Introduction to Managerial Economics

Course Objectives Explain What is Managerial Economics Describe the Purpose of Managerial Economics Explain the Principles of Managerial Economics List the Objectives of a Business Firm Describe the Role of Environmental Analysis in ME Explain Role of Cost Analysis in ME Explain the Classification of Market Structures Explain What is Demand Explain the Law of Demand Explain the Why Demand Curve has Negative Slope List the Exceptions to Law of Demand Explain Price Elasticity of Supply & Supply Curve Describe Determinants of Price Elasticity of Supply Explain How Managers can Apply ME List the Benefits of Managerial Economics

Introduction ‘Zen Garments’ is a large and reputed garments manufacturing company. It has established a niche for itself in the garments industry and is a leader in its industry and segment. In summer, it being an off-season, Zen announced a huge ‘Off Season Sale’ and offered a discount of 75% on its winter wear collection.

Introduction The Managers at Zen did not correctly forecast such a huge demand and so the company was not prepared for the overwhelming response of the customers to this sale. The demand was so huge that the company ran out of its winter wear stocks and could not fulfil all of its customer’s demands.

Now, let us see what happened in winter? Introduction Now, let us see what happened in winter?

Introduction In winter, owing to the Christmas Season, the discount on winter wear was a nominal 20% as it was the on-season. This time the Managers at Zen had taken care to keep huge stocks ready for meeting the demand of customers in the on-season.

Introduction However, owing to the nominal discount, the demand was far less than what the Managers had predicted. Zen also incurred huge losses due to the vast amount of inventory of winter wear that it had maintained for the winter season.

Introduction Hence, you can understand that understanding the concepts of demand and supply and other concepts of microeconomics are crucial for the efficient working of Managers to ensure the smooth and successful running of any business.

Introduction This is where ‘Managerial Economics’ can help Managers as it is an ‘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 forecasting of demand and supply and solving obstacles faced in the firm’s activities.

Introduction Managerial Economics makes use of economic theory and concepts and helps in formulating logical managerial decisions. Managerial Economics is a science dealing with effective use of scarce resources.

Introduction 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. Let us learn about ‘Introduction to Managerial Economics’ in detail.

What is 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.

Purpose of Managerial Economics Managerial Economics is useful wherever there are scarce resources and it helps to ensure 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 the following three fundamental questions: What to produce? How to produce? For whom to produce? The purpose of use of Managerial Economics principles in a firm is to answer these questions. Let us try to understand how a manager can use Managerial Economics principles to answer the three questions.

Opportunity Cost Principle The ‘opportunity cost’ of a decision means the sacrifice of alternatives required by that decision. If there are no sacrifices, there is no cost. According to Opportunity Cost Principle, a firm can hire a factor of production if and only if that factor earns a reward in that occupation/job equal or greater than its opportunity cost.

Uses of Managerial Economics 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 such as 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 & Environmental Analysis Managerial Economists should carry out a thorough analysis of the environment of a business. Thus, Managerial Economists should analyze the four environmental influences on a business such as: Economic Social Political Technological

Industry Competition Role of Market Analysis in Managerial Economics Hence, the competition faced by companies has been classified based on the degree of product substitution in the following categories: Brand Competition Industry Competition Industry Competition Product Competition A competition in which a company considers all companies making the same product or class of products as its competitors is known as an ‘Industry Competition’. For example: Pepsi would consider all other soda manufacturers as its competitors. Generic Competition

Law of Demand The ‘Law of Demand’ states that there is an inverse relationship between quantity demanded of a commodity and its price, other factors being constant. In other words, higher the price, lower the demand and vice versa, other things remaining constant.

Demand Curve A ‘Demand Curve’ is a diagrammatic representation of Demand Schedule. It is a graphical representation of price-quantity relationship. The individual demand curve shows the highest price which an individual is willing to pay for different quantities of the commodity.

Law of Diminishing Marginal Utility ‘Law of Diminishing Marginal Utility’ is the basic cause of the law of demand. The ‘Law of Diminishing Marginal Utility’ state that as an individual consumes more and more units of a commodity, the utility derived from it goes on decreasing.

Real Life Example Rachel is very fond of mangoes. She eats six mangoes in ten minutes. Eating mangoes gives Rachel a sense of satisfaction or happiness.

Real Life Example Do you think the amount of satisfaction that Rachel would get from eating the last mango would be the same as she gets from the first one?

Example of Price Elasticity of Supply Let us consider an example for better understanding of ‘Price Elasticity of Supply’. Let’s say that for a given product X, the price earlier was $3 and the units supplied were 300. Now, the price increased to $3.5 and the units supplied have changed to 500. In this case, the calculation will be as follows: = (500 - 300) / 300 * 100 / ($3.5 - $3) / $3 * 100 = 66.66% / 16.66% = 4

Perishable vs. Non Perishable Storage capacity is not the only issue. The supplier also needs to consider whether or not the goods that they hold are perishable or not. Perishable goods have a limited shelf life and the buyers know it. The buyers can wait for some time and producers will have to lower the prices or take the losses that arise from wastage.

Role of Managerial Economics in Business Decisions Managerial Economics helps in achieving business objectives by making strategic business decisions as follows: It helps to maximize organization’s response to demands and opportunities. It helps to overcome organization’s threats. It helps to reverse organization’s weaknesses.

How Managers can Apply Managerial Economics? Some of the ways in which a Manager can apply Managerial Economics are: If a manager wants to increase the price of the product due to increase in cost of production, he should analyze the price elasticity of demand for that product so that price rise is not followed by substantial fall in the demand of the product. It is the application of demand analysis to the real world situation. Managers should determine the price and output with the acquaintance of market structures and approaches pertinent for determination of price and output in the given market setup.

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