571102 ECONOMIC ANALYSIS FOR BUSINESS

FACILITATOR – PRAVEEN KUMAR.T

REFERENCE • MANAGERIAL ECONOMICS

– AUTHOR – GEETIKA , PIYALI GHOSH, PURBA ROY CHOUDRY

– PUBLICATION – TATA MACRAW HILL

• MANAGERIAL ECONOMICS ANALYSIS, PROBLEMS AND CASES

– AUTHOR –P.L.MEHTA

– PUBLICATION- SULTAN CHAND AND SONS

• BUSINESS LINE , ECONOMIC TIMES

• GOOGLE NEWS

• ECONOMIC FORUMS AND BLOGS……

EXPECTATION YOUR SIDE

INTERNAL MARKS

• INTERNAL / MODEL EXAMS- 10 MARKS

• ATTENDANCE

/ CLASS PARTICIPATION - 5 MARKS

• ASSIGNMENTS - 5 MARKS

Economics Is The Art Of Making The Most Of Life

- GB SHAW

WHAT IS ECONOMICS? • Scarcity – a basic human dilemma

– Limited resources vs. unlimited wants

– The human condition requires making choices

• Definitions of Economics

– Mankiw’s definition

• …is the study of how society manages its scarce resources

– Hedrick’s definition

• …is how society chooses to allocate its scarce resources among competing demands to improve human welfare

– Alternative definitions

• … what economists do.

• … is the study of choice.

DEFINITIONS – BY VARIOUS GURUS • The term economics comes from the Greek word

oikos (house) nomos (custom or law)

• Adam smith – father of economics – He saw economic as “ an enquiry into an nature and

causes of the wealth of nations”

• Alfred marshall – Economic s is the study of mankind in the everyday

business of life

• Lionel robins – Economics is the science which studies human

behavior as a relation ship between ends and scarce means which have alternative uses

Debate – Whether Economics Is A Science Or An Art?

BASIC ASSUMPTIONS

• Economic theories are based on certain assumptions.

• The assumptions are nothing but tools in the hands of economists to convert complications to their own advantages and simplicity.

• The basic assumptions are – Ceteris paribus – Latin word(things being equal/

constant) – Rationality(compare the cost and benefits of a

decision before going a head) • Firms aims at maximize profit and minimize cost • Consumer aims at maximizing utility and minimizing

sacrifice

TYPES OF ECONOMIC ANALYSIS

• Micro and macro.

• Positive and normative.

• Short run and long run.

• Partial and general equilibrium.

MICRO AND MACROECONOMICS • MICRO ECONOMICS

– It looks at the smaller picture of the economy.

– It is the study of behavior of smaller economic units such as that an individual consumer, producer/seller or a product.

– It focuses on the basic theory of supply and demand in individual markets.(Example- automobiles, FMCG, Telecommunication etc)

– It deals with the how individual businesses decide how much to produce and what price to sell it and how individual consumer decide how much to buy.

– It analysis the market behavior of individual consumers and firm and their decision making.

….CONTD

• MACRO ECONOMICS

– It is the branch of economics that deals with the study of aggregates.

– Study the industry as a unit and not the firm.

– It talks about aggregate demand and aggregate supply

– It talks about national income, GDP,GNP, inflation, employment etc.

• Micro and macro economics complement each other

POSITIVE AND NORMATIVE

• POSITIVE STATEMENT

– This are factual by nature, whose truth or falsehood can be verified by empirical study or logic.

• NORMATIVE STATEMENTS

– It involve some degree of value judgment and cannot be verified by empirical study or logic

ILLUSTARTION- FOR POSITIVE AND NORMATIVE ECONOMICS

• The distribution of income in India is unequal.

• The distribution of income in India should be equal.

..contd

• POSITIVE ECONOMICS – It establishes relationship between cause and

effect.

– It analysis problems on the basis of facts.

– It describe the probable effect of cause bit it would not provide any guidelines/instruction to avoid those causes.

• NORMATIVE ECONOMICS – It concerned with the questions involving value

judgment.

– It incorporates the value judgments about what the economy should be like.

SHORT RUN AND LONG RUN • Marshall gave the contribution of different period

time in market analysis.

• He defined the periods in market as a market period.

• Short run(less than a year) – It is a time period not enough for consumers and

producers to adjust completely to any new situation.

– In production decisions short run is a period when it may not be possible to change all the inputs.

– In this some input are fixed others are variable.

– Manager has to select different levels of variable input to combine with the fixed input in order to optimize the level of production

…CONTD

• LONG RUN

– It is a time period long enough for consumers and producers to adjust to any situation.

– All inputs can be varied.

– Managerial economist deals with decisions whether to expand capacity , change product lines etc.

– Time period – 5-6 years/ even as high as 20 years

PARTIAL AND GENERAL EQULIBRIUM

• EQUILIBRIUM

– It is a state of balance that occur in a model.

• Partial equilibrium analysis

– It studies the internal outcome of any policy action in a single market only.

– The effects are examined only in the markets which is directly affected not on other markets.

– We refer to partial equilibrium analysis when a single firm or a single consumer is in equilibrium others firms in industry may not be in equilibrium.

….CONTD

• General equilibrium analysis

– It is the branch of economics that seeks to explain economic phenomena like production, consumption and prices in a economy as whole.

– It tries to give an understanding of the whole economy by looking at the macro perspective.

KINDS OF ECONOMIC DECISION • Fundamental Questions of Economics - Scarcity

requires all societies to answer the following questions:

– What is to be produced?(consumer goods/capital goods)

– How is to be produced? (efficiency)

– For whom will it be produced? • Market economy

• Command economy

– Are resources used economically?

– Are resources fully employed?

– Is the economic growing

WHFM Questions

MANAGERIAL ECONOMICS-MEANING

“Managerial economics is a means to an end to managers in any business in terms of finding the most efficient way of allocating scarce organizational resources and reaching stated objectives.”

DEFINITION- MANAGERIAL ECONOMICS

• BY SALVATORE

– Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organization can achieve its objectives most effectively.

• BY DOUGLAS

– Managerial economics is the application of economic principles and methodologies to the decision making process with in the firm or organization.

MANAGERIAL ECONOMICS- MICRO VS MACRO

• Managerial economics is applied micro economics to a significant extent though it draws extensively from macroeconomics theory.

– Example : it draws demand analysis, cost and production analysis, pricing and output decision from micro economics. Where it also derives market intelligence knowledge from GDP,GNP, INFLATION etc.

MANAGERIAL ECONOMICS- NORMATIVE BIAS

• Managerial economics has a normative bias stating what firms should do. In order to reach certain objectives.

• Economic issues confronting managers would often involve value judgments.

• In managerial situations one has to take decisions which will affect organizations future therefore managers cannot be simply content with being factual

MANAGERIAL ECONOMICS – PARTIAL EQUILIBRIUM

• Managerial economics deals with partial equilibrium analysis with focus on equilibrium of a firm or an industry, not the economy.

• Decision making of managers would relate to the equilibrium of particular firm.

ECONOMIC PRINCIPLES TO MANAGERIAL DECISIONS

• The key economic concepts and principles that constitute the broad framework of managerial economics are – Concept of scarcity

– Concept of opportunity cost

– PPF – production possibilities curves

– Concept of margin or increment

– Discounting principle

• According to the above economic principles the decision are taken by managers in their operating environment.

Concept of scarcity

• The starting point of any economic analysis is the existence of human wants(unlimited).

• All desirable things(resources) are short in supply compare to our needs(demand).The decision should made to optimally utilize them.

RESOURCES DEMAND FOR

RESOURCES

…contd

• So the economic problems lies in making the best possible use of resources.

• In order to get maximum satisfaction (consumer point of view) or maximum output (producers point of view)

Concept of opportunity cost

• The managerial economist has to make rational choices in all aspects of business because of scarce resources and unlimited wants.

• Opportunity cost is the benefit from alternative that is not selected.

B C D E F A

Production Possibility Frontiers-PPF/PPC/TRANSFORMATION CURVE

• Show the different combinations of goods and services that can be produced with a given amount of resources.

• It also depicts the trade off between any two items produced /consumed.

• This curve measures the opportunity cost by indicating the opportunity cost of increasing one items production /consumption in terms of units of other.(slope of the curve)

• PPC highlights the significance of scarcity of resources and need to use them judiciously

..CONTD

• The concept of PPC used in both micro and macro economics.

• PPC for individual firm/consumer-micro

• PPC for entire society – macro.

Production Possibility Frontiers-individual

X axis- clothing y axis- food

M

N P

Q

A

Fp

Fq

Cp Cq B

Assumptions and explanation • What ever is earned by individual is spent. • At point P on AB shows

– At given income individual can buy Fp units of food and Cp units of clothing.

• If the individual wants to have any more clothing at same level of income they needs to sacrifice some units of food.

• That bring individual to point Q • Fq < Fp and Cq>Cp • M – not attainable it represents combination of

commodities beyond income. • N- not desirable combination of commodity that

would not maximally utilize the individuals income.

Production Possibility Frontiers-society

Capital Goods

Consumer Goods

Yo

Xo

A

B Y1

X1

If it devotes all resources to capital goods it could produce a maximum of Ym.

If it devotes all its resources to consumer goods it could produce a maximum of Xm

Ym

Xm

If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods

If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra Xo – X1 consumer goods is Yo – Y1 capital goods.

Production Possibility Frontiers- society

Capital Goods

Consumer Goods

Yo

Xo

A

.B

C Y1

X1

Production inside the PPF – e.g. point B means the country is not using all its resources

It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards.

…contd

• Assumptions – Factors of production are fixed in supply – Technology remains same

• No ‘ideal’ point on the curve • Any point inside the curve – suggests resources

are not being utilised efficiently • Any point outside the curve – not attainable with

the current level of resources • Useful to demonstrate economic growth and

opportunity cost

CONCEPT OF MARGIN AND INCREMENT

• Marginal analysis is one of the cornerstones of economic theory.

• The concept of marginality deals with a unit increase in cost or revenue or utility.

• Marginal cost – It is the change in total cost /total revenue/total

utility due to unit change in output.

– Marginal cost/marginal revenue/marginal utility is the total cost /total revenue/total utility of the last unit of output.

….contd • Marginal cost express in

– MCn =TCn-TCn-1………. Where n is the number of units of output

– Marginal cost= change in total cost/change in total output(dtc / dq )

How ever in reality variables may not be subject to such unit change as explained above. So for practical purpose we use incremental concept rather than marginal concept

• Incremental concept is applied usually when the changes are not necessarily in terms of a single unit but in bulk.

• In such additional revenue earned as “incremental revenue”

• Example = increase in sales

– Due to promotional activities

DISCOUNTING PRINCIPLE

• Discounting refers to the time value of money.

• The in hand today is more value than a rupee received tomorrow.

• The value of money depreciates with time.

• PVF=1/(1+r)n

PVF= present value of fund

n=period

r=rate of discount.

MANAGERIAL ECONOMICS AND FUNCTIONS OF MANAGEMENT.

PRODUCTION AND OPERATIONS

HUMAN RESOURCE

MARKETING

FINANCE & ACCOUNTING

SYSTEM AND LEGAL APPLICATIONS

MANAGERIAL ECONOMICS

RELATION OF MANAGERIAL ECONOMICS WITH DECISION SCIENCES

• Decision sciences provide the tools and techniques of analysis used in managerial economics.

• The theory of managerial economics largely utilizes the tools of mathematics and econometrics.

• Important aspects of decision sciences that are used in managerial economics include numeric and algebraic analysis , optimization , statically estimation , forecasting and game theory.

• Economic theory

• Theory of firm

• Price theory

• GNP GDP

• Managerial economics

• Quantitative analysis

• All your analysis

• Solution to managerial decision making

HOW DIFFERENT ECONOMICIES SLOVE THEIR ECONOMIC PROBLEMS?

• Economies are classified into three broad categories according to their mode of production , exchange , distribution and the role which government plays in economic activity.

– Capitalist economy.

– Socialist economy.

– Mixed economy.

CAPITALIST ECONOMY

• An economy is called capitalist or a free market economy if it has a following characteristics.

– The right of private property

– Freedom of enterprise

– Freedom to choice by the consumer(consumer sovereignty)

– Profit motive

– Competition

– Inequalities in income.

How capitalist economics solve their problems

• This economy has no central planning authority to decide what , how , and for whom to produce.

– Deciding what to produce

– Deciding how to produce

– Deciding for whom to produce

– Deciding about consumption , saving and investment.

THEORY OF FIRM

• FIRM

– Firm is an entity that draws various types of factors of production in different amounts from the economy and converts them into desirable output through a process with the help of suitable technology.

– There are five factors of production namely land , labor , capital , enterprise and organization.

Form of ownership

Private sector

Individual

proprietorship

collective

partnership cooperative

Public sector

company corporation department

Joint sector

OBJECTIVES OF FIRM

• Profit maximization

• Baumols theory of sales revenue maximization.

• Marris hypothesis of maximization of growth rate.

• williamson’s model of managerial utility function

• Behavioral theories……

How Do Economists Study Human Behavior?

• Economics as a Science – The scientific method

• Observation→Theory→Data→Testing

– Rational Behavior • Weighing benefits and costs and maximizing total net benefits • Marginal vs. Total Thinking

– Economic Theory and Models • Simplification by assumption • Ceteris Paribus – Holding other factors constant • Prediction vs. realism

– Microeconomic versus Macroeconomics

– Bias towards use of natural rather than controlled experiments

– The specialized language of economics (e.g. “He has lots of money.”) • Money – medium of exchange • Wealth – accumulated financial and non-financial assets • Income – the purchasing power earned during a given period

Why do Economists Study Human Behavior?

• Scientists versus policy makers • Positive Economics

– Descriptive - what the world is like. – Objective- value judgments need not be made – Positive statements can theoretically be tested by

appealing to the facts

• Normative Economics – Prescriptive - what the world ought to be like – Subjective – value judgments must be made – Normative statements cannot be tested appealing to facts.

Categories of Basic Principles of Economics

• How do people make decisions?

• How do people interact?

• How does the economy work overall?

How Do People Make Decisions?

• Principle #1 - People face tradeoffs

– Time allocation – an example of tradeoffs

– Efficiency versus equity

– Production Possibilities Frontier

• Principle #2 - The cost of something is what you have to give up to get it

– Opportunity costs are independent of monetary units

• Principle #3 - Rational people think at the margin

– Rational or irrational decision-making

– Marginal benefits and costs versus total benefits and costs

– Weighing marginal costs and benefits leads to maximizing net benefits (total welfare)

– The boxes example

.

• Principle #4 –People respond to incentives

– Reactions to changes in marginal benefits and costs

– Increases (decreases) in marginal benefits mean more (less) of an activity

– Increases (decreases) in marginal costs mean less (more) of an activity

How Do People Interact?

• Principle #5 - Trade can make everybody better off

• Principle #6 - Markets are usually a good way of organizing economic activity – the “failure” of centrally planned economies and the

movement towards markets for the WHFM questions

Markets

– Principles 1-5 combine with markets to turn the pursuit of self-interest into promoting the interests of society

– creativity and productivity are stimulated by the pursuit of self-interest into improving resource allocations

– in some cases markets fail to allocate resources effectively so,

• Principle #7 Governments can sometimes improve interaction that occurs in markets – there are circumstances when market signals fail to

allocate resources efficiently or equitably

– Public Goods, Externalities and Income Distribution

– Some goods or services that people desire will not be produced by markets.

– Some goods or services will either be underproduced (vaccines) or overproduced (pollution) because markets fails to register certain benefits or costs.

– markets may also fail to provide an equitable or fair distribution of resources

– government intervention with its ability to coerce (the opposite of voluntary) can regulate, tax and subsidize to change market outcomes

– efficiency and equity: the pie analogy

– if government intervention always the proper solution?

How Does the Economy Work as a Whole?

• Principle # 8 – A country’s standard of living depends upon its ability to produce goods and services – Materialism – more toys mean more welfare

– wealth: a necessary or sufficient condition for happiness (are rich people happier, children with lots of toys)

• Principle #9 – The general level of prices rises when the government prints and distributes too much money