Introduction
Topic 1
Economics: Concept
Economics: study of how economic
agents/societies chose to use scarce
productive resources that have alternative
uses to satisfy wants that are unlimited and
of varying degrees of importance
Economic problem: identification, description,
explanation and solution
Problem of scarcity
Job of a manager: decision making: evaluate
alternatives and chose the best; one of
constrained optimization
Managerial economics
Macroeconomics: study of economic system as a whole
Microeconomics: focuses on behaviour of individual players like
consumers, producers and their interaction in markets
Managerial economics:
applied microeconomics
focuses on topics of greatest interest and importance to managers,
like demand, production, cost, pricing, market structure
Assists in evaluating if resources are allocated efficiently and in
responding to economic signals/ changes in variables
Assists in decision making by evaluating alternatives and selecting
optimal course of action, given the constraints, and profit
maximisation objective of the firm
Circular flow of economic activity
Households supply factor inputs to firms thru
factor markets; firms in turn manufacture and
provide goods and services to households
thru product markets
In return, firms make payments to
households for factor inputs which is used by
these households to make payments for
goods and services provided by firms
Factor inputs/goods/services move in one
circular direction, rupee payments in the
other circular direction
Fundamental questions in
economy
What goods and services to produce and in
what quantity: demand and supply theories,
costs and pricing decisions
How to produce them, ie. how the scarce
resources are optimally allocated: production
theories
How these goods and services so produced
are distributed among the households:
market structure
Alternative economic systems
Market economy: market forces of demand and supply operate
freely to determine solutions to questions
Command economy: govt. decides market functions/systems;
govt. controls all productive resources; govt. enterprise and
ownership is the rule; authoritarian methods used to determine
resource use and prices; like in earlier Russia, eastern Europe
economies
Mixed economy: both markets and command mechanisms used,
govt. may control areas like defence, roads, pensions,
schooling…. May also intervene in markets to control prices and
correct other shortcomings
Objective of a Firm
Profit Maximization: both current and future profits
Thus maximize sum of present value of all future profits
(discounted values)
This equals the value of the firm
Thus profit maximization same as value maximization
Subject to other objectives like those of maximization of market
share, revenues, salaries, social welfare etc.
Thus we may talk of “satisficing” (satisfactory profits) rather
than “maximizing” various management objectives
Subject to constraints like legal, moral, contractual,
technological etc.
Principles of managerial economics allow accurate
predictions of decision making in business
Principal-agent problem: due to possibility that
owners and their managers may have different
objectives: hence need to align these
Invisible hand principle:
Proclaimed by Adam Smith
Pursuit of self interest by players in the markets will lead to
promotion of public good, will ensure economic well being of
society
Concept of Profit
Profit = total revenues – total costs
Accounting profit different from
economic profit
Economic profit takes care of all costs, explicit
and implicit, while accounting profits take
care of only explicit costs
Implicit costs include opportunity costs
Opportunity costs: cost of next best
alternative
Externalities:
Benefits: enjoyed with out paying for
them; eg. increased economic activity of
an area where a large industry is set up
Costs: paid by those who are not using the
services: eg. social costs of pollution by an
industrial enterprise
