerial Economics is a science- Economics is regarded as social science because it uses
scientific methods (principles) to build theories that can help to explain the behavior of individuals
groups and organization. It establishes relationship between cause and effect by collecting,
classifying and analyzing the facts on the basis of certain principles. Managerial Economics is a
science of making decisions with regard to scare resources with alternative applications. It is a body
of knowledge that it remains observe the internal and external environment for decision making.

2. Managerial Economics is an art- An art is the practical application of knowledge for achieving
particular goals (creativity and skill is required) science gives us principles of any discipline however
arts turns all those principles into reality. (Rigorous practice is required for any field to call it as an
art)

3. Managerial economics as microeconomics- managerial economics applies microeconomic theory

and techniques to management decisions. Microeconomics studies the actions of individual
consumers and firms. In managerial economics manages generally deal with the problems related to
a particular organization instead of the whole economy.

4. Managerial economics as normative science- it is concerned with" what management should do"
under particular circumstances. It determines the goals of the enterprise then it develops the ways
to achieve these goals.
Scope of managerial economics
1. Demand analysis and forecasting- A Business form is an economic unit which transforms
productive resources into saleable goods. Since all output is meant to be sold, accurate estimates of
demand help a firm in minimizing its costs cost of production and storage. A firm must decide its
total output before preparing its production schedule and deciding on the resources to be
employed. Demand forecast can also serve as a guide to the management for maintaining its market
share in competition with its rivals, thereby securing its profits. Demand analysis also facilitates the
identification of the various factors affecting the demand for a firm's product which help the firm in
manipulating the demand for its output. In fact, demand forecasts are the starting point for a firm's
planning and decision making.

2. Cost and production analysis- A firm's profitability depends much on its costs of production. A
wise manager would prepare cost estimates of a range of output, identify the factors causing
variations in costs and choose the cost- minimizing output level, taking also into consideration the
degree of uncertainty in production and cost calculations. Production processes are under the
charge of engineers but the business manager is supposed to carry out the production function
analysis in order to avoid wastages of materials and time. Sound pricing practices depend much on
cost control.

3. Pricing decisions, policies and practices- pricing of the firm's products is a very important task
before a business manager. Since of firm’s income and profit depend crucially on the price decision,
the pricing practices, policies and decisions are to be taken after careful analysis of the nature of the
market in which the firm operates.

4. Profit management- Business firms generally organized for earning profit and in the long period, it
is profit which provides the chief measure of success of a firm. Economics tells us that profits are the
reward for uncertainty bearing and risk-taking. A successful business manager is one who can form
more or less correct estimates of costs and revenues likely to accrue to the firm at different levels of
output. The most successful manager is reducing uncertainty, the higher the profits earned by him.
In fact profit planning and profit measurement constitutes the most challenging area of Business
Economics.

5. Capital management- the most challenging problem for a business manager is of planning capital
investment. Investments in plant and machinery, buildings are relatively large. Therefore capital
management requires top-level decisions. Capital management implies planning and control of
capital expenditure.

Fundamental concepts/principles of managerial economics

Managerial Economics offers the number of concepts and analytical tools which can be used by
business organization in decision making.

1. Scarcity principle- Economic Analysis begins with the existence of human wants. Human wants
are unlimited and resources to satisfy them are limited. Wants are always unlimited in numbers but
resources available with the firm are limited therefore management is supposed to go for optimum
utilization of resources. Anytime, if demand of a particular product/ goods or services exceeds the
supply (Availability) then there is a scarcity for that product.

2. Marginalism- when there is a change in even one unit of output, then the total value is changed.
This change should be in the form of increase or decrease.
Marginalism is a theory of economics that attempts to explain the discrepancy in the value of goods
and services by reference to their secondary, or marginal, utility. The reason why the price of
diamonds is higher than that of water, for example, owes to the greater additional satisfaction of the
diamonds over the water. Thus, while the water has greater total utility, the diamond has
greater marginal utility.

3. Equi-marginalism - it states that input should be allocated that the value added by the last units is
same in all cases. The principle is also known as the principle of maximum satisfaction by allocating
available resources to get optimum benefit.

The law explained as to how a consumer distributes his limited income among various commodities.
He will spend his income in such a way that the last rupee spent on each of the Commodity gives him
the same marginal utility.

Suppose there are different commodities like A, B……N

A consumer will get the maximum satisfaction in the case of equilibrium i.e.

MUA / PA = MUB / PB = … = MUN / PN

Where MU’s are the marginal utilities for the commodities and P’s are the prices of the
commodities.

4. Opportunity cost principle - Opportunity costs represent the potential benefits an individual,
investor, or business misses out on when choosing one alternative over another. The idea of
opportunity costs is a major concept in economics.

Because by definition they are unseen, opportunity costs can be easily overlooked if one is not
careful. Understanding the potential missed opportunities foregone by choosing one investment
over another allows for better decision-making.

While financial reports do not show opportunity costs, business owners often use the concept to
make educated decisions when they have multiple options before them. Bottlenecks, for instance,
are often a result of opportunity costs.

Opportunity cost is the forgone benefit that would have been derived by an option not chosen.

To properly evaluate opportunity costs, the costs and benefits of every option available must be
considered and weighed against the others.

Considering the value of opportunity costs can guide individuals and organizations to more
profitable decision-making.

Opportunity Cost Formula

Opportunity Cost= FO-CO

WHERE, FO= Return on best foregone option and CO= Return on chosen option

5.DiscountingPrinciple- -
According to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible. Discounting can be defined as a process used to transform future
dollars into an equivalent.
 One of the fundamental ideas in economics is that a dollar tomorrow is worth less than a
dollar today. This seems similar to the saying that a bird in hand is worth two in the bush. A
simple example would make this point clear. Suppose a person is offered a choice to make
between a gift of 100$ today or 100$ next year. Naturally he will choose the 100$ today.

This is true for two reasons. First, the future is uncertain and there may be uncertainty in
getting 100$ if the present opportunity is not availed of. Secondly, even if he is sure to
receive the gift in future, today’s 100$ can be invested so as to earn interest, say, at 8
percent so that. One year after the 100$ of today will become 108$ whereas if he does not
accept 100$ today, he will get 100$ only in the next year. Naturally, he would prefer the first
alternative because he is likely to gain by 8$ in future. Another way of saying the same thing
is that the value of 100$ after one year is not equal to the value of 100$ of today but less
than that. To find out how much money today is equal to 100$ would earn if one decides to
invest the money. Suppose the rate of interest is 8 percent. Then we shall have to discount
100$ at 8 per cent in order to ascertain how much money today will become 100$ one year
after.
The formula is:

PV = 100/ (1+i)

Where,

 PV = Present Value
 i = Rate of Interest.

Now, applying the formula, we get PV = 92.59$

If we multiply 92.59$ by 1.08, we shall get the amount of money, which will accumulate at 8
per cent after one year.

The same reasoning applies to longer periods. A sum of 100$ two years from now is worth:

PV= 100/ (1+i) ²

 Similarly, we can also check by computing how much the cumulative interest will be after
two years.
 Therefore, for making a decision in regard to any investment which will yield a return over a
period of time, it is advisable to find out its ‘net present worth’. Unless these returns are
discounted and the present value of returns calculated, it is not possible to judge whether or
not the cost of undertaking the investment today is worth.
 The principle involved in the above discussion is called the discounting principle and is
stated as follows: “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.”
 The concept of discounting is found most useful in managerial economics in decision
problems pertaining to investment planning or capital budgeting.

6. Time Perspective Principle

 The time perspective principle states that a manager should consider both short run & long
run while taking decisions. Economists related to short run as the current period whereas long
run as a future period. Some inputs of production are regarded as fixed in that short run and it
is a time period where the existing producers respond to price changes by using more or may
be less of their variable inputs. From the standpoint of consumers the short run is a period in
which they respond to price changes with the prevalent tastes & preferences.
 Long run is a time period known in which new sellers may enter a market or a seller already
existing may leave. This time period is sufficient for both old & new sellers to vary all their
factors of production. From the standpoint of consumers" long run provides enough time to
respond to price changes by actually changing their tastes & preferences or their alternative
goods and services.
 Some companies provide a good free of cost, with a popular brand, in the current period with
an eye on the future profits. Promos have traditionally been used to gain market share. HLL,
for instance has done- promos of Fair & Lovely on Lux soaps as the company is of the view
that a large proportion of population does not use F&L in the current period. The promos
have been done to create and maintain demand for the product in future.

7. Risks and Uncertainty - Risk taking as a function of the entrepreneur. the work of the
entrepreneur involves many risks like risk of marketability of the product, risk of competition
from substitutes etc., as future conditions cannot be precisely predicted there is always some
risk and uncertainty in decision making. A firm operates along with other firms in the
industry. The actions and reactions of other competing firms are uncertain. Even the
consumer’s demand for the product is uncertain as their tastes, choices, fashions etc. may
change from time to time profits may be Commensurate with risk and uncertainty. Higher
the risk and uncertainty, higher may be the expected rate of profit, but very often we find that
high risks in certain businesses may not necessarily get high profits. Sometimes there may
not be much profit. The amount of profit or loss are quite uncertain and cannot be estimated
with any precision. Generally it is assumed that firms have perfect knowledge of cost and
demand relationship. But they have to take the factors of risk and uncertainty before taking
decisions.

8. Profits -Profit maximization is one of the most common goal of any organization/firm.
The management has to formulate policies so as to accomplish the objectives of profit
maximization. Profit has several meanings in economics. At its most basic level, profit is the
reward gained by risk taking entrepreneurs when the revenue earned from selling a given
amount of output exceeds the total costs of producing that output. This simple statement is
often expressed as the profit identity, which states that:

Total Profit = Total Revenue (TR) - Total Cost (TC)

Profit, in business usage, the excess of total revenue over total cost during a specific period of
time

9. Case Study Method - A case is usually a "description of an actual situation, commonly

involving a decision, a challenge, an opportunity, a problem or an issue faced by a person or
persons in an organization." In learning with case studies, the student must deal with the
situation described in the case, in the role of the manager or decision maker facing the
situation.

An important point to be emphasized here is that a case is not a problem. A problem usually
has a unique, correct solution. On the other hand, a decision-maker faced with the situation
described in a case can choose between several alternative courses of action, and each of
these alternatives may plausibly be supported by logical argument. To put it simply, there is
no unique, correct answer in the case study method.

The case study method usually involves three stages: individual preparation, small group
discussion, and large group or class discussion. While both the instructor and the student start
with the same information, their roles are clearly different in each of these stages, as shown in
Table 1.

Case studies are usually discussed in class, in a large group. However, sometimes, instructors
may require individuals or groups of students to provide a written analysis of a case study, or
make an oral presentation on the case study in the classroom.