Introduction to

Managerial Economics
-Chapter 1
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Managerial Economics
• Management decisions need to be made in any organization—be it a firm, a not-for-profit
organization (such as a hospital or a university), or a government agency—when it seeks
to achieve some goal or objective subject to some constraints.
• For example, a firm may seek to maximize profits subject to limitations on the availability
of essential inputs and in the face of legal constraints.
• A hospital may seek to treat as many patients as possible at an “adequate” medical
standard with its limited physical resources (physicians, technicians, nurses, equipment,
beds) and budget.
• The goal of a state university may be to provide an adequate education to as many
students as possible, subject to the physical and financial constraints it faces.
• Similarly, a government agency may seek to provide a particular service (which cannot be
provided as efficiently by business firms) to as many people as possible at the lowest
possible cost.
• In all these cases, the organization faces management decision problems as it seeks to
achieve its goal or objective, subject to the constraints it faces.
• The goals and constraints may differ from case to case, but the basic decision-making
process is the same.
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Concept of Economics
• Economy and Economics are two different things/terms
• Economy is the system of production, distribution & consumption of
goods & services that a society uses to tackle the problem of scarcity
(unlimited wants and limited recourses) of resources
• Economics refers to the conditions under which goods are produced
in a society and the way the people are gainfully employed.
• When we are producing goods and services , it will create
employment, it will lead to income, it will lead to the growth of the
economic

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Three Economic Questions?
• What to produce?
• How to produce?
• For whom to produce?

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Basic concepts of ME
• https://youtu.be/DQq-zJPSf4U

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Circular flow of Economic Activity

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Introduction of Economics
• Economics is a social science concerned chiefly with the way society
chooses to employ its limited resources which have alternative uses,
to produce goods and services for present and future consumption
• Embedded in the definition are three key words:
• Social sciences
• Limited Recourses
• Alternative uses

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Scope of Managerial Economics

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Scope of ME
Tools and tech of ME are used to
• Production
• Reduction & control of cost
• Determining price of item
• Capital and investment decisions
• Profit planning management

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Nature of Managerial Economics

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Production Possibility curve/Transformation
curve
• DEFINITION
• A production possibilities curve in economics measures the
maximum output of two goods using a fixed amount of input. The
input is any combination of the four factors of production: natural
resources (including land), labor, capital goods, and entrepreneurship.
• In business, a production possibility curve (PPC) is made to evaluate
the performance of a manufacturing system when two commodities
are manufactured together. The management utilises this graph to
plan the perfect proportion of goods to produce in order to reduce
the wastage and costs while maximising profits.

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EXAMPLE

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Module 1: Introduction to Managerial Economics 22
Example

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• Key Takeaways
• The production possibilities curve shows the possible combinations of
production volume for two goods using fixed resources.
• The assumption is that production of one commodity decreases if
that of the other one increases.
• Production points inside the curve show that an economy is not
producing at its comparative advantage, and production outside the
curve is not possible.
• The production possibilities curve displays the right proportional mix
of goods to be produced.

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Discovery of Economics
• Many Indians like to think of Kautilya ’s Arthashastra to be the first book of
economics, written in 3rd century BC.
• However, Kautilya wrote about statecraft and political science, which touch upon
economic affairs as a matter of a king’s duty rather than a study of economic
issues.
• The modern-day understanding of economics began when Adam Smith, a
philosopher, published his book An Inquiry into the Nature and Causes of the
Wealth of Nations in 1776.
• He invoked a set of questions, contexts, and engrossing discussions that formed
the basis for economic studies thereafter.
• Another significant contributor was David Ricardo who published his book On the
Principles of Political Economy and Taxation in 1817.
• Smith and Ricardo founded an economic philosophy, which eventually came to be
known as the Classical School of Economics.
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 Economics- As a science is concerned with the problem of allocation of scare sources among
competing ends.
• problem confronted by individuals, firms, nation, etc.
• Provide a no. of concepts & analytical tools to understand & analyze such problems.

Managerial Economics :- It is economics applied in decision making .

• serves as link between abstract theory and managerial practice.
• based on the Economics analysis for – identifying problems , organizing
information and evaluating alternatives.
Macro Economics- is concerned with the behaviour of economy as a whole & theory about its
operation.
• Determination of National Income.
• Employment / Prices
• Analysis of aggregate consumption & BOP.

Micro Economics :- deals with theory of firm / Industry/ Individuals.

Managerial Economics helped by macro-economics in studying the firm.

Positive Approach :- concern with what is?, was? and will?

Normative Approach :- what ought to be, set standards.

Relationship to Economic Theory
• The organization can solve its management decision problems by the application
of economic theory and the tools of decision science.
• Economic theory refers to microeconomics nd macroeconomics.
• Microeconomics is the study of the economic behavior of individual
decision-making units, such as individual consumers, resource owners, and
business firms, in a free-enterprise system.
• Macroeconomics , on the other hand, is the study of the total or aggregate level
of output, income, employment, consumption, investment, and prices for the
economy viewed as a whole.
• Although the (microeconomic) theory of the firm is the single most important
element in managerial economics, the general macroeconomic conditions of the
economy (such as the level of aggregate demand, rate of inflation, and interest
rates) within which the firm operates are also very important.

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Managerial Economics Characteristics-

• Micro Economics
• Take helps of Macro Economics
• Normative Approach
• Based on “Theory Of Firm” – helps in Analyses of profit , leading to theory of Distribution.

Significance of Managerial Economics :-

• Provides tools and techniques in order to choose and eliminate the alternatives available.
• Concepts provided helps in evaluating – Cost , Price, Distribution , Profit
Managerial Economist :-

• Production scheduling
• Demand estimation & forecasting
• Preparation of Business/ sales forecast.
• Market research and survey.
• Analysis of the issues and problems
• Planning new investments.
• Discovering new and possible fields of business
• Evaluation of Capital Budgeting
• Evaluating Business Environment –domestic and global.
CONCEPTS :-

Incremental Reasoning :- It involves the estimation of the impact of decision alternatives.

• Incremental cost
• Incremental Revenue.

Incremental Rev > Incremental Cost

Opportunity Cost :- O.C of a decision is the sacrifice of alternative reqd. by

that decision.

Contribution :- It takes help from both the Principle of –

Incremental Reasoning
Opportunity Cost.
It tells about the contribution of a unit of output to overheads & Profit.
CONCEPTS :-

Helps in :-
• Determining best product mix when allocation of scare resources.
• To accept fresh order or not.
• To increase production or not.
• To introduce a new product
• To shut down / continue production line / existing plant.

Time Perspective :- Economist often mark a distinction between short and long run.
• Short Run – means that period within which some of the inputs ( called fixed inputs ) cannot be altered ;

• Long Run - All factors are variables

Entrepreneur has no. of alternatives .
Also called planning curve.
Guide in future expansion of output.
Feasibility to adjust to most suitable plant size.
CONCEPTS :-

Risk and Uncertainness :- Firm should have perfect knowledge about cost and demand relationship
and its environment.
-Uncertainness influence the profit of firm.
-Decision is taken considering the future risk and barriers.
e.g.- action and policies of competitors , govt. policies, national and international policies

Decision depends upon –

• Information, knowledge, computational ability and time on part of Managers.
• Criteria of choosing an action
• Entrepreneur's attitude towards taking risk
THE BASIC PROCESS OF DECISION MAKING

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THE BASIC PROCESS OF DECISION MAKING
• The first step involves defining the problem that the firm or organization
faces.
• For example, in 1979 the Xerox Corporation, which invented the copying
machine in 1959 and had no competition until 1969, found itself unable to
compete with Japanese copiers, which were of better quality and cheaper.
• The second step in the decision-making process is for the firm or
organization to determine the objective of the firm.
• In the case of Xerox, the company had to decide whether to try to meet the
competition or leave the copier market to the Japanese and move on to
develop and produce some other more technologically advanced product.
• Xerox decided to stay in the market by trying to meet the competition
head-on.

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THE BASIC PROCESS OF DECISION MAKING
• The third step is to identify the options or range of possible solutions
to the problem defined in step one in order to achieve the objective
set in step two.
• In the case of Xerox, the range of choices included trying to improve
quality while reducing the costs of production in its American plants,
import from Japan those parts and components that could be
produced better and more cheaply in Japan, or transfer its entire
production of copiers to Fuji Xerox, its Japanese subsidiary.

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THE BASIC PROCESS OF DECISION MAKING
• The fourth step in the decision-making process is for the firm or
organization to select the best possible solution or course of action
among the choices identified in step three.
• In the case of Xerox, this required reorganization and integration of
development and production, and an ambitious companywide
quality-control effort in its domestic plants with the direct
involvement of Fuji Xerox

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THE BASIC PROCESS OF DECISION MAKING
• The fifth and final step is the implementation of the best possible
solution identified in step four.
• To continue with our example, Xerox greatly increased employee
involvement, brought suppliers into the early stages of product
design, greatly reduced inventories and the number suppliers of
suppliers, and used Fuji Xerox to produce in Japan those parts or
components that could of be better supplied from Japan and, more
important, to monitor progress in the companywide be
quality-control program and customer satisfaction.
• By taking these drastic actions, Xerox was quality-able to reverse the
trend toward loss of market share to Japanese competitors

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An Example of Bounded Rationality
• Have you ever invested in share markets? If you are given some money, how would you invest it in stocks?
• An economist would hope that you are rational, i.e., you would want to maximize your returns on stock and you would prefer more return over less.
• Your preference of stocks would be transitive, driven by a spirit to maximize your own gains rather than giving away stock gains to other buyers in
the market.
• You would also be expected to read, understand, and apply all the knowledge you can for selecting the right stocks and constructing an appropriate
portfolio.
• However, an economist would point out another interesting aspect of bounded rationality.
• Suppose you find Stock of ABC Corp. very promising and wish to buy the same.
• Now, you must find someone, who is willing to sell the same.
• However, if you are truly a representative rational consumer, just as everyone else, then everyone else in the market would also want to buy the
same stock instead of selling.
• Does this mean that there would be only buyers or sellers in the market at a given point in time?
• We know that that doesn’t happen.
• What actually happens is that there would be someone, whose understanding or objectives differ from yours and they would be willing to sell the
stock to you.
• In essence, both of you behave perfectly rational yet, differently. In economic parlance, both of you behave like a Homo economicus—
the rational economic being.
• The underlying lesson here is that if we do not have our respective bounded rationalities which differ from each other, we would all want to buy, sell,
or want the same thing at the same time and therefore, there would be no market function at all. It is this bounded rationality that makes the whole
world move.

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Module 1: Introduction to Managerial Economics 42
Choice in ME
• Choice refers to the selection of the best alternative from the
available options.
• In managerial economics, managers have to make choices based on
the limited resources available to them.
• They need to analyze the costs and benefits of each option and select
the one that maximizes profits and minimizes costs

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Significance of Managerial Economics
• Informed Decision-Making
• Profit Maximisation
• Resource Allocation
• Risk Management
• Market Adaptation
• Government Regulations
• Strategic Planning
• International Business
• Continuous Improvement
• Ethical Considerations
• (https://www.jaroeducation.com/blog/nature-and-types-of-managerial-ec
onomics/#:~:text=Managerial%20economics%20guides%20managers%20in
,optimal%20prices%20and%20production%20levels.)
Module 1: Introduction to Managerial Economics 44
Important Topics
• Define Managerial Economics and explain its significance in business
decision-making.
• Briefly discuss the scope of Managerial Economics.
• Explain the concept of scarcity and its relevance in economic
decision-making.
• Define the production possibility curve and its key features.
• Differentiate between microeconomics and macroeconomics.
• Discuss the concept of choice in Managerial Economics.
• Differentiate between positive and normative economics.
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• Discuss characteristics of Managerial Economics
• Analyze the factors that influence managerial decisions in the application of Economics to business.
• Explain the concept of opportunity cost and provide an illustrative example.
• Describe the importance of production possibility curve in understanding economic choices and
trade-offs.
• Discuss the impact of scarcity on business decision-making, providing real-world examples.
• Explain how Managerial Economics addresses the issue of risk and uncertainty in decision-making.
• Compare and contrast short-run and long-run decision-making in Managerial Economics.
• Draw the circular flow of economic activity
(https://keydifferences.com/difference-between-short-run-and-long-run-production-function.html

Module 1: Introduction to Managerial Economics 46

• Elaborate on the methods used in Managerial Economics to analyze business
problems and decision-making.
• Discuss the economic principles of Managerial economics.
• Evaluate the relationship between production possibility curve and efficient
resource allocation in an economy.
• Analyze the impact of government policies on business decisions using Managerial
Economics concepts.
• (https://www.vedantu.com/commerce/how-government-policies-affect-business
es)
• Discuss the limitations of Managerial Economics in providing solutions to business
challenges.
• Elaborate on the concept of elasticity's and their relevance in Managerial
Economics decision-making.
• Elaborate the nature and types of managerial economics
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