Unit 1.pdf of mba of far Western University

Firstcsem

2. Subject code: Eco 522
Credit Hours: 2
Semester: First
Lecture Hours: 30
F.M. 100
P.M. 50
Time: 4 hrs
Saturday, February 10,
2024R K Saud Asst. Prof. FWU 2

3. Group-A: Case Analysis-1: (1×20 = 20 marks)
Group-B: Problem solving/Critical analysis
questions-6 (any five): (5 ×12 = 60 marks)
Group-C: Concept based short answer questions-4
(all): 4 ×5 = 20 marks
Saturday, February 10,
2024R K Saud Asst. Prof. FWU 3

4. Unit -1: Introduction and Objectives Firm (LH 6)
Unit -2 : Demand Analysis and Forecasting (LH 6)
Unit -3 : Theory of Production and Cost (LH 6)
Unit -4 : Pricing Theory and Techniques (LH 7)
Unit -5: Role of Government in Market (LH 5)
Saturday, February 10, 2024 R K Saud Asst. Prof. FWU 4

5. Text Books:
1. Dwivedi, D. N. (2008). Managerial Economics, 7th
Edition, VikashPublishing House PVT LTD.
2. Hirschey, Mark (2009). Fundamentals of Managerial
Economics, 9th Edition, CengageLearning
3. Salvatore, D. (2012). Managerial Economics Principles
and Worldwide Application, 7th Edition, Oxford University
Press.
4. Petersen, Craig H., Lewis, W Cris, Jain, SudhirK.
(2009). Managerial Economics, 4th Edition, Indian Institute
of Technology, Delhi.
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2024R K Saud Asst. Prof. FWU 5

6. 1. Mankiw, N. G. (2011), Principles of Microeconomics.
Sixth Edition, USA: South Western College publication.
2. P. Robert S., R. Daniel L., M. Prem L. (2012).
Microeconomics, 7th Edition, Published by Dorling
Kindersley (India) Pvt. Ltd.
3. Dwivedi, D. N. (2012 ). Microeconomics, Theory and
Application, 2nd Edition, Dorling Kindersley (India) Pvt. Ltd.
4. Chandra, P. (2002), Project Planning, Analysis Financing,
Implementation and Review, New Delhi, Tata McGraw-Hill
Publishing Company Limited.
Saturday, February 10,
2024R K Saud Asst. Prof. FWU 6

7. Other Books (Nepali Writer):
1)Managerial Economics: Prof. Dr. ShyamJoshi
2)Business Economics: SushilKumar Nepal and two
others
3)Managerial Economics: Prof . Tara P Bhusal, Shankar
DattBhatt and three others
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2024R K Saud Asst. Prof. FWU 7

8. Meaning and Scope of Managerial Economics
Role of Managerial Economics in Business Decision Making
Organizational Objectives:
1.Profit Maximization
2.Sales Maximization
3.Value Maximization
4.Simon’s Theory of Satisfaction Behaviour and
5.Williamsons’ Model of Managerial Discretion
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2024R K Saud Asst. Prof. FWU 8

9. ReasonsfortheemergenceofManagerialEconomics
asaseparatecourseofmanagementstudies:
1)Growingcomplexityofbusinessdecisionmaking
processduetochangingmarketconditionsand
businessenvironment.
2)Theincreasinguseofeconomiclogic,concepts,
theoriesandtoolsofeconomicanalysisinthe
processofbusinessdecisionmaking.
3)Rapidincreaseindemandforprofessionally
trainedmanagerialmanpower.etc
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2024R K Saud Asst. Prof. FWU 9

10. Nowadays,businessdecisionprocesshasbecome
increasinglycomplicatedduetoevergrowing
complexitiesinthebusinessworld.
Therewasatimewhenbusinessunitsweresetup,
ownedandmanagedbyindividualsorbusiness
families.
But,nowtheindustrialbusinessworldhaschanged
drasticallyinsize,natureandcontent.
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2024R K Saud Asst. Prof. FWU 10

11. Thegrowingcomplexityofthebusinessworldcanbe
attributedtothegrowthoflargescaleindustries,
growthoflargevarietyofindustries,diversification
ofindustrialproducts,expansionanddiversification
ofbusinessactivitiesofcorporatefirms,growthof
multinationalcorporationsetc.especiallyafterthe
secondworldwar.
Thesefactorshavecontributedagreatdealtothe
recentincreaseininter-firmandinternational
competition,riskanduncertainty.
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2024R K Saud Asst. Prof. FWU 11

12. Businessdecisionmakinginthiskindofbusiness
environmentisverycomplexaffairandthefamily
trainingandexperienceisnolongersufficienttomet
themanagerialchallenges.
Forbusinessdecisionmaking,thereisneedof
applicationofeconomicconcepts,theoriesandtoolsof
economicanalysis.
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13. Theapplicationofeconomicconcepts,
theories,logicandanalyticaltoolsinthe
assessmentandpredicationofmarket
conditionsandbusinessenvironmenthas
provedtobeofgreathelpinbusinessdecision
making.
Thecontributionofeconomicstobusiness
decisionmakinghascometobewidely
recognized.
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2024R K Saud Asst. Prof. FWU 13

14. Consequently,theeconomictheoriesand
analyticaltools,whicharewidelyusedin
businessdecisionmaking,areincludedina
separatebranchofmanagerialstudies,called
‘ManagerialEconomics’.
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2024R K Saud Asst. Prof. FWU 14

15. Managerialeconomicsisapartofeconomicsandit
provideseconomictheories,analyticaltoolanddecision
makingtoolsinbusinessandeconomicsactivitiestothe
Managerialeconomics.
Therefore,weshouldhaveknowledgeabouteconomics.
Economicsisasocio-economicscienceanditisthestudy
ofeconomicactivitiesofhumanbeing.
Itsbasicfunctionistostudyhowpeoplelikeindividuals,
households,firmsandnationmaximizetheir
gains/satisfactionfromtheirlimitedresourcesand
opportunities.
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2024R K Saud Asst. Prof. FWU 15

16. Ineconomicterminology,thisiscalledmaximizing
behavior,ormoreappropriately,oroptimizing
behavior.
Optimizingbehaviorisselectingthebestoutof
availableoptionswiththeobjectiveofmaximizing
gainsfromthegivenresourcesorminimizingcostfor
givenoutput.
Themainobjectiveofeconomicsishow
households/consumersmaximizetheirsatisfaction
andfirms/producersmaximizetheprofitorminimize
thecostofproductionbyallocatingtheirlimited
resources.
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2024R K Saud Asst. Prof. FWU 16

17. Therefore,economicsisastudyofthechoicemaking
behaviorofthepeople.
However,choicemakingi.e.decisionmakingisnotas
simpleasitlooks,undertheconditionofimperfect
knowledge,riskanduncertainty.
Therefore,takinganappropriatedecisioninanextremely
complexsituationisaverydifficulttask.
Forthecomplexdecisionmakingprocess,economists
havedevelopedalargekitofanalyticaltoolsand
techniqueswiththeaidofmathematics,econometrics
andstatistics,thatareusedinmanagerialeconomics.
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2024R K Saud Asst. Prof. FWU 17

18. Managerialeconomicsreferstotheapplication
ofeconomictheory,lawsandtoolsofanalysis
ofdecisionsciencetoexaminehowan
organizationcanachieveitsobjectivesmost
efficiently.
Itcanbebroadlydefinedasthestudyof
economictheories,logicandtoolsof
economicanalysisthatareusedintheprocess
ofbusinessdecisionmaking.
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2024R K Saud Asst. Prof. FWU 18

19. Economictheoriesandtechniquesof
economicanalysisareappliedtoanalyze
businessproblems,evaluatebusinessoptions
andopportunitieswithaviewtoarrivingata
appropriatebusinessdecision.
Managerialeconomicsisthusconstitutedof
thatpartofeconomicknowledge,logic,
theoriesandanalyticaltoolsthatareusedfor
rationalbusinessdecisionmaking.
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2024R K Saud Asst. Prof. FWU 19

20. AccordingtoMansfield,-“Managerial
economicsisconcernedwiththeapplicationof
economicconceptsandeconomicstothe
problemsofformulatingrationaldecision
making.”
AccordingtoSpencerandSEigelman,-
“Managerialeconomicsistheintegrationof
economictheorywithbusinesspracticeforthe
purposeoffacilitatingdecisionmakingand
forwardplanningbymanagement.”
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2024R K Saud Asst. Prof. FWU 20

21. AccordingtoDouglas,-“Managerialeconomicsis
concernedwiththeapplicationofeconomic
principlesandmethodologiestodecisionmaking
processwithinthefirmororganization.Itseeksto
establishingrulesandprinciplestofacilitatethe
attainmentofthedesiredeconomicgoalsof
management.”
Thus,managerialeconomicsistheappliedand
decisionmakingscience,thatincludesthepractical
theoriesandconceptsofeconomics.
Theapplicationofeconomicconcepts,theoriesand
quantitativetoolscanbeshownbyfollowingfigure:-
Saturday, February 10,
2024R K Saud Asst. Prof. FWU 21

22. Saturday, February 10,
2024R K Saud Asst. Prof. FWU 22
Managerial Decision areas:
Selecting business area
Choice of fund
Determining optimal output
Determining price of the product
Determining input combination and technology
Sales promotion
Application of economic
concepts and
theories in decision making
Use of quantitative methods
Mathematical tools
Statistical tools,
Econometrics
Managerial Economics
Application of economic concepts, theories
and analytical tools to find optimum solution
to business problems
Figure-1

23. Saturday, February 10,
2024R K Saud Asst. Prof. FWU 23
Managerial Economics
Economic theory
Micro-economics
Macro-economics
Decision science
Mathematical economics
Econometric
Managerial Economics
Application of economic theory
and decision science tools to
solve managerial decision problems
Optimal solution to managerial problems
Figure-2

24. Scopeofmanagerialeconomicsincludesthearea,subject
matter,nature,importanceandlimitationofmanagerial
economics.
Againnature,importanceandlimitationsofmanagerial
economicsdependsonsubjectmatterofmanagerialeconomics.
Therefore,scopeofmanagerialeconomicsdependsonthe
subjectmatterofmanagerialeconomics.
Thatis,scopeandsubjectmatterareusedinsimilarmeaning.
Ingeneral,thescopeorsubjectmatterofmanagerialeconomics
includesallthoseeconomicconcept,theoriesandtoolsof
analysiswhichcanbeusedtoanalyzeissuesrelatedtodemand
prospects,levelofcompetitionandgeneralbusiness
environment.
Saturday, February 10,
2024R K Saud Asst. Prof. FWU 24

25. Theareaofbusinessissuestowhich
economictheoriescanbedirectlyapplied
maybebroadlydividedintofollowingtwo
categories:-
1.Micro-economicsappliedtooperationalor
internalissuesand
2.Macro-economicissuesappliedto
environmentalorexternalissues.
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2024R K Saud Asst. Prof. FWU 25

26. Operational and internal issues includes all
those problems arise within the business
organizations.
Some internal issues are: i) what to produce
ii) how to produce iii) how much to produce
iv) for whom to produce v) how to price of
the commodity vi) how to promote sales vii)
how to face price competition viii) how to
determine new investment ix) how to manage
capital x) how to manage human resource
etc.
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2024R K Saud Asst. Prof. FWU 26

27. Thefollowingmicroeconomictheoriesdeal
withmostofthesequestions:
a)TheoryofDemand:
Theoryofdemanddealswithconsumer’s
behavior.
Itanswerthequestionssuchas–howtothe
consumerdecideonthequantityofa
commoditytobepurchased?Whendothey
stopconsumingacommodity?Howdothe
consumerbehavewhenpriceofthe
commodity,incomeetc.changes.
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2024R K Saud Asst. Prof. FWU 27

28. Theknowledgeofdemandtheorycan
thereforebehelpfulinmakingthechoiceof
thecommodities,findingoptimallevelof
outputandindeterminingthepriceofthe
product.
Theoryofdemandincludesfactorsaffecting
thedemand,typesofdemand,elasticityof
demand,techniquesofdemandforecastingetc.
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2024R K Saud Asst. Prof. FWU 28

29. b)TheoryofProductionandProduction
Decision:
Productiontheoryexplainstherelationship
betweeninputsandoutput.
Italsoexplainshowtotaloutputbehaves
whenunitofonefactorsorallfactorsare
increased?Howoptimumcombinationof
inputsbedetermined?Howcantheoptimal
sizeofoutputbedetermined?
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2024R K Saud Asst. Prof. FWU 29

30. Theproductiontheorythus,helpsin
determiningthesizeofthefirm,sizeofthe
totaloutput,amountofcapitalandlabourtobe
employedetc.
Theoryofproductionincludestheproduction
function,optimaluseofaninput,optimaluse
oftwoinputs,economiesofscopeetc.
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2024R K Saud Asst. Prof. FWU 30

31. c)AnalysisofMarketStructureandPricing
Theory:
Pricetheoryexplainshowpriceis
determinedunderdifferentmarketstructures.
Pricetheorycanbehelpfulindetermining
pricepolicyofthefirm.
Itincludesthepricingunderdifferentmarket
structures,strategicbehaviourandgame
theory.
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2024R K Saud Asst. Prof. FWU 31

32. d)ProfitAnalysisandProfitManagement:
Itexplainsthetechniquesofprofit
maximizationundertheconditionsofrisk
anduncertainty.
Profittheoryguidesthefirminthe
measurementandmanagementofprofit.
Itincludesthetechniquesofcalculatingthe
purereturnoncapital,pureprofitandfactors
affectingprofit.
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33. e)TheoryofCapitalandInvestment
Decisions:
Capitalisthefoundationofbusiness.
Itsefficientallocationandmanagementis
oneofthemostimportanttaskofthe
managers.
Themajorissuesrelatedtocapitalarei)
choiceofinvestmentprojectii)efficiencyof
capitaletc.
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2024R K Saud Asst. Prof. FWU 33

34. Knowledgeofcapitaltheorycancontributea
greatdealinindustrialdecisionmaking,
choiceofprojects,capitalbudgetingetc.
Itincludesthefactorsaffectinginvestment
decision,riskanalysis.
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2024R K Saud Asst. Prof. FWU 34

35. Businessenvironmentisrelatedtotheoverall
economic,socialandpoliticalatmosphereof
thecountryaswellastheworld.
Itincludesthetypeeconomicsystem,general
trendsinnationalincome,price,salaries,
investment,employment,magnitudeand
trendsinforeigntrade,conditionoffinancial
institutions,trendinlabourmarket.
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36. Italsoincludesthecapitalmarkets,economic
policiesofthegovernment,socialtraditions,
customs,conditionoftradeunions,political
environment,degreeofglobalizationetc.
Theseenvironmentalfactorsarefarbeyondthe
powersofasinglefirmbuttheyaredirectlyor
indirectlyaffectingthebusinessdecision
making
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2024R K Saud Asst. Prof. FWU 36

37. So,businessdecisionmakershavetotakeinto
accountthepresentandfutureeconomic,
politicalandsocialconditioninthecountry
andtheseallarethesubjectmatterof
managerialeconomics.
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2024R K Saud Asst. Prof. FWU 37

38. Decisionmakingisanimportantfunctionofa
businessexecutive.
Itisaprocessofselectingaparticularcourseof
actionfromamongnumberofalternativecourse
ofaction.
Thatis,ittheprocessofselectingbestalternate
outofdifferentalternatives.
Ifallthefactorsofproductionareeasily
available,thenthereisnoneedofdecision
making.
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2024R K Saud Asst. Prof. FWU 38

39. But,thefactorsofproductionarelimitedand
canbeusedformanypurposeandthereare
unlimitedendsofafirm.
So,thequestionofchoicemakingarises.
Decisionswillhavetobemadeinconditionof
uncertaintyandmustformulateplansforthe
future.
Insuchsituation,managerialeconomicsisof
considerablehelp.
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40. Managerialeconomicsusestheprinciples,
lawsandmethodsinmanagerialdecision
making.
Byusingthetoolsandtechniquesofeconomic
analysisinsolvingmanagerialproblems,
managerialeconomicslinksthetraditional
economicswiththedecisionscience.
Asaresult,managerialeconomicsdevelops
thetools,whichareimportantformanagerial
decisionmaking.
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2024R K Saud Asst. Prof. FWU 40

41. Itteachesthemanagerashowtheworks
shouldbedoneefficientlytoachievethe
objectives.
Italsohelptoknowthathoweconomicfactor
affectstheorganizationandidentifyingthe
waystoachieveobjectivesoftheorganization
efficiently.
Itprovidespricingandoutputstrategiesforthe
efficientattainmentoftheobjectiveslikerapid
growthforthefirmorprofitmaximizationor
outputmaximizationetc.
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42. Ithelpsthefirmsintheproperuseofscare
capitalandhumanresources.
Managerialeconomicsexplainshowthe
economicenvironmentaffectsmanagerial
decisionsandhowthemanagerialdecision
affecteconomicenvironment.
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43. Managerialeconomicsprovidesthebasisfor
evaluatingwhethertheresourcesarebeing
efficientlyallocatedwithinthefirmornot.
Thetheoriesofmanagerialeconomicshelps
themanagertoactaccordingtovarious
economicsignalsorindicators.
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2024R K Saud Asst. Prof. FWU 43

44. Suppose a firm/organization plans to lunch a
new product in Mahendranagarfor which
close substitutes are available in market. If the
matter has to decided by the managers of the
firm or organization themselves, then discuss
the areas which they will need to investigate
and analyze.
Hints:-a) Production related issues and
b) Sales prospects and problems.
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2024R K Saud Asst. Prof. FWU 44

45. In regard to production related issue, managers will
be required to collect and analyze the data on:-
Available techniques of production.
Cost of production associated with each production
techniques.
Supply position of inputs required to produce the
planed commodity.
Price structure of competitive products.
Price structure of inputs.
Available of foreign exchange if inputs are to be
imported.
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46. Inregardtosalesprospectsandproblems
managersarerequiredtocollectandanalyzethe
dataon:-
Marketsize,generalmarkettrendsanddemand
prospectsfortheproducts.
Priceofcompetingproducts.
Trendsinindustrytowhichtheplanedproductbelongs.
Majorexistingandpotentialcompetitorsandtheir
respectivemarketshares.
Pricingstrategyoftheprospectivecompetitors.
Marketstructureanddegreeofcompetition.
Supplypositionofcomplementarygoods.Etc.
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47. Therearevariousobjectivesofafirm.
Thetraditionalobjectiveofafirmistomaximizethe
profit.
Nowadays,therearedifferentotherobjectiveslike
valuemaximization,salesrevenuemaximization,
goodwillmaximization,satisfactionmaximization
etc.onthebasisofempiricalanalysis.
Butthefinaltargetofallotherobjectiveisalsoprofit
maximization.
Thispartanalyzethedifferentempiricaltheoriesof
firmincludingtraditionaltheoryofafirm.
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48. Itisatraditionalandimportantobjectiveofa
firm.
Itisalsoknownasbasicorfundamental
objective.
Thismodelassumesthatafirmorproducer
alwaystrytomaximizeitsprofit.
Thefollowingarethemainassumptionsof
thismodel:
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2024 48R K Saud Asst. Prof. FWU

49. Thefirmisanindividualenterprises
Rationalentrepreneur
Eachfirmproducesonlysinglegoods
Priceoffactorsofproductionremainsconstant
Allthefactorsofproductionarehomogeneousetc.
Onthebasisofaboveassumptions,equilibrium
conditionofafirmwithprofitmaximizationcan
explainedbyusingfollowingtwoapproaches:
1.TR-TCapproachand
2.MR-MCapproach
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2024 49R K Saud Asst. Prof. FWU

50. UnderTR-TCapproach,themainobjectiveofafirmisto
maximizetheprofit.
So,afirmalways,trytomaximizeitsprofit.
TR-TCapproachisonetraditionalwayoffinding
equilibriumunderprofit-maximizationmodel.
Profitismaximizedatthatoutputlevelatwhichtotal
revenueexceedstotalcostbythelargestamount.
Accordingthisapproach,profitisthedifferencebetween
totalrevenueandtotalcost.
50
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2024R K Saud Asst. Prof. FWU

51. IfthepositivedifferencebetweenTRandTCismaximum
thenthefirmwillbeinequilibrium.
Inotherwords,underthisapproachthefirmwillproduce
thatlevelofoutputwherethepositivedifferencebetween
totalrevenueandtotalcostismaximizedi.e.
Profit=TR–TC……(i)
=Maximum
Therefore,underTR–TCapproach,thefirmwillbein
equilibriumwhenitgetsmaximumprofit.
51
Saturday, February 10,
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52. Thatis,inthissituationthefirmwillbein
equilibriumwithmakingmaximumprofit.
Theequilibriumsoffirmunderthisapproachcanbe
explainedbyusingfollowingfigure:
52
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53. Saturday, February 10,
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54. Intheabovebothfigures,theequilibriumconditionofa
firmunderTR–TCapproachhasbeenexplained.
TheTRlineunderperfectcompetitionisupwardsloping
straightlineduetotheconstantpriceforeveryunitsand
theTRlineunderimperfectcompetitionormonopolyis
initiallyincreasesatdecreasingrateandafterreachingthe
maximumpoint,itstartstodecreaseduedecrreseinprice
withtheincreaseinquantitysold.
54
Saturday, February 10,
2024R K Saud Asst. Prof. FWU

55. Intheshortrun,thetotalcostcurveisdeterminedby
thelawofvariableproportionunderbothmarkets.
So,inthebeginningitincreasesatdecreasingrateand
lateronincreasesatincreasingrateanditsshapeis
nearlyinverseof‘S’.
Inthefirstfigure,afirmisbearinglossesbeforeM
1
andafterM
2unitsofoutputandtheprofitorpositive
gapbecomesmaximumatMlevelofoutput.
55
Saturday, February 10,
2024R K Saud Asst. Prof. FWU

56. Thisfactisjustifiedbythetotalprofitcurve(TPC),
whichisnegativeuptoM
1levelofoutputandthenit
ispositivebetweenM
1M
2levelofoutputand
becomesmaximumatMlevelofoutput,finallyafter
M
1itbecomesnegative.
So,M
1istheequilibriumlevelofoutput,wheretotal
profitbecomesmaximum.
Similarly,Inthesecondfigure,afirmisbearing
lossesbeforeCandafterDunitsofoutputandthe
profitorpositivegapbecomesmaximumatQlevel
ofoutput.
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2024R K Saud Asst. Prof. FWU 56

57. Thisfactisjustifiedbythetotalprofitcurve(TP),
whichisnegativeuptoClevelofoutputandthenitis
positivebetweenCDlevelofoutputandbecomes
maximumatQlevelofoutput,finallyafterDit
becomesnegative.
So,Qistheequilibriumlevelofoutput,wheretotal
profitbecomesmaximum.
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2024R K Saud Asst. Prof. FWU 57

58. MR –MC approach is a modern approach for equilibrium
or profit maximization of a firm under every market
structure.
According to this approach, equilibrium of a firm under
perfect competition and other market is explained on the
basis of MR and MC.
Marginal revenue is the additional revenue obtained from
the sale of one extra unit of goods and marginal cost is the
additional cost of production to produce one extra unit of
output.
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Saturday, February 10,
2024R K Saud Asst. Prof. FWU

59. Thisapproachexplainsthatwhenmarginalrevenue
andmarginalcostareequaltoeachotherthenthe
firmgetsequilibriumandearnsmaximumprofit.
Accordingtothisapproach,theproducerwill
continueincreaseinproductiontillMRisequalto
MC.
TheequalitybetweenMRandMCmaybeattwo
levelsofproduction.
Thissituationisonlynecessaryconditionfor
equilibriumbutforthesufficientconditionMCmust
cutsMRfrombelow.
59
Saturday, February 10,
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60. Therefore,thefollowingtwoconditionsmustbefulfilled
forprofitmaximizinglevelofoutputunderthis
approach.
1)Necessaryconditionforequilibrium:
MC=MR
1)Sufficientconditionforequilibrium:
MCcutsMRfrombelowi.e.
slopeofMC˃slopeofMR
Whenthesetwoconditionsarefulfilled,thenthefirmis
saidtobeinequilibriumwithmaximizationofprofit.
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61. On the basis of above analysis and two conditions, short
run equilibrium of a with profit maximization can be
explained by the following figure:
(Under Perfect Competition)
61
AR=MR=P
Output
Qe
Q1
O X
Y
Pe
A B
EM
Abnormal Profit
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2024R K Saud Asst. Prof. FWU

62. (Under Imperfect Competition or Monopoly)
62
AR=P
Output
Qe
O
X
Y
Pe
A B
E
C
Abnormal Profit
MR
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2024R K Saud Asst. Prof. FWU

63. In the above both figures, equilibrium of a firm is
explained with the help of MR and MC curves.
In these figure, MC and MR are equal to each other and
MC cuts MR from below at point ‘E’.
That is, the necessary and sufficient condition for
equilibrium are fulfilled at point ‘E’, so this point is an
equilibrium point and at this point, profit of a firm
becomes maximum.
63
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2024R K Saud Asst. Prof. FWU

64. At this point the firm sells OQ
eunits at OP
eprice and
maximized its profit.
The firms profit per unit at this point is BE and the total
profit is P
eABE on both figures.
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2024R K Saud Asst. Prof. FWU

65. This model is a neo-classical model of firm’s objective.
This model is also known as shareholder’s wealth
maximization.
It is the analysis of value maximization objective of a
firm and this model is modified form of profit
maximization.
So, this objective of a firm is also known as long run
profit maximization objective.
65
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2024R K Saud Asst. Prof. FWU

66. According to this model, the act or process of adding to
an individual's net worth by increasing the share price of
the common stock in which that individual has invested.
It says that all firms seek to maximize their total market
value and maximizing social welfare .
If the manager of a firm is able to receive more and more
return then value of a firm will be maximized.
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2024R K Saud Asst. Prof. FWU 66

67. Under this model, the main objective of the financial
manager is to maximize the shareholder’s wealth and
wealth of shareholders is measured on the basis of price
of share.
This model focused that profit of a firm in the beginning
may reduce but it should increase for long period of time
so as to maximize the value of shares.
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2024 67R K Saud Asst. Prof. FWU

68. If there is maximization of long run profit then there
will be value maximization or shareholder’s wealth
maximization.
According to this model, value maximization is the
maximization of present value or discounted value of
future profit.
Present value is the firm’s expected future profit
discounted to present value.
Saturday, February 10,
2024 68R K Saud Asst. Prof. FWU

69. Symbolically, it can be expressed as follows:
Maximize of PV (π) = π
1+ π
2+…. …….. π
n….(i)
 (1+r) (1+ r)
2
(1+r)
n
Where, π1, π2, …….πn = future expected profit of ‘n’ years.
 r = discount rate
 t = time period
 n = no of years
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2024 69R K Saud Asst. Prof. FWU
n

70. In this way, the present value of expected future profit
should be maximize for value maximization of a firm
or shareholder’s wealth maximization.
If there is maximization of wealth then there will be
maximization of long run profit.
Saturday, February 10,
2024 70R K Saud Asst. Prof. FWU

71. Sales maximization model is also known as sales revenue
maximization model.
This model was explained by W.J. Boumol by criticizing
profit maximization model.
According to Boumol, the main objective of manager is
to maximize the sales revenue in place of maximization
of profit.
Boumol conclude that, a firm under oligopoly wants to
maximize its sales subject to a minimum profit
constraint.
Saturday, February 10,
2024 71R K Saud Asst. Prof. FWU

72. In this way, this model explains that there should be
minimum profit but total sales revenue or market share
should be maximized.
Under this objective, output is greater and price is lower
than under the objective of profit maximization.
Boumol analyze that in modern businesses, owners and
management are separate.
Therefore, top management always want to maximize
the sales revenue in place of profit maximization.
Saturday, February 10,
2024 72R K Saud Asst. Prof. FWU

73. The following are the main reason for sales maximization:
The salary and other facilities of top management depends
on sales revenue than profit.
Banks and financial institutions can provide more loan on
the basis of sales in place of profit.
Maximization of sales is beneficial and easy to provide
salary and other facilities to the employee.
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2024R K Saud Asst. Prof. FWU 73

74. Increase in sales will determine the efficiency and
prestige of the manager.
Easy to competitive with others with the sales revenue
maximization. etc.
According to Baumol, there are two types of
equilibrium under sales revenue maximization model.
They are:
1.Sales revenue maximization without profit
constraint and
2.Sales revenue maximization with profit constraint
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2024 74R K Saud Asst. Prof. FWU

75. Saturday, February 10,
2024 75R K Saud Asst. Prof. FWU
N
P1
L

76. In the above figure, TR and TC are the total revenue
and total cost curves respectively.
Similarly, TP is the total profit curve, which is the
positive difference between TR and TC curves.
Initially TP curve is continuously increasing and after
reaching the maximum point it is continuously
decreasing and also becomes negative.
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2024R K Saud Asst. Prof. FWU 76

77. According to the above figure, if the firm aims to
maximize the profit, then it will produce OQ units of
output with QB level of profit.
But, according to this model, firm should maximize its
sales revenue.
So, the firm will produce OK level of output, where TR
becomes maximum.
At OK level of output, the total profit is KS, which is
less than QB.
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2024R K Saud Asst. Prof. FWU 77

78. In this way, OK level of output under the objective of
sales revenue maximization without profit constraint is
more than the OQ level of output under the objective of
profit maximization.
If the firm’s objective is to earn certain level of profit i.e.
profit constraint or OM level of profit then the firm will
produce OD level of output.
Similarly, if the firm’s profit constraint is ON, then the
firm will produce OL level of output and so on.
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2024R K Saud Asst. Prof. FWU 78

79. Again, under the objective of sales revenue
maximization with profit constraint, there is the greater
output and lower level of price than under the objective
of profit maximization.
In this way, Baumol conclude that sales revenue
maximization objective is better than the profit
maximization objective of a firm.
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2024R K Saud Asst. Prof. FWU 79

80. This model of a firm is related with managerial
discretion or judgment/diplomacy.
According this theory, the managers look their self
interest while making decisions about price, output,
sales, advertisement etc of a firm.
This theory conclude that managers are motivated
by their self interest and they are not interested for
profit maximization.
The managers of a company always wants to
increase their own utility by increasing salary,
security, power etc.
Saturday, February 10,
2024 80R K Saud Asst. Prof. FWU

81. Therefore, according to this theory, the main objective
of a manager is to maximize his/her utility and the
manager’s utility functionis expressed as follows:
U = f ( S, M, I
D) …………….(i)
Where, U = manager’s utility
 f = function
 S = expenditure on staffs
 M = managerial emoluments or management slack/ Extra facilities
to the manager
 ID = discretionary or flexible investment
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2024R K Saud Asst. Prof. FWU 81

82. On the basis of this theory, factors determining utility
of a manager are as follows:
1.The salaries and other forms of monetary
compensation to the manager.
2.Quality of staffs and control over the number of
staffs.
3.Managerial emoluments like extra facilities of
personal secretary, car, and other equipments.
4.Discretionary investment expenditure i.e. amount
that the manager spend according to his desire. etc
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2024 82R K Saud Asst. Prof. FWU

83. According to Williamson, if the above factors
favourable for manager then the utility of manager
becomes maximum.
That is, all the managers wants to maximize their
utility subject to minimum profit constraint.
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2024 83R K Saud Asst. Prof. FWU

84. The following are the two levels of decision makingfor
achieving the goals of a firm:
1.Decision at the top level management (resource
allocation to various department)
2.Decision at the lower level of administration (various
degree of freedom for action)
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2024R K Saud Asst. Prof. FWU 84

85. ThistheorywaspropoundedbyHerbertAlexander
Simonin1955AD.
Thistheorywasfirstbehaviouraltheoryrelatedwith
firm,whichwasbasedonthecriticismofprofit
maximizationmodelofthefirm.
Thistheoryexplainedthatbusinessfirmswantsto
achieveasatisfactorylevelofprofitratherthan
maximizinglevelofprofit.
Saturday, February 10,
2024R K Saud Asst. Prof. FWU 85

86. Simonexplainsthatmanagerswillhaveimperfect
knowledgefortakingproperdecision.
Heexplainsthatduetotheuncertaintiessurrounding
decisionmakinginreality,businessmencannever
knowwhethertheyaremaximizingprofitornot.
Therefore,businessmenmaynotmaximizetheirprofit
andtheyaimatsatisfactorylevel.
Duetofutureuncertaintiesandlackofaccurateand
requiredinformationrelatedtothefirm,managershave
totakedecisionaboutfutureconditionofthebusiness
onthebasisofpasteventsandincompleteinformation.
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2024R K Saud Asst. Prof. FWU 86

87. Inthelargefirmsmanypeopleareinvolvedinthetopand
mediummanagementandallthesepersonsareinvolvedin
formulatingdifferentpoliciesofthefirmandmostofthelarge
firmscan’tknownaboutwhere,howandfromwhomthe
decisionsaremade.
Thistheoryexplainsthatdifferentgroupswithinafirmand
developtheirownviewandintra-firmpoliticsisimportantinthe
processofpolicymakingoffirm.
Inotherwords,iftherearedifferentdepartmentsinthecompany
theneachdepartmentstrugglestoincreaseitsshareinthe
company’sbudgetandeachdepartmenttriestokeepother
departmentsatalowerlevel.
Inthisway,thepoliticalstrugglewithinthefirmplaysan
importantroleindeterminingitsobjectives.
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2024R K Saud Asst. Prof. FWU 87

88. This theory explained that a firm has satisfactory ambition
level of profit and an ambition level is the level of
achievement that the firm hopes for in a particular field.
The ambition level of profit depends on last experience and
if it is attained easily then the ambition level will be higher
and if it is difficult to attain then it will be decreased .
If the actual performance of a firm fails to obtain ambition
level, then research for new alternatives actively will be
started so that corrective action can be taken to achieve the
ambition level by better performance.
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2024R K Saud Asst. Prof. FWU 88

89. Butthereisaproblemofbudgetforsuchresearchor
exploringdifferentalternativesandasatisfactory
alternativecourseofactionwillbeselectedandthe
firmwillnotgoforallthealternativesformaximizing
profit.
Therefore,thistheoryconcludethatformsaima
satisfyinglevelofprofitratherthanmaximizinglevel
ofprofit.
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2024R K Saud Asst. Prof. FWU 89

90. Thistheorywasunabletoexplaintheequilibriumofa
firm.
Thistheoryexplainsaboutsatisfyinglevelofprofitbut
itisnotclearaboutthatsatisfyinglevelofprofit.
Thistheoryexplainedabouttheintra-firmconflictand
politicsbutdidnotgiveanysolutionsofsuchconflict
andtheireffectondecisionmakingofthefirm.
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2024R K Saud Asst. Prof. FWU 90

91. A company has the following demand and cost function:
Demand function, P = 40 –2Q
Cost function, C = Q
2
+10Q + 4
Determine the optimum level of output(Q), price(P), total
profit (π), and total revenue(R)
a) Under profit maximization
b) Under sales revenue maximization and
c) Under sales revenue maximization subject to profit constraint of
Rs 23.
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2024R K Saud Asst. Prof. FWU 91

92. Given that, P = 40 -2Q ………….(i)
 C = Q
2
+ 10Q +4 ……..(ii)
Q = ?, P = ?, π= ? and R or TR =? Under different
objectives.
a) Calculation of Q,P, πand R under the objective of
profit maximization:
We know that,
Profit(π) = TR –TC
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2024R K Saud Asst. Prof. FWU 92

93. or, π= P*Q –TC
 = (40 -2Q)Q –(Q
2
+ 10Q + 4)
 = 40Q –2Q
2
-Q
2
-10Q –4
π= -3Q
2
+ 30Q -4 ……………(iii)
For profit maximization, first order
derivative of equation (iii) should equal to
zero.
Therefore, d/dQ(π) = 0
or, d/dQ(-3Q
2
+ 30Q -4 ) = 0
or, -6Q + 30 = 0
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2024R K Saud Asst. Prof. FWU 93

94. or, -6Q = -30
or Q = 5 units
Now, putting the value of Q in equation (i), we get:
P = 40 -2*5
P = Rs 30
Similarly, from equation (iii), we get
π= -3(5)
2
+ 30*5 -4
= -75 + 150 -4
π= Rs 71 and TR = P*Q = 30*5 = Rs 150
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2024R K Saud Asst. Prof. FWU 94

95. b) Calculation of Q,P, πand R under the objective of
sales revenue maximization:
We know that,
TR = P*Q
or, TR = (40 -2Q)Q
or, TR = 40Q –2Q
2
……….(iv)
For sales revenue maximization, first order
derivative of equation (iv) should equal to
zero.
Therefore, d/dQ(TR) = 0
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2024R K Saud Asst. Prof. FWU 95

96. or, d/dQ (40Q –2Q
2
)= 0
or, 40 –4Q = 0
or, -4Q = -40
or, Q = 10 units
Now, putting the value of Q in equation (i), we get:
P = 40 -2*10
P = Rs 20
Similarly, from equation (iv), we get;
TR = 40Q –2Q
2

or,
TR = 40 *10 –2(10)
2
or, TR = Rs 200
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2024R K Saud Asst. Prof. FWU 96

97. And, π= TR –TC
or, π= 200 –(10
2
+ 10*10 +4)
or, π= 200 –100 -100 -4
or, π= Rs -4
Therefore, loss = Rs 4
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2024R K Saud Asst. Prof. FWU 97

98. c) Calculation of Q,P, πand R under sales revenue
maximization subject to profit constraint of Rs 23:
We know that,
π= TR –TC
or, π= -3Q
2
+ 30Q -4 [from equation
(iii)]
or 23 = -3Q
2
+ 30Q -4
or, 3Q
2
-30Q + 27 = 0
or, 3Q
2
-27Q -3Q + 27 = 0
or, 3Q( Q –9 ) -3( Q –9) =0
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2024R K Saud Asst. Prof. FWU 98

99. or, (Q –9)( 3Q –3) =0
So, Q –9 = 0 and 3Q -3 = 0
Q = 9 and Q = 1
Now from equation (i),
P= 40 -2 *9 = Rs 22 ( when Q = 9)
And P = 40 –2*1 = Rs 38 ( when Q = 1)
Similarly, TR = P*Q = 22*9 = Rs198
And TR = P*Q = 38*1 = Rs 38
Again from equation (iii)
π= -3Q
2
+ 30Q -4
or, π= -3(9)
2
+ 30(9) -4 = -247 + 270 = Rs 23
And,π= -3(1)
2
+ 30(1) -4 = Rs 23
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2024R K Saud Asst. Prof. FWU 99

100. 1) A ‘XYZ’ company of Mahendranagar has the
following demand and cost function:
Demand function, P = 20 –Q
Cost function, C = Q
2
+8Q + 2
Determine the optimum level of output(Q), price(P),
total profit (π), and total revenue(R)
a) Under profit maximization
b) Under sales revenue maximization and
c) Under sales revenue maximization subject to profit constraint
of Rs 8.
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2024R K Saud Asst. Prof. FWU
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0

101. Thank You
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2024R K Saud Asst. Prof. FWU
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1