Managing a Business/Managerial Economics
I am doing MBA General in Annamalai University. If you give me the answers for the below questions related to the subject of Managerial Economics it will be very greatful to you. Thanks in advance...
Write a short Notes On:
(a) Economics and Decision making.
(b) Demand functions.
(c) Barometric forecasting.
(d) Opportunity cost.
(e) Oligopoly market
(f) Different types of pricing.
(g) Sources of National Income.
(a) Economics and Decision making.
CONCEPT OF ECONOMICS IN DECISION MAKING
-What do you mean by decision making? Well decision making is not something which is related to managers only or which is related to corporate world, but it is something which is related to everybody’s life. Whether a person is working or non working, irrespective of his/her field decision making is important to everyone. You need to make decision irrespective of the work you are doing. As a student also you have to take so many decisions. Suppose at a particular point of time you want to go for a movie, and at the same point of you want to go for shopping then what you will do. You can’t do two things at the same point of time. You have to decide what to first and what to do next. Therefore decision making can be called as choosing the right option from the given one. To decide is to choose. Whether to do this or to do that is what decision making. Meaning of decision making: Decision making is the most important function of business managers. Decision making is the central objective of Managerial Economics. Decision making may be defined as the process of selecting the suitable action from among several alternative courses of action. The problem of decision making arises whenever a number of alternatives are available. Such as : What should be the price of the product? What should be the size of the plant to be installed? How many workers should be employed? What kind of training should be imparted to them? What is the optimal level of inventories of finished products, raw material, spare parts, etc.? Therefore we can say that the problem of decision making arises due to the scarcity of resources. We have unlimited wants and the means to satisfy those wants are limited,
2.with the satisfaction of one want, another arises, and here arises the problem of decision making. While performing his function manager has to take a lot of decisions in conformity with the goal of the firm. Most of the decisions are taken under the condition of uncertainty, and involves risks. The main reasons behind uncertainty and risks are uncertain behavior of the market forces which are as follows: The demand and supply Changing business environment Government policies External influence on the domestic market Social and political changes Economic problem: Meaning of Economic problem: To know the meaning of the term economic problem we have to put together the four characteristics i.e. Human wants are unlimited. Human wants vary in their intensity. The means or resources are relatively limited. There are alternative uses of the limited resources. Therefore economic problem can be called as the problem related to the unlimited wants with limited resources. Problem arises due to this unlimited wants only. Resources used to satisfy one want cannot be used to satisfy the other want – it means that every man begins to face the problem of economizing his means. The problem of economy is how to use the relatively limited resources with alternative uses in the face of unlimited wants. Every try to use his/her limited resources with alternative uses so that he gets the maximum satisfaction out of his limited resources. Everyone tries to satisfy those wants which are most urgent or intense and then those wants slightly less urgent and so on thus sacrificing the satisfaction of those wants which lower on the scale of preference for which he may not have resources. This is known as the problem of economy--- how to make the maximum use of limited resources.
3. The sources of Economic problem: Resource sand scarcity: This is the main source of the economic problem. we have limited resources and the means to satisfy those resources are very limited. Here the resources of the society consists not only of the free gifts of the nature such as land, forests and minerals, but also of human capacity both mental and physical and of all sorts of man-made aids to further production, such as tools, machinery, building etc. These resources can be divided into three main groups: 1. All those free gifts of nature, such as land, forests, minerals, etc. are commonly called as natural resources and known to economists as LAND. 2. All human resources, mental and physical, both inherited and acquired, which economists call LABOUR. 3. All those man-made aids to further production, such as tools, machinery, plants and equipments, including everything man-made which is not consumed for its own sake but is used in the process of making other goods and services, and which is known to economists as CAPITAL. Economics help us in economizing our means. It helps us in understanding the problem and making the right decision so that its helpful for the organization for its further planning. Managerial economic is concerned with decision making at the firm level. Decision making problems faced by business firms: • To identify the alternative courses of action of achieving given objectives. • To select the course of action that achieves the objectives in the economically most efficient way. • To implement the selected course of action in a right way to achieve the business objectives. The prime function of management is Decision making and forward planning. Forward planning goes hand in hand with decision making. Forward planning means establishing plans for the future.
Economic models help managers and economists analyze the economic decision-making process. Each model relies on a number of assumptions, or basic factors that are present in all decision situations. Almost everyone in society engages in economic decision making at some point, from the billionaire investing in real estate, to the small business owner signing a contract with a supplier, to the teenager buying a video game or applying for a job; and these basic factors almost always come into play.
Working on a Budget
Even the wealthiest individuals and organizations have a limited amount of capital resources to work with. The constraints of a budget influence nearly all economic decisions, since the sum of all expenditures should never exceed the availability of capital. Cash availability is not always a direct limiting factor in economic decision making, since credit arrangements can allow people to spend more than they have. Even with credit purchase agreements, however, borrowers still take into account the ability to repay the debt over time, which brings the decision back to the issue of budgets and limited resources.
The fundamental basis of economic decision making is individuals' or organizations' desire to maximize benefits while minimizing costs. This balancing act is referred to as maximizing value, and it is a skill that takes practice to master. For individuals, value maximization decisions may include choosing between name-brand products and generic products, and choosing between small or bulk sizes. For a company, value maximization involves finding the lowest-cost suppliers that meet the company's quality standards, then determining the economic order quantity (EOQ) for each purchase. Economic order quantity is the perfect amount of a product or material to order at a time, taking advantage of quantity discounts while also keeping holding and transportation costs under control.
Rational Decision Making
Nearly all economic models and theories have one irreconcilable flaw: they assume that all economic decision makers act logically and rationally, taking all available information into account in an objective manner before making a decision. While it is true that most people and organizations attempt to do this, the reality of economic decisions is slightly different. Emotional theory in the stock market is a prime example of people's inability to make purely rational decisions on a consistent basis. Emotional theory states that everyone is influenced by his past experiences, expectations, emotional state and emotional memory when making a decision. People can place too much emphasis on certain information, such as recent news or bad news, which can skew their rational decision making as well.
Costs Versus Benefits
Costs and benefits are key factors that all economic decision makers take into account. Families, small business owners and others weigh the benefits and costs of decisions related to purchases, investments, sales and other expenditures before making a decision. This concept is similar to the idea of value maximization, with a distinct difference. Cost-benefit analyses assume that for every decision, something must be gained and something must be lost. Even in investment decisions, there is an opportunity cost—the cost of not using the money in another way—that must be considered. The goal of economic decision making is to make tradeoffs that allow you to gain more than you lose each time.
(b) Demand functions.
demand function -- a behavioral relationship between quantity consumed and a person's maximum willingness to pay for incremental increases in quantity. It is usually an inverse relationship where at higher (lower) prices, less (more) quantity is consumed. Other factors which influence willingness-to-pay are income, tastes and preferences, and price of substitutes.
The Law of Demand
• Demand implies that somebody wants it, has the means to pay for it and is willing to acquire it for the price at which you are selling it. Without these qualifiers, demand does not exist.
The Demand Function
• The function that illustrates a product's demand is the price of the good compared to a related or competitive product and the average consumer's income. Weighted together, this results in an estimate of the demand for the product or the quantity that will sell without saturating the market. When making managerial decisions, the relationship between quantity and each variable should be specified.
A Practical Example
• A recent customer survey indicates 90 percent of a hotel's guests will not return or recommend it to co-workers, because they do not like paying $9.99 for access to the hotel's Wi-Fi; the competition provides it for free. The hotel eventually changed its policy to include free Wi-Fi access for all guests. The demand and its function were recognized; in turn, the hotel implemented a service to generate economic gain through return visits and referrals.
(c) Barometric forecasting.
Barometric Forecasting Indicator Series : when one series is correlated with another one then the second one is called the indicator of the first one. Coincident Indicator : when both the series moves together Leading Indicator : when the indicator series moves ahead of the other one
Barometric Forecasting Techniques
Barometric techniques examine the relationships between causal or coincident events to predict future events. This approach is based on the logic that key current developments can serve as a barometer of the future. This approach assumes the key developments can be identified, measured and recorded as a statistical time series. The barometric or what is also called the leading indicators approach to forecasting is often traced to work done at the National Bureau of Economic Research from the 1920s through the 1940s.
A leading indicator predicts three to six months in the future another event. Examples of indicators include: payroll employment, personal income less transfer payments, an index of industrial production, stock prices, changes in business inventories, consumer expectations, building permits, new orders for goods and materials and retail sales.
Caveats about Barometric Forecasting and Leading Indicators
"Like all forecasting techniques, the leading indicator method has its limitations. For instance:
• While the leading indicator may warn us about a change in the direction of the business cycle, they do not provide us with very reliable information about the magnitude of that change.
• Moreover, the magnitude of change of the indicator in any one direction is not necessarily a measure of how good or bad the economy is likely to get. It is only when the indicator clearly reverses direction that its value as a forecasting tool is relevant.
• The component indicators of the overall leading indicator often are not consistent with one another in their predictions. Rarely do all indicators signal a change in direction at the same time.
• It is hard to decide when a leading indicator is signaling a true turn in the cycle or is showing a variation that will be reversed in subsequent observations. Rules of thumb like 'three consecutive downturns during an expansion signal a recession' and 'three consecutive upturns during a recession indicate an end to that recession' are not always reliable.
• Ironically, the widespread use of a reasonably reliable leading indicator may, in itself, lead to less reliability in the indicator over time. This can happen if players in the economy act on the forecast and alter either the economic outcome or the "lead" time between the indicator and the economy.
"Despite its drawbacks, a leading indicator series, in conjunction with other forecasting results, can help economists, business and government predict and prepare for significant changes in the economic environment."
The cost of passing up the next best choice when making a decision. For example, if an asset such as capital is used for one purpose, the opportunity cost is the value of the next best purpose the asset could have been used for. Opportunity cost analysis is an important part of a company's decision-making processes, but is not treated as an actual cost in any financial statement.
1. The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.
2. The difference in return between a chosen investment and one that is necessarily passed up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your money in the stock, you gave up the opportunity of another investment - say, a risk-free government bond yielding 6%. In this situation, your opportunity costs are 4% (6% - 2%).
1. The opportunity cost of going to college is the money you would have earned if you worked instead. On the one hand, you lose four years of salary while getting your degree; on the other hand, you hope to earn more during your career, thanks to your education, to offset the lost wages.
Here's another example: if a gardener decides to grow carrots, his or her opportunity cost is the alternative crop that might have been grown instead (potatoes, tomatoes, pumpkins, etc.).
In both cases, a choice between two options must be made. It would be an easy decision if you knew the end outcome; however, the risk that you could achieve greater "benefits" (be they monetary or otherwise) with another option is the opportunity cost.
(e) Oligopoly market
A situation in which a particular market is controlled by a small group of firms.
An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market.
The retail gas market is a good example of an oligopoly because a small number of firms control a large majority of the market.
The term oligopoly is derived from two Greek words, Oleg’s and 'Pollen'. Oleg’s means a few and Pollen means to sell thus. Oligopoly is said to prevail when there are few firms or sellers in the market producing and selling a product. Oligopoly is often referred to as “competition among the few". In brief oligopoly is a kind of imperfect market where there are a few firm in the market, producing either and homogeneous product or producing product which are close but not perfect substitutes of each other.
There is no such border line between a few and many. Usually oligopoly is understood to prevail when the numbers of sellers of a product are two to ten. Oligopoly is of two types-oligopoly without product differentiation or pure. Oligopoly and oligopoly with product differentiation.
Characteristics of Oligopoly:
The firms under oligopoly are interdependent in making decision. They are interdependent because the number of competition is few and any change in price & product etc by an firm will have a direct influence on the fortune of its rivals, which in turn retaliate by changing their price and output. Thus under oligopoly a firm not only considers the market demand for its product but also the reactions of other firms in the industry. No firm can fail to take into account the reaction of other firms to its price and output policies. There is, therefore, a good deal of interdependences of the firm under oligopoly.
2. Importance of advertising and selling costs:
The firms under oligopolistic market employ aggressive and defensive weapons to gain a greater share in the market and to maximise sale. In view of this firms have to incur a great deal on advertisement and other measures of sale promotion. Thus advertising and selling cost play a great role in the oligopolistic market structure. Under perfect competition and monopoly expenditure on advertisement and other measures is unnecessary. But such expenditure is the life-blood of an oligopolistic firm.
3. Group behaviour:
Another important feature of oligopoly is the analysis -of group behaviour. In case of perfect competition, monopoly and monopolistic competition, the business firms are assumed to behave in such a way as to maximize their profits. The profit-maximizing behaviour on his part may not be valid. The firms under oligopoly are interdependent as they are in a group.
4. Indeterminateness of demand curve:
This characteristic is the direct result of the interdependence characteristic of an oligopolistic firm. Mutual interdependence creates uncertainty for all the firms. No firm can predict the consequence of its price-output policy. Under oligopoly a firm cannot assume that its rivals will keep their price unchanged if he makes charge in its own price. As a result, the demand curve facing an oligopolistic firm losses its determinateness.
The demand curve as is well known, relates to the various quantities of the product that could be sold it different levels of prices when the quantity to be sold is itself unknown and uncertain the demand curve can't be definite and determinate.
5. Elements of monopoly:
There exist some elements of monopoly under oligopolistic situation. Under oligopoly with product differentiation each firm controls a large part of the market by producing differentiated product. In such a case it acts in its sphere as a monopolist in lining price and output.
6. Price rigidity:
Under oligopoly there is the existence price rigidity. Prices lend to be rigid and sticky. If any firm makes a price-cut it is immediately retaliated by the rival firms by the same practice of price-cut. There occurs a price-war in the oligopolistic condition. Hence under oligopoly no firm resorts to price-cut without making price-output decision with other rival firms. The net result will be price -finite or price-rigidity in the oligopolistic condition.
(f) Different types of pricing.
Pricing is one of the four elements of the marketing mix, along with product, place and promotion. Pricing strategy is important for companies who wish to achieve success by finding the price point where they can maximize sales and profits. Companies may use a variety of pricing strategies, depending on their own unique marketing goals and objectives.
Premium pricing strategy establishes a price higher than the competitors. It's a strategy that can be effectively used when there is something unique about the product or when the product is first to market and the business has a distinct competitive advantage. Premium pricing can be a good strategy for companies entering the market with a new market and hoping to maximize revenue during the early stages of the product life cycle.
A penetration pricing strategy is designed to capture market share by entering the market with a low price relative to the competition to attract buyers. The idea is that the business will be able to raise awareness and get people to try the product. Even though penetration pricing may initially create a loss for the company, the hope is that it will help to generate word-of-mouth and create awareness amid a crowded market category.
Economy pricing is a familiar pricing strategy for organizations that include Wal-Mart, whose brand is based on this strategy. Aldi, a food store, is another example of economy pricing strategy. Companies take a very basic, low-cost approach to marketing--nothing fancy, just the bare minimum to keep prices low and attract a specific segment of the market that is very price sensitive.
Businesses that have a significant competitive advantage can enter the market with a price skimming strategy designed to gain maximum revenue advantage before other competitors begin offering similar products or product alternatives.
Psychological pricing strategy is commonly used by marketers in the prices they establish for their products. For instance, $99 is psychologically "less" in the minds of consumers than $100. It's a minor distinction that can make a big difference.
Status Quo Pricing
• Status-quo pricing aims to match, or closely approximate, the price charged by major competitors. It is frequently used by retailers offering essentially the same product array as other nearby stores. For a small firm with a product that is neither new nor unique, status-quo pricing is a low-risk option. However, this approach must be used with caution over the long term, as production costs and/or competition can increase enough to make status-quo pricing unprofitable.
(g) Sources of National Income.
"National Income is the money value of all goods and services produced in a country during a year"
National income measures the money value of the flow of output of goods and services produced within an economy over a period of time. The level and rate of growth of national income provide various purposes regarding economy, production, trade, consumption, policy formulation, etc.
National income is a measure of the total value of the goods and services (output) produced by an economy over a period of time (normally a year). It also represents the total value of the primary incomes receivable within an economy less the total of the primary incomes payable by resident units . Economists have defined national income using some variations. For example, Alfred Marshall describes it as “The labour and capital of the country acting on its natural resources produce annually a certain net aggregate of commodities, material and immaterial, including services of all kinds… This is the net annual income or revenue of the country, or the national dividend”. the national income represents “the national dividend or income consists solely of services as received by ultimate consumers, whether from their material or from their human environment”;
“Gross national product (GNP) is the most comprehensive measure of a nation’s total output of goods and services. It is the sum of the dollar (money) value of consumption, gross investment, government purchase of goods and services and net exports”. There are some variations among these definitions, but the basic idea is that the national income is simply the income of the whole nation. It gives an idea about the economic position of a nation and represents the capacity to acquire goods and services for consumption. It is a determinant of material living standards and is also important for other aspects of progress. Indeed, the basic objective of an economy is to achieve economic progress. This is reached by coordinating natural resources, human resources, capital, technology etc. Thus, national income will help to assess and compare the progress achieved by a country over a period of time. Further, measuring national income is essential for various purposes that include projection about the future course of the economy, assisting government as the basis to design (or redesign) suitable development policies, helping firms in forecasting future demand for their products and facilitating international comparison.
The Importance of National Income
Measuring national income is crucial for various purposes. It allows to:
1. measure the size of the economy and level of country’s economic performance;
2. trace the trend or the speed of the economic growth in relation to previous year(s) also in other countries;
3. know the composition and structure of the national income in terms of various sectors and the periodical variations in them.
4. make projection about the future development trend of the economy.
5. help government formulate suitable development plans and policies to increase growth rates.
6. fix various development targets for different sectors of the economy on the basis of the earlier performance.
7. help business firms in forecasting future demand for their products.
8. make international comparison of people’s living standards.
Measuring National Income
National income calculation is not an easy task. There exist three methods:
1. Product or Output Method
2. Income Method
3. Expenditure Method
It can be possible to find out a relation between production, income and expenditure, using a circular flow of income. The model consists of two segments (real flow and money flow) and two sectors, business (firms or producers) and public (household or consumers). The public owns the productive resources (i.e. factors of production namely land, labour and capital). Business sector or producers employ the factors of production to produce goods and services. Such goods and services are bought by the public. Hence, the public owns the factors of production and provides them to producers. The producers employ the factor inputs to produce output of goods and services, which is bought by the consumers (public). For the employment of factor services, the public receive the factor income namely rent (for land), wages (for labour) and interest (for capital). This income flows back from the public to the business sector as consumption expenditure to buy the goods and services.
The most important consequence for the computation of national income is that received income (Y) is equal to the consumption expenditure (C) made by the consumers ( i.e. Y=C), though other components of national income - savings or investment (I), public expenditure by government (G) and expenditure on net exports (X-M) – miss in this circular flow model. If we include all the above components of national income, Y= C will become: Y = C + I + G + (X-M)
Through the model above, it is more clear the link between income and production. Indeed, income is generated through production process, and the GDP (one of the major indicators of national accounts) represents the measure of an economy’s total output. It is also used as a measure of total income and total expenditure in that economy. Thus, income is equal to expenditure and expenditure is equal to the value of output produced in the economy; or better :
Income = expenditure = output
Y = E = O
Similarly, investment expenditure, government expenditure and net expenditure on trade will be added in to the circular flow. These additions are called injections. However, after aggregating all leakages (outflow) and injections (inflow) in any one year, the total income components of the economy will be equivalent to the total expenditure or total output. Therefore, analyzing each of all the three methods, the same results can be achieved.
Output or Product Method
This method is based on the total production of a country during a year. The measures of GDP are calculated by adding the total value of the output (of goods and services) produced by all activities during any time period, such as a year. The major challenge of this method is the problem of double-counting. All production units are classified into primary, secondary and tertiary sectors. Then, the various units are identified under these sectors and the goods and services, produced in each of these sectors, will be estimated. The sum total of products generated in these three sectors is the total output of the nation. The next step is to find out the value of these products in terms of money. This method helps to find out contributions of various sectors to national income.
In the income method, the measures of GDP are calculated by adding all the income earned by various factors of production which are engaged in the production of output. The various incomes included to compute the gross national income are: wages and salaries, income of self-employed, profits and dividends of business corporations, interest, rent, surplus of government enterprises and net flow of income from abroad. Factors of production together produce output and income and the sum will be equal to the income of the nation. In other words, total (national) income is equal to the reward given to various factors of production.
National income can also be calculated by adding up the expenditure incurred for goods and services. Government as well as private individuals spend money for consumption and production purposes. The sum total of expenditure incurred in a country during a year will be equal to national income.
Another important aspect concerning the computation of national income is the difference between a measurement at “current price” and /or at “constant price”. The measure based on current price uses the ongoing market prices to compute the value of output. It is quite possible that the current price may always be higher than real value due to many factors like taxes and inflation (or rising prices). Hence, national income arrived at ‘current price’ includes such influences as inflation and taxes. With inflation as a common feature in almost all the economies, it is necessary to measure the national income after deducting any such increase in the value of any output or income. National income at ‘constant price’ measures the national income after making necessary adjustment to eliminate the effect of inflation. Thus it is based on unchanged price of output. As the national income at ‘constant price’ is computed, based on the real worth of the purchasing power of income, it is also called as ‘real national income’ or national income in ‘real’ terms.