Business economics UNIT-1 befa engineering

business economics

1. What is Economics? Manage ment + Economics: Economics is the study of men as they live, behave, move and think in ordinary business life. Economics is a social science, which studies human behaviour in relation to optimizing allocation of available resources to achieve the given goals. It is the study of how society uses its scarce resources. Wants are Unlimited and Means are Limited. How to use Limited means for unlimited wants?

2. Income – Expenses = Savings. Income : How much the people earn and How they earn? Expenses : How much the people spend and How they spend? Sa v in g s: How much the people save and How they save?

3. Micro and Macro Economics. Micro Economics The branch of economics that analyzes the market behavior of individual consumers and firms in an attempt to understand the decision-making process of firms and households. The analysis of the decisions made by individuals and groups, the factors that affect those decisions, and how those decisions effect others . Macro Economics. Study of the entire economy in terms of the total amount of goods and services produced, total income earned, level of employment of productive resources, and general behaviour of prices. Macroeconomics examines economy-wide phenomena such as changes in unemployment, national income, rate of growth, gross domestic product, inflation and price levels.

4. Meaning of Managerial Economics Manager + Economics: Management is Planning, Organising, Staffing, Directing, Coordinating, Controlling, budgeting and Reporting. Application of Principles of Economics by a Manager in day to day decision making. Managerial Economics is the study of allocation of resources available to a business firm or an organisation. ME generally refers to the integration of economic theory with business practice

5. Meaning of Managerial Economics It relates to the managerial decision making in achieving a business goal by using the given business resources in the most effective manner. Managerial economics can be broadly defined as the study of economic theories, logic and tools of economic analysis that are used in the process of decision making. Economic theories and techniques of economic analysis are applied to analyze business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision.

6. Definitions of Managerial Economics “Managerial economics is the Integration of economic theory with business practices for the purpose of facilitating decision making and forward planning by management” -Spencer and Siegelman “ Managerial Economics is the use of Economic modes of thoughts to analyse business situation” - Mc Nair and Meriam “The Pur p ose o f Man a geri a l Econ o m ics i s t o how Economic analysis can be used in formulating policies.” -Jeal Dean

7. Definitions of Managerial Economics “Managerial economics is concerned with the application of economic principles and methodologies to the decision making process within the firm or organization. It seeks to establish rules and principles to facilitate the attainment of the desired economic goals of the management.” - Douglas Managerial economics is a “fundamental academic subject which seeks to understand and to analyse the problem of business decision taking”. D.C.Hayue Managerial Economics is “the application of theory and methodology to business administration practice”. Brigham and Pappas.

8. Characteristics of Managerial Economics Microeconomic in nature Pragmatic Descriptive as well as prescriptive. Conceptual in nature Utilizes some theories of Macroeconomics Finds solutions to Problems. Involves Decision making Reco n c iling T ra d itional Theoret i c a l conce p ts t o the actual business behaviour and conditions. Incorporates useful Ideas from other branches of study

9. Scope of Managerial Economics There are 5 departments in an organisation: Production/Operations Department. Finance Department: Marketing Department: Human Resources Department: IT Department: ME has a wide scope in all these departments

10. Scope of Managerial Economics Production/Operations Department. ME tries to answer the following questions. What to Produce? How to Produce? When to Produce? Where to Produce? For whom to Produce? How much to Produce? What is the Cost of Production? To Produce or not?

11. Scope of Managerial Economics Finance Department. ME tries to answer the following questions. How much capital to Invest? How much Equity? How much Debt? From which source? When to Invest? What is Cost of Capital? How to service the Debt? What is the return on investment?

12. Scope of Managerial Economics Marketing Department. ME tries to answer the following questions. How much to Spend on Marketing? How to market? How to identify the customers? When to Inform the customers about your product? How to forecast the Demand? What is the pricing policy? What is face the competition? How to retain the customers?

13. Scope of Managerial Economics Human Resources Department. ME tries to answer the following questions. How much to Spend on Salary and wages? How t o ass e ss the s kills r equir e d for employees? How to recruit the employees? How to compensate the employees? What is face the competition? How to retain the employees?

14. Scope of Managerial Economics IT Department. ME tries to answer the following questions. How much to Spend on IT? How t o ass e ss the hard ware and s o f t ware required for the organisation? How to buy the hard ware and software? From whom to buy the hard ware and software?

15. What is Demand? Effective demand is a desire backed by ability to pay and willingness to pay for it, Demand= Want + Ability to pay +Willingness to pay for it. Demand is defined as “Demand for any commodity, at a given price, is the quantity of it which will be purchased per unit of time at that price”.

16. Types of Demand Firm Demand Vs Industry Demand Short run demand Vs. Long run Demand Autonomous Demand Vs Derived Demand Demand for Perishable and Durable goods. Complimentary Vs Supplementary Demand

17. Law of Demand The law of demand state that “other things being same”, the quantity of goods purchased will vary inversely with its price i.e. the lower price, more will be the quantity demanded and vice –versa. If Price goes up the demand comes down and If Price comes down the demand goes up.

18. Demand Schedule Demand schedule shows the various quantities of a commodity which bought at different prices during a specific period. Price of Vegetable per Kg in Rs 10 8 6 Quantity Demanded in Kg 15 25 30

19. Demand Curve 20 10 0 2 4 6 8 10 12 When pric e inc r eases deman d d e c r eases or when price decreases demand increases. 30 60 50 40 Quantity Demanded in Kg Quantity Demanded in Kg

20. Shift in Demand

21. Price Elasticity of Demand Dr.Marshall has defined price elasticity of demand as follows:”The elasticity of demand in market is great or small according to the amount demanded increases much or little for a given rise in the price”. We can define price elasticity of demand as the degree of responsiveness of demand for commodity to a change in price. “Price elasticity of demand is the ratio of proportionate change in the quantity demanded of commodity to given proportionate change in its price”. It is the ratio of the relative change in quantity to a relative change in price.

22. Price Elasticity of Demand Change in Demand due to Change in Price %change in the elasticity demanded of X %change price of X . Price elasticity E pd = Example: When the price of a produce was Rs. 10 the demand was 100 units and when the price changed to Rs.11 the demand was 95 units %Change in Demand=D2-D1/D1*100 =95-100/100*100 =-5% % Change in Price=P2-P1/P1*100 =11-10/10*100 =10% E pd = -5%/10% =-0.5

23. Types of Price Elasticity of Demand There are six types of Price Elasticity of Demand as under:- Zero elastic Demand. Less than Unitary Elastic Demand Unitary Elastic Demand More than Unitary Elastic Demand Perfectly Elastic Demand Negative Elastic Demand

24. Zero Price Elasticity of Demand N o cha n g e i n D e mand e v en t h oug h the r e is change in Price Pri c e Chan g es f r o m R s .1 /- t o R s . 1 1/ -. D e mand remains at 100 units Epd = 0. Angle : 90 degree Graph”

25. Zero Price Elasticity of Demand N o cha n g e i n D e mand e v en t h oug h the r e is change in Price Pri c e Chan g es f r o m R s .1 /- t o R s . 1 1/ -. D e mand remains at 100 units Epd = 0. Angle : 90 degree

26. Less than Unitary Elastic Demand Chan g e i n Dem a n d i s less p r o p ortion a t e to change in Price Pri c e Chan g es f r o m R s .1 /- t o R s . 1 1/ -. D e mand Changes from 100 to 95 units Epd < 1. Angle : <90 degree > 45 degree Graph”

27. Unitary Elastic Demand Chan g e i n Dema n d i s p r oportion a t e to in Price c ha n g e Pri c e Chan g es f r o m R s .1 /- t o R s . 1 1/ -. D e mand Changes from 100 to 90 units Epd = 1. Angle : 45 degree Graph”

28. More than Unitary Elastic Demand Chan g e i n Deman d i s m o r e p r oportion a t e to change in Price Pri c e Chan g es f r o m R s .1 /- t o R s . 1 1/ -. D e mand Changes from 100 to 85 units Epd > 1. Angle : <45 degree > 0 degree Graph”

29. Infinite Elastic Demand Chan g e i n Deman d e v en thou g h the r e i s no change in Price Chan g e i n Deman d e v en thou g h the r e i s no change in Price Epd = ∞. Angle : 0 degree Graph”

30. Supply Analysis The quantity of stock offered for sale at a particular price is called as Supply. There is a difference between the Stock and Supply. Example: A farmer has 100 Kg of Rice. The price is Rs.40 per KG. He has offered 60 KG for sale at this rate. Then the stock is 100 Kg and supply is 60 KG. Sup p ly i s l e s s t h an or e q ua l t o S t oc k . Sup p ly cannot be more than Stock

31. Law of Supply The law of Supply state that “other things remaining unchanged”, the quantity of goods supplied will vary in direct proportion with its price i.e. the lower price, the less will be the quantity supplied and vice –versa. If Price goes up the Supply goes up and If Price comes down the Supply comes down.

32. Supply Schedule Supply schedule shows the various quantities of a commodity which bought at different prices during a specific period. Price of Vegetable per Kg in Rs 6 8 10 Quantity Supplied in Kg 15 25 30

33. Supply Curve Price 10 8 6 15 25 30 (Supply)

34. Law of Supply When the price of a goods rises, other things remaining the same, its quantity which is offered for sale increases and if price falls, the amount available for sale decreases.

35. Determinants of Supply The Cost of Production. Technology. N a tu r al c ond i tion s . Ra i n f a l l , w e a the r , Natural calamities. G o v ernme n t policie s r e g a r d i n g t a x r a t e s , Interest rates, subsidy and inflation. Speculation and Hoarding Transportation Costs.

36. Shift in Supply Curve Price S2 10 S 1 8 S2 S 3 6 S1 S3 15 25 30 (Supply)

37. Shift in Supply Curve Shift in Supply means increase or decrease in supply due to factors other than the price . During drought the supply of agricultural goods goes down. During optimum rainfall supply of agricultural goods goes up.

38. Price Equillibrium Equilibrium occurs at the intersection of the demand and supply curves, It indicates efficiency. At this point, the price of the goods will be P* and the quantity will be Q*. These figures are referred to as e q u i lib r i u m pr i ce and qua n tit y .

39. Costs of production are the most important force governing the supply of a product. A firm chooses a combination of factors which minimizes its cost of production for a given level of output. Cost Concepts Production of a commodity involves expenses to be incurred on different factors viz. Land, Labour, Capital and Enterprise. It is the sum total of expenses incurred by the producer to pay for the factors of production. Costs of production have different meanings .

40. Accounting Cost , Money Cost and Real Cost Accounting Cost: All those expenses incurred by a producer that enter the accounts is known as accounting cost. Land : Rent , Labour: Wages, Capital: Interest and Enterprise: Profit. Money Cost: The sum of money spent for producing a particular quantity of commodity is called its money cost. Real Cost : According to Marshall the real cost of production of a commodity is expressed not in money but in efforts and sacrifices undergone in the making of a commodity.

41. Opportunity Cost Opportunity Cost: opportunity cost of a commodity is forgoing the opportunity to produce alternative goods and services. In view of scarcity of resources, every producer has to make a choice among several alternatives. The second alternative use of a resource has to be sacrificed for using it in a particular way. Examples: Rent on own land and building used for business. Salary on the own efforts of owners/proprietor. Interest on the own capital invested by owners.

42. Opportunity Cost: It can be also defined as the benefit forgone on the second best alternative. If you have a building, you can give it on rent. If Opportunity Cost you are using it for the own business, the rent that you would have received is sacrificed by you and that is the opportunity cost of Building. If you were not working in your own business, you would have done a job and earned salary. The salary that you would have received is sacrificed by you and that is the opportunity cost of your services.

43. Explicit cost Explicit cost includes these payments which are made by the employer to those factors of production which do not belong to the employer himself. Direct Contractual Monetary Payments. These costs are explicitly incurred by the producer for buying factors from others on contract. For example, the payments made for raw materials, power, fuel, wages and salaries, the rent on land and interest on capital are all contractual payments made by the employer. Explicit cost is also called accounting cost.

44. Implicit cost Implicit cost includes the opportunity costs of those factors of production which are already owned by the businessman. These costs are not explicitly incurred by the producer for buying factors. Implicit cost is also called opportunity cost.

45. Direct and Indirect Cost Direct Cost indicates that cost which can be identified with the individual cost center. It consists of direct material cost, direct labour cost and direct expenses. It is also termed as Prime Cost. Indirect Cost indicates that cost which cannot be identified with the individual cost center. It consists of indirect material cost, indirect labour cost and indirect expenses. It is also termed as overheads. As it is not possible to identify these costs with individual cost centers, such identification is done in the indirect way by following the process of allocation, apportionment and absorption.

46. Fixed, Variable and Semi-Variable/Semi-Fixed Cost Fixed cost indicates that portion of total cost which remains constant at all the levels of production, irrespective of any change in the later. As the volume of production increases, per unit fixed cost may reduce, but not the total fixed cost. Variable cost indicates that portion of the total cost which varies directly with the level of production. The higher the volume of production, the higher the variable cost and vice versa, though per unit variable cost remains constant at all the levels of production. Semi-variable or semi-fixed cost indicates that portion of the total cost which is partly fixed and partly variable in relation to the volume of production.

47. Graphical Representation a) Fixed Cost. b) Variable Cost c) Semi Variable Cost

48. Marginal cost I n E c onomic s a n d F i nanc e ma r g in a l c o s t i s the change in Total Cost that arises when the quantity produced changes by one unit. It is the cost of producing one more unit of a commodity. The marginal cost of production is the increase in Total cost as a result of producing one extra unit. It is the variable costs associated with the production of one more units. Marginal Cost = Change in Total Cost = ΔTC Change in Output Δ Q

49. Marginal cost: Example Units of Output Total Cost Marginal Cost 1 5 5 2 9 4 3 12 3 4 16 4 5 21 5 6 29 8

50. Sunk Cost The historical cost which has been incurred in the past is called as “Sunk Cost”. This type of cost is normally not relevant in the decision making process. This is also called as the Historical Cost. Example: Cost of acquiring a machinery for the business. The Relevant cost: It the realisable Market Value of an asset. This type of cost is relevant in the decision making process.

51. Controllable and Uncontrollable costs Th e co s ts wh i c h c an b e Co n t r ol l e d b y the management are called Controllable Costs. Example: Advertising expenses, Pay packages. Th e co s ts wh i c h c an n ot b e Co n t r olled b y t h e management are called Uncontrollable Costs. Example: Cost of Interest, Depreciation, Taxes, Dearness Allowances, raw material prices, electricity charges, water charges etc.

52. Normal and abnormal costs The costs which are incurred in the normal course of the business are called as Normal Costs. Example: Rent, Material Cost, Wages, . The costs which are incurred due to the reasons beyond the control of the management such as Floods, earthquake, Tsunami, fire etc are called as abnormal Costs. Example: Dacoit/loot of the goods, Loss of goods due to fire/flood/earthquake.

53. Average costs No of units Fixed cost Average Fixed Cost Variable Cost Average Variable Cost Total Cost Aver Total Cost 100 ,0 n. a . 100 ,0 n.a 200 1 0, 00 500 20,0 100 1 2 0, 00 600 400 1 0, 00 250 40,0 100 1 4 0, 00 350 600 1 0, 00 167 60,0 100 1 6 0, 00 267 800 1 0, 00 125 80,0 100 1 8 0, 00 225 1, 00 1 0, 00 100 1 0, 00 100 2 0, 00 200 1, 5 00 1 0, 00 67 1 5 0, 00 100 2 5 0, 00 167

54. Average Fixed cost. Calculation of average cost is important to fix the selling price per unit. Average Fixed Cost = Total Fixed Cost Total No. Of Units. Total Fixed Cost remains constant but Average Fixed Cost goes on decreasing as the level of production increases. If the production is very high, the average fixed cost may become negligible. This is called Economy of Scale. It means if the scale of business is high, the average fixed cost becomes negligible and average cost becomes equal to variable cost.

55. Average Variable cost. Average Variable Cost = Total Variable Cost Total No. Of Units. Average Variable Cost remains constant but Total Variable Cost goes on increasing as the level of production increases. Average Variable Cost Total Variable Cost

56. Average Total cost. Average Total Cost = Total Fixed + Variable Cost Total No. Of Units. Average Total Cost goes on decreasing as the level of production increases. But, Total Cost goes on increasing as the level of production increases. Average Total Cost Total Cost Total Cost = Total Fixed Cost + Total Variable Cost

57. Formulas. Average Fixed Cost = Total Fixed Cost Total No. Of Units. Average Variable Cost = Total Variable Cost Total No. Of Units. Average Total Cost = Total Cost Total No. Of Units. Total Cost = Total Fixed Cost + Total Variable Cost. Total Variable Cost = Total No. Of Units X Variable Cost Per Unit

58. Abbreviations. TFC = Total Fixed Cost AFC= Average Fixed Cost TVC = Total Variable Cost AVC= Average Variable Cost ATC= Average Total Cost (AC= Average Cost) TC = Total Cost TR= Total Revenue AR= Average Revenue TP = Total Profit AP = Average Profit

59. Average Fixed cost. Fill in the Blanks No of units Fixed cost Average Fixed Cost Variable Cost Average V ariable Cost Total Cost Aver Total Cost 5,000 n. a . 5,000 n.a 200 5,000 25.00 600 5,600 28.00 400 5,000 12.50 3 6,200 15.50 600 8.33 1,800 3 6,800 1 1.33 800 5,000 6.25 2,400 3 9.25 5,000 5.00 3,000 3 8,000 8.00 1,500 5,000 3.33 4,500 3 9,500 2,000 5,000 6,000 3 1 1,000 5.50 2,500 5,000 2.00 7,500 3 12,500 5.00

60. Revenue Concepts. Revenue also means Total Sales or Turnover. Total Revenue = Total No. Of Units X Selling Price Per Unit Average Revenue = Total Revenue Total No. Of Units. Total Profit = Total Revenue-Total Cost Average Profit = Total Profit Total No. Of Units.

61. Marginal Revenue. The Marginal Revenue is the increase in Total Revenue as a result of selling one extra unit. Marginal Revenue = Change in Total Revenue = ΔTC Change in Quantity Δ Q No of units Sales Change in Units Change in Revenue Marginal Revenue 200 30000 400 60000 200 30000 150 600 87000 200 27000 135 800 112000 200 25000 125 1,000 136000 200 24000 120

62. Cost, Volume and Profit Relation. No of units Total Cost Aver Total Cost Sales (Revenue) Average Revenue Total Profit Average Profit No of units 10,000 n.a n.a -10,000 na 500 15,000 30 7,500 15 -7,500 -15 500 1,000 20,000 20 15,000 15 -5,000 -5 1,000 1,500 25,000 17 22,500 15 -2,500 -2 1,500 2,000 30,000 15 30,000 15 2,000 5,000 60,000 12 75,000 15 15,000 3 5,000 10,000 110,000 11 150,000 15 40,000 4 10,000