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Notes for Managerial Economics - ME by Tulasi Miriyala

  • Managerial Economics - ME
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UNIT-1 Managerial Economics – Definition: “Managerial economics is concerned with the application of economic concepts and economic analysis to the problems of formulating rational managerial decisions. Nature and Scope of Managerial Economics: The most important function in managerial economics is decision-making. It involves the complete course of selecting the most suitable action from two or more alternatives. The primary function is to make the most profitable use of resources which are limited such as labor, capital, land etc. A manager is very careful while taking decisions as the future is uncertain; he ensures that the best possible plans are made in the most effective manner to achieve the desired objective which is profit maximization.  Economic theory and economic analysis are used to solve the problems of managerial economics.  Economics basically comprises of two main divisions namely Micro economics and Macro economics.  Managerial economics covers both macroeconomics as well as microeconomics, as both are equally important for decision making and business analysis.  Macroeconomics deals with the study of entire economy. It considers all the factors such as government policies, business cycles, national income, etc.  Microeconomics includes the analysis of small individual units of economy such as individual firms, individual industry, or a single individual consumer. All the economic theories, tools, and concepts are covered under the scope of managerial economics to analyze the business environment. The scope of managerial economics is a continual process, as it is a developing science. Demand analysis and forecasting, profit management, and capital management are also considered under the scope of managerial economics.

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Demand Analysis and Forecasting: Demand analysis and forecasting involves huge amount of decision-making! Demand estimation is an integral part of decision making, an assessment of future sales helps in strengthening the market position and maximizing profit. In managerial economics, demand analysis and forecasting holds a very important place. Profit Management: Success of a firm depends on its primary measure and that is profit. Firms are operated to earn long term profit which is generally the reward for risk taking. Appropriate planning and measuring profit is the most important and challenging area of managerial economics. Capital Management: Capital management involves planning and controlling of expenses. There are many problems related to capital investments which involve considerable amount of time and labor. Cost of capital and rate of return are important factors of capital management. Demand for Managerial Economics: The demand for this subject has increased post liberalization and globalization period primarily because of increasing use of economic logic, concepts, tools and theories in the decision making process of large multinationals. Objectives of firm: 1. Profit Satisficing: In many firms there is separation of ownership and control. Those who own the company (shareholders) often do not get involved in the day to day running of the company. A. This is a problem because although the owners may want to maximise profits, the managers have much less incentive to maximise profits because they do not get the same rewards, (share dividends). B. Therefore managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives, such as enjoying work, getting on with other workers. (e.g. not sacking them) This is the problem of separation between owners and managers. C.This ‘principal agent’ problem can be overcome, to some extent, by giving mangers share options and performance related pay although in some industries it is difficult to measure performance. 2. Sales maximization: Firms often seek to increase their market share – even if it means less profit. This could occur for various reasons: A. Increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run. B. Managers prefer to work for bigger companies as it leads to greater prestige and higher salaries. C. Increasing market share may force rivals out of business. E.g. supermarkets have lead to the demise of many local shops. Some firms may actually engage in predatory pricing which involves making a loss to force a rival out of business. 3. Growth maximization: This is similar to sales maximisation and may involve mergers and takeovers. With this objective, the firm may be willing to make lower levels of profit in order to increase in size and gain more market share.

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4. Long run; profit maximization: In some cases, firms may sacrifice profits in the short term to increase profits in the long run. For example, by investing heavily in new capacity, firms may make a loss in the short run, but enable higher profits in the future. 5. Social / environmental concerns: A firm may incur extra expense to choose products which don’t harm the environment or products not tested on animals. Alternatively, firms may be concerned about local community / charitable concerns. 6. Co-operatives: Co-operatives may have completely different objectives to a typical PLC. A co-operative is run to maximise the welfare of all stakeholders – especially workers. Any profit the co-operative makes will be shared amongst all members. Diagram showing different objectives of firms Management Theories: Management theories are implemented to help increase organizational productivity and service quality. Not many managers use a singular theory or concept when implementing strategies in the workplace. Theory X and Theory Y The management theory an individual chooses to utilize is strongly influenced by beliefs about worker attitudes. Managers who believe workers naturally lack ambition and need incentives to increase productivity lean toward the Theory X management style. Theory Y believes that workers are naturally driven and take responsibility. While managers who believe in Theory X values often use an authoritarian style of leadership, Theory Y leaders encourage participation from workers.

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Profit Maximization. Vs. Wealth Maximization: Definition of Profit Maximization Profit Maximization is the capability of the firm in producing maximum output with the limited input, or it uses minimum input for producing stated output. It is termed as the foremost objective of the company. Definition of Wealth Maximization Wealth maximization is the ability of a company to increase the market value of its common stock over time. The market value of the firm is based on many factors like their goodwill, sales, services, quality of products, etc.

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