MEFA – Managerial Economics & Financial Accounting (6HS502HS)

ECE – III Semester (Autonomous) - 2023-24

Unit-I

What is Economics?
Economics is the social science that studies the production, distribution,
and consumption of goods and services.
Any activity involved in efforts aimed at earning money and spending this money to satisfy our
wants such as food, clothing, shelter, and others are called “Economic activities”.
Definition of Economics:
According to Lionel Robbins (1932), Economics is the science which studies human
behaviour as a relationship between ends and scarce means which have alternative uses.

Microeconomics
➢ The study of an individual consumer or a firm is called microeconomics.
➢ Microeconomics deals with behavior and problems of single individual and of micro
organization.
➢ It is concerned with the application of the concepts such as price theory, Law of Demand and
theories of market structure and so on.

Macroeconomics:
➢ The study of ‘aggregate’ or total level of economic activity in a country is called
macroeconomics.
➢ It studies the flow of economics resources or factors of production (such as land, labor,
capital, organization and technology) from the resource owner to the business firms and then
from the business firms to the households.
➢ It is concerned with the level of employment in the economy.
➢ It discusses aggregate consumption, aggregate investment, price level, and payment, theories
of employment, and so on.

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Introduction to Managerial Economics

 Managerial economics is a discipline which deals with the application of economic

theory to business management.
 It deals with the use of economic concepts and principles of business decision making.
 Managerial Economics may be defined as the study of economic theories, logic and
methodology which are generally applied to seek solution to the practical problems of
business.
 It is based on economic analysis for identifying business problems, organizing
information and evaluating alternatives.
 Managerial economics is a stream of management studies that emphasizes primarily on
solving business problems and decision-making by applying the theories and principles
of microeconomics and macroeconomics.
 It is a specialized stream dealing with an organization’s internal issues using various
economic tools.
Definition:
“Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision making and forward planning by management.”
— Spencer and Seegelman.

Managerial Economics is the use of economic modes of thought to analyze business situations.
- M.C.Nair
Managerial Economics in other words is the combination of Economics and Business
Management, specifically when the concepts of Economics are applied to all the management
functions in the organization.

Managing a business in practical sense means managing limited resources for the attainment of
organizational goals. The resources required for the organization such as labor, land, money,
materials, machines, etc are always limited in nature. Hence, it is necessary for any manager to
take the help of economics concepts in the process of decision making for optimum and best
allocation of these limited resources.

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The business management functions that involve decision making are:

1) Planning: It is the basic function of management. It deals with chalking out a future course of
action & deciding in advance the most appropriate course of actions for achievement of pre-
determined goals.
2) Organizing: It is the process of bringing together physical, financial and human resources and
developing productive relationship amongst them for achievement of organizational goals.
3) Staffing: It is the function of manning the organization structure and keeping it manned.
Staffing has assumed greater importance in the recent years due to advancement of technology,
increase in size of business, complexity of human behavior etc.
4) Directing: It is that part of managerial function which actuates the organizational methods to
work efficiently for achievement of organizational purposes.
5) Controlling: It implies measurement of accomplishment against the standards and correction
of deviation if any to ensure achievement of organizational goals.

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Scope of Managerial Economics:
Managerial economics provides management with a strategic planning tool that can be used to
get a clear perspective of the way the business world works and what can be done to maintain
profitability in an ever-changing environment.
1. Demand Analysis and Forecasting
An economic organization is engaged in converting productive resources into goods that can be
sold in the market. A major part of this decision-making is based on accurate estimates of
demand. When future sales are forecast, the management gets a better idea of when to produce
and how much labor to employ. This helps management maintain its market profit and
strengthen the customer base and profit base. Decision analysis also helps to understand various
factors affecting a company’s growth.
2. Cost and Production analysis
While making a managerial decision, cost estimates are very important. All the different factors
that cause fluctuations in cost should be given due importance. This is very important for
planning purposes. This is also very difficult because many cost fluctuating factors are
uncontrollable or not known. Due to this uncertainty of cost, managerial economics comes into
the picture. If a company can measure cost, it would help them make sound profit planning,
pricing, and cost control practices. The scope of managerial economics in cost and production
analysis extends to
 Estimation of the cost in production
 Recognizing the factors, which are causing costs to the firm
 Suggests cost should reduce for making good profits
 Production analysis deals with, Minimum cost that should be spent on raw materials and
maximum production should be obtained
3. Pricing decisions, policies, and practice
The scope of managerial economics is not just limited to making decisions. It also helps in
drafting policies. The price of the product/ service offered by the company gives them profit and
hence is considered to be the most important field of managerial economics. If the company
makes the correct price decisions, it will be far more successful. The various factors that are dealt
with under this are market forms, pricing policies, pricing methods, differential pricing,
productive pricing, and price forecasting.

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4. Profit Management
Most businesses start for the sole reason of earning maximum profit. But this is always uncertain
due to fluctuations in the market costs and revenues. The world is not perfect, therefore profit
analysis is a very difficult task. Profit planning and measurement make up a large part of the
scope of managerial economics. A proper study of the nature and management of profit, profit
policies, and techniques of profit planning like break-even analysis has to be done.
5. Capital Management
If you know the business, you know how troublesome and stressful investment decisions are.
Planning and controlling capital expenditure is very difficult as it involves a large sum of money.
Also, disposing of capital assets is complex and requires time and labor. The main aspects to
consider in capital management are the cost of capital, rate of return, and selection of projects.
6. Analysis of Business Environment
The scope of managerial economics is not just limited to the operational issues of a firm. Various
environmental factors affect the performance of a business. The factors that affect the business
climate most are the general trend in national income and consumption expenditure, general
price trends, trading relations with other countries, trends in the world market, economic and
business policies of the government, and industrial relations.
Importance of Managerial Economics
Managerial Economics has become a highly useful and practical discipline now days as it helps
to analyze and offers best s solutions to various kinds of problems faced in routine affairs of the
organization in a systematic and realistic manner. The following points highlights significance of
the managerial economics:
1. Better allocation of resources:
Managerial economics not only offers the better allocation of scarce resources among competing
ends but also ensure the proper utilization of resources.
2. Right decision at the right time:
It helps the executives working in the firm to understand the various details of business and
problems encountered and to take right decision at the right time by the identification of key
variables in decision-making process. Thus managerial economics attempt to avoid the
complexities of wrong decisions. Every manager has to take various relevant decisions about the
utilization of limited resources like land, capital, labour, funds etc. to get the maximum returns,
therefore, managerial economics, concentrates on practical aspects which facilitates decision-
making.

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 3. Identification of Problems:
In today’s scenario, economy is becoming highly competitive and dynamic, it helps in
identifying various business and managerial problems, their causes and consequence, and
suggests various policies and programs to overcome them.
4. Offers tools and techniques:
Managerial economics ensures availability of the various conceptual and technical skills, tools of
analysis and techniques of judgment and other modern tools and instruments like elasticity of
demand and supply, cost and revenue, income and expenditure, profit and volume of production
etc to solve various dynamic problems of business.
5. Attainment of business objectives:
Managerial economics helps the business executives to become more responsive, realistic and
competent to overcome upcoming challenges in the dynamic business scenario. This in turn
facilitates achievement of various objectives like profit and wealth maximization, society
welfare, Customer satisfaction, attaining industry leadership, market share expansion and social
responsibilities etc.
6. Facilitates decision making and forward planning:
Managerial Economics enables decision making and forward planning by the evaluation of
alternatives available to the managers.
7. Understanding the various external factors:
It also helps in understanding and analyzing the various external factors which affect the
decision-making of an organisation and ultimately affecting the functioning and the
success of the firm.

Managerial Economics and its relation to other sciences:

Basically, Managerial
economics is a branch of
traditional economics that
propounding its theories
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and decisions with the
help of other disciplines.
It is closely related with
certain subjects like
economics, statistics,
mathematics, accounting,
and operational research.
i)
: Managerial economics
has its relationship with
Relationship with
Traditional Economics
both the branches of
economics i.e. micro and
macro-economic. It uses
concepts from
micro economics such as
marginal cost, marginal
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revenue, pricing theories
and tactics,
elasticity of demand and
the theories of market
structure in taking various
managerial
decisions. Managerial
economics also studies
the micro-economics
concepts price level,
employment level, income
level, investment and
consumption in the
economy as well as the
matters related to
international trade, Money,
public finance, etc.
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ii)
Managerial economics
uses perfect knowledge of
Relationship with
Accounting:
accounting concepts to
take various types of
business
Relationship
with other
Disciplines
Basically, Managerial
economics is a branch of
traditional economics that
propounding its theories
9
and decisions with the
help of other disciplines.
It is closely related with
certain subjects like
economics, statistics,
mathematics, accounting,
and operational research.
i)
: Managerial economics
has its relationship with
Relationship with
Traditional Economics
both the branches of
economics i.e. micro and
macro-economic. It uses
concepts from

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micro economics such as
marginal cost, marginal
revenue, p
1. Managerial Economics and Statistics
Statistical tools are playing very important role in business decision-making. Statistical
techniques are used in collecting, processing and analyzing data, testing the validity of the
economic laws with the real economic phenomenon before they are applied to business analysis.
Probable economic events are the basis of a good business decision. Various statistical tools
Such as theory of probability, forecasting techniques etc., help the decision-makers in the
prediction of future economic events.

2. Managerial Economics and Mathematics

The main challenge of a businessman is how to minimize cost or how to maximize profit or how
to optimize sales. To find the answers of these questions, various mathematical concepts and
techniques are widely used in economic logic. The knowledge of geometry, trigonometry and
algebra is not only important but various mathematical tools and techniques such as logarithms
and exponentials, vectors, matrix, calculus, differential and integral are also necessary for
managerial economics.
3. Managerial Economics and Accounting
Various data are required by a managerial economist for the decision-making purpose.
Accounting details are included in data. For example, the profit and loss statement of a firm
gives details about the performance of the firm and guides the managerial economist to prepare
the future course of action-whether it should improve or close down.
4. Managerial Economics and Operations Research
Managerial economics has generalized and developed the models and tools of operations
research for the purpose of business decision-making. Linear programming models, inventory
models, game theory, etc. are a few tools that have originated in the works of operation
researchers.
5. Managerial Economics and Organizational Behavior & Psychology

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Organizational Behavior deals with behavioral aspect of an individual or a person within the
group. Psychology deals with overall attitude of a personal internally and externally. Therefore,
the same task is carried out by managerial economics for performance appraisal.
6. Managerial Economics and Management
Managerial Economics is the combination of management and economics which helps to use
managerial principles and directs to attain the goals of the organization which includes the
following steps/ functions: 1) Planning 2) Organizing 3) Staffing 5) Directing 5) Controlling
7. Managerial Economics and Economics
Managerial economics has been described as economics applied to decision-making. Managerial
economics has been studied as a special branch of economics, bridging the gap between pure
economic theory and managerial practice. Economics has two main branches – microeconomics
and macro-economics.

Usefulness of Managerial Economics to Engineers-

It has wide scope in manufacturing, construction, mining and other engineering industries.
Examples of economic application are as follows:
(i) Selection of location and site for a new plant.
(ii) Production planning and control.
(iii) Selection of equipment and their replacement analysis.
(iv) Selection of a material handling system.
1. Better decision making on the part of engineers.
2. Efficient use of resources results in better output and economic development.
3. Quantity that should be produced and supplied.
4. Cost of production can be reduced.
5. Helps in pricing decisions.
6. Alternative courses of action using economic principles may result in reduction
of prices of goods and services.
7. Elimination of waste can result in application of engineering economics.
8. More capital will be made available for investment and growth.

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 9. Helps managers in taking technical decisions based on demand analysis,
elasticity of demand, demand forecasting, break-even analysis, capital
budgeting etc.
10. Improves the standard of living with the result of better products, more wages,
and salaries, more output etc. from the firm applying engineering economics.
Basic concepts of Managerial Economics
Economic theory provides a number of concepts and analytical tools which can be of
considerable help to a manager in taking scientific decisions and business planning. The
fundamental concepts are:
1) The concept of Scarcity:
 It is a basic economic problem that arises because people have unlimited wants and the
resources to fulfill these wants are limited.
 If the demand for a commodity exceeds its supply, then it is called a scarcity situation.
 The main cause of all economic problems is scarcity, and Managerial Economics is the
use of economic analysis to make business decisions involving the best use of
organizational scarce resources.

Limited Unlimited
Resources Human Wants
Scarcity

Economic Problems

Society

Improve available resources Expectations of Human should reduce Economic growth

2) The concept of Marginalism:
 Marginalism means when there is a change in one unit of input, the total value of the
output will change. This change can be in the form of increase or decrease.
 When the change is in the decrease form, then it is called marginal cost.
 When the change is in the increase form, then it is called the marginal revenue.

Example: Suppose a small scale industry employs 10 technicians for production of a given good,
for 8 hours a day. If a technician doesn't show up on any given day, it would result in production
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loss for the industry. The firm can mitigate the loss by asking the other employee to work for few
extra hours, in return for a sum paid out of the absent technician's wages. As long as the wage
paid to the employee is less than the production loss reduced, the decision is beneficial.
The Marginal benefit derived out of an activity should always be greater than the Marginal cost
of the decision made. In the above case, the Marginal cost is the wage paid and the Marginal
benefit is the loss which was mitigated.
Marginalism helps policy makers in forming essential economic policies and enables people to
think at the margin.
3) The concept of Equi-Marginalism:
 This principle deals with allocation of available resources among the alternative
activities.
 According to this principle, “an input should be so allocated that the value added by the
last unit is the same in all cases”. This generalization is called equi-marginalism.
For example, if there are 4 workers in a production unit and 5th worker is recruited, then the 5th
worker is paid at the cost of other 4 workers each.
4) The concept of Opportunity Cost:
 In Managerial Economics, the opportunity cost concept is useful in decision involving a
choice between different alternative courses of action.
 It is the cost of sacrificing something else from the use of given resources when the
decision is made in favor of one alternative.
 “Opportunity Cost is the cost incurred in choosing the next best alternative”
 If resource has no alternative use, then its opportunity cost is nil.
Some general examples of OC:
 Someone gives up going to see a movie to study for a test in order to get a good grade.
The opportunity cost is the cost of the movie and the enjoyment of seeing it.
 A company owns its building. If the company moves out, the building could be rented to
someone else. The opportunity cost of staying there is the amount of rent the company
would get.
5) The concept of Time Perspective:
 According to this concept, a decision should be taken into account with both the ‘short-
run’ and ‘long-run’ effects on revenues and costs, so as to maintain a right balance
between short-run and long-run perspectives.
 Here, the short-run refers to the period in which some inputs cannot be converted into
cash.
 The long-run refers to all inputs can be converted into cash/ money value.

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Example:
The firm which ignores the short run and long run considerations will meet with failure can be
explained with the help of the following illustration. Suppose, a firm having a temporary idle
capacity, received an order for 10,000 units of its product. The customer is willing to pay only
Rs. 4.00 per unit or Rs. 40,000 for the whole lot but no more.
The short run incremental cost (ignoring the fixed cost) is only Rs. 3.00. Therefore, the
contribution to overhead and profit is Rs. 1.00 per unit (or Rs. 10, 000 for the lot). If the firm
executes this order, it will have to face the following repercussion in the long run:
(a) It may not be able to take up business with higher contributions in the long run.
(b) The other customers may also demand a similar low price.
(c) The image of the firm may be spoilt in the business community.
(d) The long run effects of pricing below full cost may be more than offset any short run gain.
6) The concept of Discounting:
 One of the fundamental ideas in economics is that “a rupee earned tomorrow is worthless
than a rupee earned today”.
 This concept is expressed also in other statement like “a rupee in the present is more
worth than a rupee earned in future”.
 In technical parlance, it is said that the present value of one rupee available in the future
is the present value of one rupee available today. The mathematical technique for
adjusting for the time value of money and computing present value is called
‘discounting’.
The following example would make this point clear:
Suppose, you are offered a choice of Rs. 1,000 today or Rs. 1,000 next year. Naturally, you will
select Rs. 1,000 today. That is true because future is uncertain. Let us assume you can earn 10%
interest during a year.
You may say that I would be indifferent between Rs. 1,000 today and Rs. 1,100 next year i.e.,
Rs. 1,100 has the present worth of Rs. 1,000. Therefore, for making a decision in regard to any
investment which will yield a return over a period of time, it is advisable to find out its ‘net
present worth’. Unless these returns are discounted and the present value of returns calculated, it
is not possible to judge whether or not the cost of undertaking the investment today is worth.
The concept of discounting is found most useful in managerial economics in decision problems
pertaining to investment planning or capital budgeting.
7) The concept of Risk & Uncertainty:

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When there are more than one possible outcomes to a decision, risk or uncertainty comes into
existence.
Risk: It refers to the situation when there is more than one possible outcome to a decision and
the probability of each outcome is known and can be estimated. For example: Tossing of a coin.
Uncertainty: It arises from changes in a situation where there is more than one possible
outcomes of a business decision and the probability of each outcome is not known and cannot be
estimated. For example: it may rain or not, irrespective of weather forecast.
8) The concept of Incremental Cost:
Incremental cost means change in total cost and incremental revenue means change in total
revenue resulting from a decision of the firm.
To make overall profit, organizations must make a profit on every job.
The firm should refuse orders that do not cover costs plus a provision of profit.
For example, the company gets a new order which gives an additional revenue of Rs.10,000/-
The costs are estimated as under:
Labour Rs. 3,000
Materials Rs. 4,000
Overhead charges Rs. 3,600
Selling and administrative expenses Rs. 1,400
Full Cost Rs.12, 000
The order appears to be unprofitable. For it results in a loss of Rs. 2,000. However, suppose there
is idle capacity which can be utilised to execute this order. If order adds only Rs. 1,000 to
overhead charges, and Rs. 2000 by way of labour cost because some of the idle workers already
on the pay roll will be deployed without added pay and no extra selling and administrative costs,
then the actual incremental cost is as follows:
Labour Rs. 2,000
Materials’ Rs. 4,000
Overhead charges Rs. 1,000
Total Incremental Cost Rs. 7,000
Thus there is a profit of Rs. 3,000. The order can be accepted on the basis of incremental
reasoning.

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