48019784 Managerial Economics Notes

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MANAGERIAL ECONOMICS Managerial economics (sometimes referred to as business eco nomics) is a branch of economics that appliesmicroeconomic analysis to decision methods of businesses or other management units. As such, it bridges economic th eory and economics in practice. It draws heavily from quantitative techniques su ch as regression analysis andcorrelation, Lagrangian calculus (linear). If there is a unifying theme that runs through most of managerial economics it is the at tempt to optimiz
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  MANAGERIALECONOMICSManagerialeconomics(sometimesreferredtoasbusinesseconomics)isabranchofeconomicsthatappliesmicroeconomicanalysistodecisionmethodsofbusinessesorothermanagementunits.Assuch,itbridgeseconomictheoryandeconomicsinpractice.Itdrawsheavilyfromquantitativetechniquessuchasregressionanalysisandcorrelation,Lagrangiancalculus(linear).Ifthereisaunifyingthemethatrunsthroughmostofmanagerialeconomicsitistheattempttooptimizebusinessdecisionsgiventhefirm'sobjectivesandgivenconstraintsimposedbyscarcity,forexamplethroughtheuseofoperationsresearchandprogramming.Almostanybusinessdecisioncanbeanalyzedwithmanagerialeconomicstechniques,butitismostcommonlyappliedto:Riskanalysis-variousmodelsareusedtoquantifyriskandasymmetricinformationandtoemploythemindecisionrulestomanagerisk.  Productionanalysis-microeconomictechniquesareusedtoanalyzeproductionefficiency,optimumfactorallocation,costs,economiesofscaleandtoestimatethefirm'scostfunction.  Pricinganalysis-microeconomictechniquesareusedtoanalyzevariouspricingdecisionsincludingtransferpricing,jointproductpricing,pricediscrimination,priceelasticityestimations,andchoosingtheoptimumpricingmethod.  Capitalbudgeting-Investmenttheoryisusedtoexamineafirm'scapitalpurchasingdecisions.  Atuniversities,thesubjectistaughtprimarilytoadvancedundergraduatesandgraduatebusinessschools.Itisapproachedasanintegrationsubject.Thatis,itintegratesmanyconceptsfromawidevarietyofprerequisitecourses.InmanycountriesitispossibletoreadforadegreeinBusinessEconomicswhichoftencoversmanagerialeconomics,financialeconomics,gametheory,businessforecastingandindustrialeconomics.MANAGERIALECONOMICSManagerialEconomicscanbedefinedasamalgamationofeconomictheorywithbusinesspracticessoastoeasedecision-makingandfutureplanningbymanagement.ManagerialEconomicsassiststhemanagersofafirminarationalsolutionofobstaclesfacedinthefirm ’s activities.Itmakesuseofeconomictheoryandconcepts.Ithelpsinformulatinglogicalmanagerialdecisions.ThekeyofManagerialEconomicsisthemicro-economictheoryofthefirm.Itlessensthegapbetweeneconomicsintheoryandeconomicsinpractice.ManagerialEconomicsisasciencedealingwitheffectiveuseofscarceresources.Itguidesthemanagersintakingdecisionsrelatingtothefirm ’s customers,competitors,suppliersaswellasrelatingtotheinternalfunctioningofafirm.Itmakesuseofstatisticalandanalyticaltoolstoassesseconomictheoriesinsolvingpracticalbusinessproblems.StudyofManagerialEconomicshelpsinenhancementofanalyticalskills,assistsinrationalconfigurationaswellassolutionofproblems.Whilemicroeconomicsisthestudyofdecisionsmaderegardingtheallocationofresourcesandpricesofgoodsandservices,macroeconomicsisthefieldofeconomicsthatstudiesthebehavioroftheeconomyasawhole(i.e.entireindustriesandeconomies).ManagerialEconomicsappliesmicro-economictoolstomakebusinessdecisions.Itdealswithafirm.TheuseofManagerialEconomicsisnotlimitedtoprofit-makingfirmsandorganizations.Butitcanalsobeusedtohelpindecision-makingprocessofnon-profitorganizations(hospitals,educationalinstitutions,etc).Itenablesoptimumutilizationofscarceresourcesinsuchorganizationsaswellas  helpsinachievingthegoalsinmostefficientmanner.ManagerialEconomicsisofgreathelpinpriceanalysis,productionanalysis,capitalbudgeting,riskanalysisanddeterminationofdemand.ManagerialeconomicsusesbothEconomictheoryaswellasEconometricsforrationalmanagerialdecisionmaking.Econometricsisdefinedasuseofstatisticaltoolsforassessingeconomictheoriesbyempiricallymeasuringrelationshipbetweeneconomicvariables.Itusesfactualdataforsolutionofeconomicproblems.ManagerialEconomicsisassociatedwiththeeconomictheorywhichconstitutes“TheoryofFirm”.Theoryoffirmstatesthattheprimaryaimofthefirmistomaximizewealth.Decisionmakinginmanagerialeconomicsgenerallyinvolvesestablishmentoffirm ’s objectives,identificationofproblemsinvolvedinachievementofthoseobjectives,developmentofvariousalternativesolutions,selectionofbestalternativeandfinallyimplementationofthedecision.ThefollowingfiguretellstheprimarywaysinwhichManagerialEconomicscorrelatestomanagerialdecision-making.ScopeofManagerialEconomicsManagerialEconomicsdealswithallocatingthescarceresourcesinamannerthatminimizesthecost.Aswehavealreadydiscussed,ManagerialEconomicsisdifferentfrommicroeconomicsandmacro-economics.ManagerialEconomicshasamorenarrowscope-itisactuallysolvingmanagerialissuesusingmicro-economics.Wherevertherearescarceresources,managerialeconomicsensuresthatmanagersmakeeffectiveandefficientdecisionsconcerningcustomers,suppliers,competitorsaswellaswithinanorganization.Thefactofscarcityofresourcesgivesrisetothreefundamentalquestionsa.Whattoproduce?b.Howtoproduce?c.Forwhomtoproduce?Toanswerthesequestions,afirmmakesuseofmanagerialeconomicsprinciples.Thefirstquestionrelatestowhatgoodsandservicesshouldbeproducedandinwhatamount/quantities.Themanagersusedemandtheoryfordecidingthis.Thedemandtheoryexaminesconsumerbehaviourwithrespecttothekindofpurchasestheywouldliketomakecurrentlyandinfuture;thefactorsinfluencingpurchaseandconsumptionofaspecificgoodorservice;theimpactofchangeinthesefactorsonthedemandofthatspecificgoodorservice;andthegoodsorserviceswhichconsumersmightnotpurchaseandconsumeinfuture.Inordertodecidetheamountofgoodsandservicestobeproduced,themanagersusemethodsofdemandforecasting.Thesecondquestionrelatestohowtoproducegoodsandservices.Thefirmhasnowtochooseamongdifferentalternativetechniquesofproduction.Ithastomakedecisionregardingpurchaseofrawmaterials,capitalequipments,manpower,etc.Themanagerscanusevariousmanagerial  economicstoolssuchasproductionandcostanalysis(forhiringandacquiringofinputs),projectappraisalmethods(forlongterminvestmentdecisions),etcformakingthesecrucialdecisions.Thethirdquestionisregardingwhoshouldconsumeandclaimthegoodsandservicesproducedbythefirm.Thefirm,forinstance,mustdecidewhichisit ’s nichemarketdomesticorforeign?Itmustsegmentthemarket.Itmustconductathoroughanalysisofmarketstructureandthustakepriceandoutputdecisionsdependinguponthetypeofmarket.Managerialeconomicshelpsindecision-makingasitinvolveslogicalthinking.Moreover,bystudyingsimplemodels,managerscandealwithmorecomplexandpracticalsituations.Also,ageneralapproachisimplemented.ManagerialEconomicstakeawiderpictureoffirm,i.e.,itdealswithquestionssuchaswhatisafirm,whatarethefirm ’s objectives,andwhatforcespushthefirmtowardsprofitandawayfromprofit.Inshort,managerialeconomicsemphasizesuponthefirm,thedecisionsrelatingtoindividualfirmsandtheenvironmentinwhichthefirmoperates.Itdealswithkeyissuessuchaswhatconditionsfavourentryandexitoffirmsinmarket,whyarepeoplepaidwellinsomejobsandnotsowellinotherjobs,etc.ManagerialEconomicsisagreatrationalandanalyticaltool.ManagerialEconomicsisnotonlyapplicabletoprofit-makingbusinessorganizations,butalsotonon-profitorganizationssuchashospitals,schools,governmentagencies,etc.PrinciplesofManagerialEconomicsEconomicprinciplesassistinrationalreasoninganddefinedthinking.Theydeveloplogicalabilityandstrengthofamanager.Someimportantprinciplesofmanagerialeconomicsare:MarginalandIncrementalPrincipleThisprinciplestatesthatadecisionissaidtoberationalandsoundifgiventhefirm ’s objectiveofprofitmaximization,itleadstoincreaseinprofit,whichisineitheroftwoscenarios-ããIftotalrevenueincreasesmorethantotalcost.Iftotalrevenuedeclineslessthantotalcost.Marginalanalysisimpliesjudgingtheimpactofaunitchangeinonevariableontheother.Marginalgenerallyreferstosmallchanges.Marginalrevenueischangeintotalrevenueperunitchangeinoutputsold.Marginalcostreferstochangeintotalcostsperunitchangeinoutputproduced(Whileincrementalcostreferstochangeintotalcostsduetochangeintotaloutput).Thedecisionofafirmtochangethepricewoulddependupontheresultingimpact/changeinmarginalrevenueandmarginalcost.Ifthemarginalrevenueisgreaterthanthemarginalcost,thenthefirmshouldbringaboutthechangeinprice.Incrementalanalysisdiffersfrommarginalanalysisonlyinthatitanalysisthechangeinthefirm'sperformanceforagivenmanagerialdecision,whereasmarginalanalysisoftenisgeneratedbyachangeinoutputsorinputs.Incrementalanalysisisgeneralizationofmarginalconcept.Itreferstochangesincostandrevenueduetoapolicychange.Forexample-addinganewbusiness,buyingnewinputs,processingproducts,etc.Changeinoutputduetochangeinprocess,productorinvestmentisconsideredasincrementalchange.Incrementalprinciplestatesthatadecisionisprofitableifrevenueincreasesmorethancosts;ifcostsreducemorethanrevenues;ifincreaseinsomerevenuesismorethandecreaseinothers;andifdecreaseinsomecostsisgreaterthanincreaseinothers.Equi-marginalPrincipleMarginalUtilityistheutilityderivedfromtheadditionalunitofacommodityconsumed.Thelawsofequi-marginalutilitystatesthataconsumerwillreachthestageofequilibriumwhenthemarginalutilitiesofvariouscommoditiesheconsumesareequal.Accordingtothemoderneconomists,thislawhasbeenformulatedinformoflawofproportionalmarginalutility.Itstatesthattheconsumerw  illspendhismoney-incomeondifferentgoodsinsuchawaythatthemarginalutilityofeachgoodisproportionaltoitsprice,i.e.,MUx/Px=MUy/Py=MUz/PzWhere,MUrepresentsmarginalutilityandPisthepriceofgood.Similarly,aproducerwhowantstomaximizeprofit(orreachequilibrium)willusethetechniqueofproductionwhichsatisfiesthefollowingcondition:MRP1/MC1=MRP2/MC2=MRP3/MC3Where,MRPismarginalrevenueproductofinputsandMCrepresentsmarginalcost.
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