Business Economics and Financial Analysis

Introduction to Managerial Economics

Presenter’s Name – Mr. N Suresh
Presenter’s ID – IARE10728
Department Name – Master of Business Administration
Lecture Number - 11
Presentation Date – 01.03.2025

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 Course Objectives
I The concepts of business economics and demand analysis helps in
optimal decision making in business environment.
II The functional relationship between Production and factors of
production and able to compute breakeven point to illustrate the
various uses of breakeven analysis.
III The features, merits and demerits of different forms of business
organizations existing in the modern business environment and market
structures.
IV The concept of capital budgeting and allocations of the resources
through capital budgeting methods and compute simple problems for
project management.
V Various accounting concepts and different types of financial ratios for
knowing financial positions of business concern.
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 Course Outcomes
COURSE OUTCOMES: After successful completion of the course,
students should be able to:
CO 1 List the basic concepts of managerial economics and analysis,
measurement of demand and its forecasting to know the current
status of goods and services.
CO 2 Examine to know the current status of goods and services. To
know the economies and diseconomies of scale in manufacturing
sector.
CO 3 Summarize the four basic market models like perfect
competition, monopoly, monopolistic competition, and oligopoly to
know the price and quantity are determined in each model.
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 Course Outcomes
COURSE OUTCOMES: After successful completion of the course,
students should be able to:
CO 4 Compare various types of business organizations and discuss
their implications for resource allocation to strengthen the
market environment.
CO 5 Analyze different project proposals by applying capital budgeting
techniques to interpret the solutions for real time problems in
various business projects.
CO 6 Develop the ability to use a basic accounting system along with
the application of ratios to create (record, classify, and
summarize) the data needed to know the financial position of
the organization.
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 Course Outcomes
At the end of the course, students should be able to
CO Course Outcomes Blooms
Taxonomy
CO 2 Examine to know the current status of goods Remember
and services. To know the economies and
diseconomies of scale in manufacturing
sector.

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In Law of Variable proportions
ASSUMPTIONS : Constant state of Technology: It is assumed that the
state of technology will be constant and with improvements in the
technology, the production will improve.
1. Variable Factor Proportions: This assumes that factors of production
are variable. The law is not valid, if factors of production are fixed.
2. Homogeneous factor units: This assumes that all the units produced
are identical in quality, quantity and price. In other words, the units are
homogeneous in nature.
3. Short Run: This assumes that this law is applicable for those systems
that are operating for a short term, where it is not possible to alter all
factor inputs.

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Production function Table
For Example:-To get a clear picture of the stages of variable proportion, we take the
example of agriculture. Let us assume that keeping land as a fixed factor, the
production of variable factor i.e., labour can be shown with the help of the following
table:

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Stages

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Graphical Representation of Three Stages of Law of Variable
Proportions
 Law of Variable proportions
Stage of production Stage -1 Stage-2 Satge-3

Total product Initially increases an Increases at a Decreases

increasing rate and decreasing rate and
later increases at a becomes maximum
decreasing rate

Average product Increases and reaches Decreases Continues to decrease

maximum

Marginal product Increases and reaches Continues to fall and Becomes negative
a maximum and starts becomes zero
falling
Production in the long-run-Law of returns to scale
In the long run the fixed inputs like machinery, building and other
factors will change along with the variable factors like labour, raw
material etc.
With the equal percentage of increase in input factors various
combinations of returns occur in an organization.
Returns to scale: the change in percentage output resulting from
a percentage change in all the factors of production. They are
increasing, constant and diminishing returns to scale.

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RETURNS TO SCALE TABLE
RETURNS TO SCALE
 STAGES OF RETURNS TO SCALE
Stage I: The total production increased at an increasing rate. We refer to
this as increasing stage
where the total product, marginal product and average production are
increasing.
Stage II: The total production continues to increase but at a diminishing
rate until it reaches the next stage. Marginal product, average product are
declining but are positive. The total production is at the maximum level at
the end of the second stage with a zero marginal product.
Stage III: In this third stage total production declines and marginal
product becomes negative. And the average production also started
decline. Which implies that the change in input factors there is a decline
in the over all production along with the average and marginal
STAGE-1
INCREASING RETURNS TO SCALE
STAGE-2-CONSTANT RETURNS TO SCALE
CONSTANT RETURNS TO SCALE
STAGE-3-DIMINISHING RETURNS TO SCALE
DIMINISHING RETURNS TO SCALE
ISO QUANTS-Production function with two variable inputs

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Assumptions of Isoquants
• There are only two factors of production.
• The two factors can substitute each other up
to certain limit.

• The shape of the isoquants depends upon

the extent of substitutability of the two inputs.
• The technology is given over a period

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ISOQUANT SCHEDULE
Isoquant curve
 Properties of Isoquant
Isoquants are Negatively Sloped : They normally slope from left to right means
they are negatively sloped . The reason is when the quantity of one factor is
reduced , the same level of output can be achieved only when the quantity of other
is increased
Higher Isoquants Represents Larger Output : Higher isoquant is one that is further
from he point of origin. It represents a larger output hat is obtained by using either
same amount of one factor and the greater amount of both the factors
No Two Isoquants Intersect or Touch each other : Isoquant do no intersect or
touch each other because they represent different level of output
Isoquants are convex to the origin : In most production processes the factors of
production have substitutability. Labor can be substituted for capital and ice
versa .however the rate at which one factor is substituted for the other in
production process i.e. marginal rate of technical substitution (MRTS) also tends to
fall
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 Iso cost
• Isocosts refers to that cost curve that represents
the combination of inputs that will cost the producer
the same amount of money.
• In other words, each isocost denotes a particular level
of total cost for a given level of production.
• If the given level of production changes, the
total cost changes and thus the isocost curve moves
upwards and vice versa.

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 The Marginal rate of technical substitution (MRTS)
 MRTS in economics refers to the Marginal Rate of Technical Substitution which is termed as the
slope of isoquant.
 The marginal rate of technical substitution (MRTS) is an economic theory that illustrates the rate at
which one factor must decrease so that the same level of productivity can be maintained when
another factor is increased.
 (or)
 The marginal rate of technical substitution (MRTS) examines the level where one input can be
replaced for another resource with production remaining constant.
 K = Capital.
 L = Labor.
 MP = Marginal products of each input.
 (∆K÷∆L) = Amount of capital that can be reduced when labour is increased (typically by one unit)

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How MRTS Works
 The marginal rate of technical substitution ascertains the amount of cost
which a specific input can be replaced for another resource of production
while maintaining a constant output. Therefore, the marginal rate of
technical substitution explains when a producer is planning to replace one
input of production with the next one.
 The company may choose several combinations of inputs that can be
alternatively substituted to produce the same level of output. The pair of
inputs determined by the management must be able to achieve the best
results.
 For example, when factor A can produce a maximum quantity of output
than factor B with the same cost incurred, the producer may end up
choosing factor A instead of B.

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least cost combination of inputs.

 The cost line or budget line for production is called the

isocost line. The first order conditions state that the
variable factors are combined in an optimal manner
when the ratio of marginal products is equal to the
ratio of factor prices. This optimal combination is called
the least cost combination of inputs.

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 Cobb-Douglas Production function – back ground

During 1900–1947,
Charles Cobb and Paul
Douglas formulated and
tested the Cobb–Douglas
production function
through various statistical
evidence

The Cobb–Douglas functional form of

production functions is widely used to
represent the relationship of an output and
two inputs.
 Cobb-Douglas Production function – Calculation

P(L,K) =BLαKβ
where:
 P = total production (the monetary value of
all goods produced in a year)

 L = labor input (the total number of person-

hours worked in a year)

 K = capital input (the monetary worth of all

machinery, equipment, and buildings)

 B = total factor productivity(efficiency

coefficient)

 α and β are the output elasticity of labor and

capital, respectively. These values are
constants determined by available
technology.
 Cobb-Douglas Production function – Importance
1. It has been used widely in empirical studies of manufacturing
industries and in inter-industry comparisons.

2. It is used to determine the relative shares of labor and capital

in total output.

3. It is used to prove Euler’s Theorem.

4. Its parameters a and b represent elasticity coefficients that

are used for inter-sectrial comparisons.

5. This production function is linear homogeneous of degree

one which shows constant returns to scale, If α + β = 1, there
are increasing returns to scale and if α + β < 1, there are
diminishing returns to scale.

6. Economists have extended this production function to more

than two variables.
What is Economies of scale?
 Economies of scale are the cost
advantages that a business
obtains due to expansion.
 Economies of scale refer to the lowering of
per unit costs as a firm grows bigger.
 When economists are talking about
economies of scale, they are usually
talking about internal economies of scale.
 These are the advantages gained
by an individual firm by
increasing its size i.e having larger or more
plants.
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What is Economies of scale

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What is Economies of scale

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Internal Economies of scale

Types of Internal Economies of Scale:

Technical Economies: Arise from the use of advanced technology and
large-scale machinery.
Example: A car manufacturer like Tesla benefits from robotic assembly
lines, reducing labor costs per unit.
Managerial Economies: Occur when a company hires specialized
managers, leading to better decision-making and efficiency.
Example: A large corporation like Amazon hires specialists in logistics,
reducing costs in supply chain management.

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Internal Economies of scale

Marketing Economies: Large firms can buy raw materials in bulk at

discounted rates and negotiate better advertising deals.
Example: Coca-Cola gets discounts for bulk purchasing of sugar and
global advertising contracts.
Financial Economies: Bigger firms have easier access to loans at
lower interest rates due to their reputation and lower risk profile.
Example: Apple can secure cheaper loans than a small startup due to its
strong credit rating.
Risk-bearing Economies: Large firms can diversify products and
markets, reducing business risks.
Example: Unilever sells multiple products (soaps, food, beverages),
minimizing risk if one product fails.

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Internal Economies of scale

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External Economies of Scale
External economies of scale :-External economies of scale are
achieved due to external factors such as tax reductions,
government subsidies, improves transportation network, etc.
For instance, suppose the government wants to increase steel
production. In order to do so, the government announces that all
steel producers who employ more than 10,000 workers will be given
a 20% tax break resulting from an industry growing in size.
Thus, firms employing less than 10,000 workers can potentially
lower their average cost of production by employing mor
workers.
This is an example of an external economy of scale – one that
affects an entire industry or sector of the economy

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External Economies of Scale
These benefits occur outside a firm but within an industry as the entire
sector grows.
Types of External Economies of Scale:
Infrastructure Economies: Improved roads, ports, and IT services
reduce costs for businesses in an industry.
Example: The Silicon Valley tech industry benefits from a strong IT
infrastructure and skilled workforce.
Supplier Economies: As an industry expands, specialized suppliers
emerge, offering cheaper and better inputs.
Example: The automobile industry benefits from specialized parts
suppliers, reducing manufacturing costs.

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External Economies of Scale

Labor Market Economies: A larger industry attracts a skilled

workforce, reducing hiring and training costs.
Example: Bangalore, India, has a strong IT talent pool, making it cost-
effective for tech companies.
Government Support Economies: Policies such as tax incentives,
subsidies, and research grants help reduce costs.
Example: Renewable energy firms benefit from government subsidies,
lowering their production costs.

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 Diseconomies of scale

Diseconomies of scale occur when a business grows so large that

the costs per unit increase. As output rises, it is not inevitable that unit
costs will fall. Sometimes a business can get too big!
Reasons for dis-economies of scale

Poor communication in a large firm. It can be hard to communicate

ideas and new working practices.
Alienation: Working in a highly specialized assembly line can be very
boring if workers become de-motivated. In a large firm, there is an
increased gap between top and bottom e.g. call centers
Lack of control: when there is a large number of workers it is easier to
escape with not working very hard because it is more difficult for
managers to notice shirking.

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Reasons for dis-economies of scale

Poor communication in a large firm. It can be hard to communicate

ideas and new working practices.
Alienation: Working in a highly specialized assembly line can be very
boring if workers become de-motivated. In a large firm, there is an
increased gap between top and bottom e.g. call centers
Lack of control: when there is a large number of workers it is easier to
escape with not working very hard because it is more difficult for
managers to notice shirking.

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 Cost
 Cost- the amount of expenditure incurred in acquiring something. The
cost denotes the amount of money that a company spends on the
creation or production of goods or services. In business, cost is a
monetary valuation of
• Effort
• Material
• Resources
• Time and utilities consumed
• Risks incurred and
• Opportunity foregone in production and delivery of goods/services.

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Thank You

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