Concept of economics
The history of economics can be studied in three different periods:
1. Classical period (1776-1890)
Adam smith who is also known as the Father of economics, studied economics as a separate science by publishing a book, "An Inquiry into the Nature and Causes of the Wealth of nation " The concept of the classical period was that wealth was all.
2. Neo-classical period (1890-1932)
Alfred Marshall criticized concept of wealth in classical economics and specified that people are all by publishing "Principles of economics"
3. Modern period (1932-onwards)
Lionel Robbins defined economics in terms of scarcity and choice.
Economics can be divided into two parts: the first used by Ragnar Frisch:
1) microeconomics
2) macroeconomics
Joel Dean introduced managerial economics in 1951. It is also called business economics.
Concept of managerial economics
- The study of economics was started in the 18th century.
- Managerial economics was born in 1951 A.D. with the publication of the book "Managerial Economics" written by the eminent economist Joel Dean.
- Managerial economics can also be taken as a branch of economics.
- Managerial economics is also called Business economics.
- Managerial economics can be defined as the application of economic theory, concepts, and tools to business practice, especially for decision-making and forward planning.
- In a nutshell, it can be said that managerial economics teaches a manager to apply economic tools, concepts, and theories in his/her business organisation to achieve the maximum return.
- As per Joel Dean, "The purpose of managerial or business economics is to show how economic analysis can be used in formulating managerial policies."
Characteristics of managerial economics:
The characteristics of managerial economics are as follows:
- Microeconomic in character
- It takes the help of macroeconomics.
- Theory of the firm
- Goal-oriented (The one and only motive is to earn profit)
- It is normative - "What ought to be?"
- Multidisciplinary-It is related to different disciplines like statistics, mathematics, research, psycology and so on.
- It has wise choices.
The scope of managerial economics means the area covered by managerial economics. The scope of managerial economics can be explained by the following points:
- Demand analysis and forecasting.
- Production and cost analysis
- Pricing theory and practice
- Profit analysis and management
- Capital and investment decision
- Inventory management: It refers to a stock of raw materials or finished goods that a firm keeps.
- Both micro and macro economic in character → Traditional economics, but managerial economics is only microeconomic in character.
- Deals only with the firm → managerial economies. Traditional economics deals with both firms and households.
- Traditional economies include theories like wage, interest and profit, but managerial economies include only the profit theory.
- Traditional economics deals with the body of economic principles itself, and managerial economics involves the application of economic principles to the problem of the firm.m
- Economic theory (traditional economics) makes certain assumption whereas managerial economics introduces certain feedbacks, such as the objective of the firm, legal Constraints, resource constraints, environmental constraints and so on.
The relation of managerial economics to traditional economics
1. Whatever the problems that arise while making managerial decisions by the manager, we can use the traditional economic theories, tools and concepts, especially to run the business organisation in a very effective and smooth way.
2. Mathematical economics is used to formalise the economic models, i.e., postulated by economic theory.
3. Econometrics then applies statistical tools, i.e. normal regression analysis, to real-world data to estimate the models of economic theory and for forecasting, i.e. Qx=a0-b1Px+b2Y+b3Ps-b4Pc
where, a0, b1, b2, b3 and b4 are constant parameters
Qx= quantity of commodity X
Px= price of commodity X
Y= income of the consumer
Ps= price of substitute goods
Pc= price of complimentary goods
Managerial economics and business decision making
→ Decision making
Decision-making is selecting the best course of action from among acceptable alternatives to accomplish the goal that has been predetermined in an organisation.
→ The basic process of decision making
- Define the problem
- Determine the objective
- Identify possible solutions
- Select the best possible solutions
- Implement the decision
→ Managerial economics helps the firm to make decisions in setting goals, resource allocation, demand forecasting and pricing.
→ The major uses of business economics for business decision-making are as follows:
- Basis for prediction: Establishes a cause-and-effect relationship between two or more than two economic events.
- Setting goals
- To know about the environment of the business
- Price discrimination (in different markets)
- Effective utilisation of resources.
Role of a managerial economist
The managerial economist especially has to perform the following two major decisions:
Specific decision:
→ Close or not to close the firm, opening hours and so on.
→ Others
- demand forecasting
- market research
- economic analysis
- security management analysis
- advice on trade
- advice on foreign exchange
- production schedule
- pricing and so on
General task
→ Use of theoretical and statistical tools to make the best decision
Nature and functions of the profit
→ The major objective of the firm is to earn profit.
→ Different economists have developed several profit theories, which are very useful to determine the profit level.
1. Compensatory profit theory
→ Profit is the reward for undertaking the risk of investing.
2. Frictional Propit theory
→ Shock may occur in the economy, which will lead to either positive or negative economic profit to the firm.
3. Monopoly theory of profit
→ Due to huge capital requirements, location and so on. will force the firm to exercise monopoly power.
4. Innovation theory of profit
Profit is the reward for developing new technology
5. Risk-bearing theory of profit
6. Uncertainty bearing theory of profit (Uncertainty itself is taken as the factor of production.)
These are the nature of profits.
Functions of profit
- Profit is the measure of performance.
- It ensures the supply of failure capital.
- It acts as a medium for resource allocation.
- It encourages organising the factors of production.
- It is the most important part of the free enterprise system (making investments in business)
- Concept of Accounting Profit and Economic Profit
Concept of Accounting Profit
→ πA=TR-AC
where, πA = Accounting Profit
TR= Total Revenue
AC= Accounting cost
TR= Total Revenue
AC= Accounting cost
Concept of economic profit
→ πE=TR-EC
→ πE=TR-(EC+IC)
→ πE=TR-(EC+Imputed costs+normal rate to the entrepreneur)
Imputed costs= Implicit rent + Implicit wages + Implicit interest
Imputed costs= Implicit rent + Implicit wages + Implicit interest
where, πE=Economic profit (net profit)
TR=Tolal Revenue
EC= Explicit cost
IC= Implicit cost
IMR= Implicit rent
IMW=Implicit wages
IMI= Implicit interest
N= normal return to the entrepreneur.
TR=Tolal Revenue
EC= Explicit cost
IC= Implicit cost
IMR= Implicit rent
IMW=Implicit wages
IMI= Implicit interest
N= normal return to the entrepreneur.
Theories of the firm
Traditional objective → Profit maximisation
Nowadays, multiple objectives (Sales maximisation)
Profit Maximisation Model
→ According to classical economists, it is the major objective of the firm.
→ According to classical economists, it is the major objective of the firm.
→ This model is based on the following assumptions:
- The firm is producing only one commodity.
- The owner himself/herself works as the manager of the firm.
- The time period is given.
- There is the existence of an imperfectly competitive market
- The firm should be rational.
1. TR/TC Approach
→ The difference between TR and TC is seen, i.e. TR>TC.
→ It can be explained in the following figure.
In the given figure, the X-axis represents quantity, and Y axis represents Total Revenue, Total Cost, and Profit. The TR curve typically starts at the origin and slopes upward, representing the total revenue earned at different output levels. The TC curve also starts at the origin and slopes upward, but typically at a steeper rate than the TR curve. The vertical distance between the TR and TC curves at any output level represents proort of loss at that level. evel The point wthe here vertical distance is greatest corresponds to profit maximizing output level. E and El are equilibrium points and break points; the level of output corresponding to OQ1 and OA2, respectively. OQ is profit-maximising output where the vertical distance between TR and TC is maximum.
nd TC is maximum.
In the given figure, the X-axis represents quantity, and Y axis represents Total Revenue, Total Cost, and Profit. The TR curve typically starts at the origin and slopes upward, representing the total revenue earned at different output levels. The TC curve also starts at the origin and slopes upward, but typically at a steeper rate than the TR curve. The vertical distance between the TR and TC curves at any output level represents proort of loss at that level. evel The point wthe here vertical distance is greatest corresponds to profit maximizing output level. E and El are equilibrium points and break points; the level of output corresponding to OQ1 and OA2, respectively. OQ is profit-maximising output where the vertical distance between TR and TC is maximum.
nd TC is maximum.
2. MC/MR approach
→ For profit maximisation under the MC/MR approach, the following two conditions must be fulfilled.
→ For profit maximisation under the MC/MR approach, the following two conditions must be fulfilled.
1. MC= MR
2. MC must cut MR from below, i.e. slope of MC> slope of MR
→ It can be explained in the following figure:
In the given figure, X axis represents quantity, and Y axis represents Profit, cost and Revenue. The MC curve and AR curve are downward sloping, and MR always lies below AR. MC curve and MR curve meet at E, which is the equilibrium point, and OA is profit maximizing output level. MC curve cuts MR from below at point E. To the left of point E or to the left of output level OQ, profit hasnot reached its maximum level because each unit of output to the left of OQ brings to the firm a revenue which is greater than its MC. To the right of OQ, each additional unit of output costs more than the revenue earned by its sale, so that a loss is made and total profit is reached. The firm's profit is equal to the area abcd. The firm's per unit cost of production is OC, but the per unit price or average revenue is OQ. Here, per unit profit= ac.
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