A Textbook of Business Economics

A TeXT BOOK OF

BUSINESS ECONOMICS

DR. SARO] PAREEK

SUNRISE

PUBLISHERS & DISTRIBUTORS

E-566, Vaishali Nagar, Jaipur - 302021 (Raj.)

Published by :

SUNRISE PUBLISHERS & DISTRIBUTORS

E-566, Vaishali Nagar,

Jaipur - 302021 (Raj.)

Ph.:9413156675,9772299149

Email: [email protected]

First Published - 2009

©Reserved

ISBN: 978-93-80207-05-6

All rights reserved. No part of this book may be reproduced in any form or by any

mean without permission in writing from the publisher.

Printed at : Jaipur

PREFACE

The economic techniques have gained a wide application in

the process of modem management decision, possible, because

recent business problems have become so complex that manager's

personal experience is no longer adequate to give an appropriate

solution. The purpose of this book is to provide, in one volume, the

different economic theories which are deemed to constitute the

subject matter of managerial economics. This book is written

especially for B.Com., B.B.A., M.Com., M.B.A., and c.A. students of

our country.

This book is intended to explain in non-technical language, the

economic concepts, tools of analysis, their relevance in management

decision-making and also the influence of economic environment

on management decisions. To facilitate an easy understanding of

the subject, the timely help of illustrations, examr::es, diagrams,

tables and charts has been taken, Important terms relevant to the

business economics are given in a separate chapter. To my publisher,

I am grateful for publishing the book with due care and skill in a

very short time. I shall be thankful to the readers for pointing out

discrepancies and errors in the text, which I hope to rectify in the

next edition of the book. Suggestions for further improvement of

this book will be highly appreciated.

Author

CONTENTS

• Preface iii

I. Introduction 1

2. Managerial Economist Role and Responsibilities 8

3. Concepts of Managerial Economics 15

4. Measurement Techniques of Marginal Economics 25

5. Important Terms used in Managerial Economics 36

6. Economic Theories 55

7. Production Theory 62

8. Consumer Behaviour 76

9. Indifference Curves Approach 84

10. Extension and Contraction Versus Increase and Decrease 105

in Demand

II. Elasticities of Demand 110

12. Empirical Studies on Demand 119

13. Demand Forecasting 126

14. Form of Market Structure 157

15. Perfect Competition 160

16. Implications of a Change in Demand for Commodity Under 173

Competition

17. Competitive Market Model 180

18. Dynamics of Supply: The Cobweb Phenomena

19. Pure Monopoly

20. Discriminating Monopoly

21. Bilateral Monopoly

22. Monopolistic Competition

23. Market Imperfection and Excess Capacity

24. Profit Decisions

25. Functions of Profit

26. Theories of Profit

27. Investments

28. Business Forecasting

29. Business Cycles

30. Theory of Trade Cycles

189

193

207

216

221

236

243

254

261

276

290

315

330

1

INTRODUCTION

Managerial economics is economics applied to decision-making

by the modem business managers. It is based on economic analysis

for identifying problems, organising information, and evaluating

alternatives. Managerial economics serves as a link between

economic theories and managerial practice. Managerial economics

can be defined as :

Managerial Economics is the integration of economic theory

with business practice for the purpose for facilitating decision￾making and forward planning by management of an organisation.

Features of Managerial Economics:

(i) It is concerned with decision-making of economic nature.

(ii) It deals with identification of economic choices and

allocation of resources.

(iii) It deals, as to how decisions should be taken to achieve the

organisational goals.

(iv) It provides a link between traditional economics and the

decision sciences for managerial decision-making.

(v) It is concerned with these analytical tools which are helpful

in improving the decision-making process.

Nature of Managerial Economics:

Managerial economics is concerned with the business unit and

the economic problems of society. To understand the nature of

2 Introduction

managerial economics better, let us study the nature of economic

theory relevant for managerial decision-making.

(a) Macro-economic Conditions: The decisions of the company

are generally made within the broad framework of economic

environment within which the company operates. These are known

as macro-economic conditions. From this point of view these

conditions are: working of the market, pace of economic change,

economic policies of the government.

(b) Micro-economic Analysis: It deals with the problems of an

individual company, industry etc. This helps in studying as to what

is going on with in the company, how best to allocate scarce

resources for various activities of the company. Some of the popular

micro-economic concepts are the elasticity of demand, marginal

cost, opportunity cost, market structure. Some of the common models

used in rnicro-economic theory are mode) for monopoly price, mode

for price determination and the behaviour and managerial models.

Integration of Economic Theory and Business Practice:

Economic theory helps to understand t11e actual business behavioU'r.

Economic theory is based on certain assumptions, therefore,

conclusions drawn from such economic theory may not generally

conform to what actually happens. Managerial economist modify

the theoretical result to conform to actual business behaviour.

Economists have developed a theory of company, which centers on

the assumption of profit maximisation and the assumption that

firms act rationally in persuit of their objectives.

Managerial economics attempts to estimate and predict the

economic quantities and relationships. The estimates of demand,

production relations etc. are necessary for forecasting, prediction

about demand, cost, pricing etc., helps for decision-making and

forward planning.

Business managers must also understand the environment and

adjust to the external factors like, government intervention, taxation,

etc.

Importance of Managerial Economics:

Managerial economics helps the decision-making process in

the following ways:

Introduction 3

(i) It gives a number of tools and techniques. These

techniques are in the form of models, which helps the

manager to establish essential relationships that represent

the actual situation.

(ii) It provides most of the concepts that are required for the

analysis .of the problems, concepts of elasticity of demand,

fixed and variable costs, short and long-run costs, etc., help

in understanding and then solving the decision problems.

(iii) It helps in taking decisions about, product-mix, level of

output and price of the product, investment, how much to

advertise, etc.

(iv) Managerial economics helps in taking decision of following

subjects:

(a) Objectives of a business company

(b) Production and cost

(c) Profit

(d) Pricing and output

(e) Demand forecasting

(f) Competition

(g) Investment

(h) Sales promotion and market strategy.

Managerial Economics and Traditional Economics:

Managerial economics is an applied field, whereas economics

provide certain basic concepts and analytical tools. Both of them

are concerned with problems of scarcity and resource allocation,

generally labour and capital in order to find the best way to utilize

them for achieving the set goals of the company.

Main contributions of economics to managerial economics are:

(a) To help in understanding the market conditions and the

general economic environment in which the company is

working.

(b) To provide philosophy for understanding and analysing

resource allocation problems.

4 Introduction

Success of any business organisation depends upon technical

and economic efficiency. Technical efficiency means production

with best technological specifications, while economic efficiency

means maximisation of its goals, i.e. sales, profit etc. Managerial

economics is concerned with both kinds of efficiencies, and takes

the help of economic analysis for achieving both these efficiencies.

Managerial Economics and Operation Research:

Object of both operation research and managerial economics to

take effective decisions, for adopting best way of achieving

company's objectives. The difference in both of them is that,

managerial economics is a fundamental academic subject to make

one understand and analyse the business problems, while operation

research is a functional activity carried out to help the manager to

carry out his job of solving decision problems.

Operation research is concerned with model building.

Economic theory is also concerned with model building. Economic

models are general and confined to broad economic decisions only,

while operation research models can solve problems of various

disciplines. O.R.. models like linear programming and queuing etc.

are widely used in managerial economics.

Role of Managerial Economics in Decision-Making: Main tasks

of a business manager are making decisions and processing

informations. For making intelligent decisions, managers must be

able to obtain, process and use information. The knowledge of

economic theories toa manager, helps to perform these functions.

Manager is required to take two type of decisions: specific decisions

or general task decisions based on the informations obtained and

processed by him.

Tools and techniques

of analysis

Fig. 1. Managerial Economics and Decision-makillg.

Introduction 5

(1) Specific Decisions: These are not likely to be frequently

repeated, and are very important decisions and require the use of

basic economics. Some of such decisions are whether install in

house computer or get the work done from outside, whether or not

to close down a branch of the company that has recently been

profitable. These are includes decisions related to pricing, demand

forecasting, economic analysis of the industry etc.

(2) General Tasks Decisions: Decisions are influenced by

external factors as well as internal factors. Internal factors are wi thin

control, while external factors are beyond control, but timely

adjustments can be done to these external factors. The managerial

economics help in understanding these external factors. Important

external factors are as follows:

(i) General economic conditions like level and rate of growth

of national economy, influence of international factors.

(ii) Prospects of demand for the product. For example change

occurring in the purchasing power of public in general,

changes undergoing in fashions, tastes and preferences.

(iii) Factors influencing input cost.

(iv) Market conditions for raw material and for finished product.

(v) Company's share in the market,

(vi) Government's economic policies.

Internal factors are:

(i) Production, sales, inventory schedules, their present

position and forecasts for future.

(ii) Pricing and profit policies.

(iii) Most profitable product-mix, and the best prices for its

various outputs considering the market conditions.

(iv) Investment decisions: forecast about the return on

investment.

Manager is required to understand both type of factors which

may influence his decisions.

Models:

Models aim at creating a set of relationship which approximate

the real world situation. These are simple from the point of view of

6 Introduction

computation and gives satisfactory results. Models are very helpful

in decision-making "Models are structures involving relationships

among concept".

Economic theory deals with the scientific approach for selecting

a best alternative, and constructs a simplified models of reality on

the basis of which laws describing regularities in economic

behaviour are derived. A model deals with the relationship of a

given dependent variables with one or more independent variables.

Example of models are: Quantitative models, allocation model,

queuing or waiting line models, Simulation models, Inventory

models, Network or scheduling models.

Complex problems of the practical world thus can be solved by

concentrating only on some key features instead of every detail.

This approximation of reality, which we may construct in various

forms are called as 'model'. Models exist in many forms, and the

particular form selected depends upon the purpose. The decision

making through models is (a) economical to construct as compared

to actual situation and its modification, if required (b) convenient

to analyse and experiment as compared to those with complex

situations, (c) decision-making with these models is quick.

Types of Models:

Models are of different types, some of them are as follows:

(i) Predictive

(ii) Descriptive

(iii) Nominative.

(iv) Iconic

(v) Analog

(vi) Symbolic

(vii) Deterministic

(viii) Probabilistic.

(i) Predictive Models: This model indicate that "if this occurs,

then that will follow".

Introduction 7

(ii) Descriptive Models: These provide descriptive picture of a

situation and do not predict or recommend e g. organisation chart.

(iii) Nominative Models: These provide the best answer to a

problem, e.g. economic let size model.

(iv) Iconic Models: These retain some of the physical

characteristics of the things they represent e.g. three dimension scale

models.

(v) Analog Model : These employ one set of properties to

represent some other set of properties which the system being sludied

possess e.g. frequency distribution charts, flow charts etc.

(vi) Symbolic Model: These use symbols to describe the real

world, e.g. quantitative models, allocation models, queuing models

inventory models., simulation models, and network or scheduling

models.

(vii) Deterministic Models: These determines the output

(representing the solution) from a set of input values, e.g. Profit =

Revenue - Costs.

(viii) Probabilistic Models: These involve probability

distributions for inputs and provide a range of values of at least one

output variables with a probability associated with each value.

These models assist with decisions made under conditions of risk.

DOD

2

MANAGERIAL ECONOMIST ROLE

AND RESPONSIBILITIES

The managerial or business economist can playa very

important role by assisting business management in using the

increasingly specialized skills and sophisticated techniques which

are required to solve the difficult problems of successful decision￾making and forward planning. That is why, in business

organisations, his importance is being growingly recognized. In

advanced countries like the U .5.A., large companies employ one or

more economists. In our country, too, big industrial houses like

Tatas and Hindustan Lever have corne to recognize the need for

managerial economists.

Let us examine in specific terms how a managerial economist

can contribute to decision-making in business. In this connection,

following two important questions need be considered:

(1) What role does he play in business, that is, what particular

management problems lend themselves to solution through

economic analysis?

(2) How can the managerial economist best serve management,

that is, what are the responsibilities of a successful

managerial economist?

Role of a Managerial Economist

One of the principal objectives of any modern management in

its decision-making process is to determine the key factors which