Economics

Objectives and Uses of Managerial Economics

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What are the objectives and uses of managerial economics? Joel Dean answers this question in the following words: "The purpose of managerial economics is to show how economics analysis can be used in formulating business policies." Success in business depends to a large extent on policies and strategies adopted in business. The basic objective of managerial economics is facilitating formulation of appropriate policies and strategies. This basic objective can be elaborated into the following larger objectives of managerial economics:

1. Integrating economic theory with business practice
2. Using economics tools to analyze business situations
3. Applying economic principles to solve business problems
4. Using economic ideas for crisis management
5. Facilitating demand analysis and demand forecasting
6. Allocating scarce resources for optimizing returns
7. Enabling risk taking and uncertainly bearing
8. Helping in profit maximization
9. Pursuing the larger objectives of the firm other than profit maximization
10. Formulating short-term and long-term business strategies

Producer's Equilibrium

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Equilibrium is a position of rest; a state of no change. A producer will be in equilibrium when he does not desire a change from his current level of production. Naturally, this will be the position of maximum profit. When a producer is earning maximum profit, he will not have any desire to change that level of output. Therefore, producer's equilibrium is at the point of maximum profit.

A producer will expand production, so long as the additional unit producer adds more to revenue than to cost. In other words, production will be increased so long as marginal revenue (MR) is greater than marginal cost (MC). Excess of MR over MC is the profit from the additional unit. When MC equals MR, further production will be stopped. This is because further increase in production will lead to excess of MC over MR. Since excess of MC over MR means loss, the producer will not produce that unit. Therefore the producer will be in equilibrium when MC=MR

Equality of MC and MR is a necessary but not a sufficient condition fore equilibrium. There is one more condition. This condition requires that the MC curve cuts the MR curve from below. The intersection of the MR curve by the the MC curve from above is not the equilibrium point. This is clear from the diagram

It can be seen from the diagram that MC and MR are equal at point F and E. But there can be only one equilibrium point. Which is that ? Point F cannot be the equilibrium point even though MC and MR are equal. This is because if the producer expands production beyond point F (output ON), his additional cost will be lower than his additional revenue (MC curve is below MR curve). This means more profit. So, the producers will expand production. He will be in equilibrium, earning maximum profits at point E (output ON).

Long Run Costs

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In the long run, all inputs are variable. Fixed factors have relevance only in the short-run. If the horizon enough. the producer can change all fixed factors to variable factors. In the long run are no TFC or AFC curves

Similarly there is no distinction total costs and total variable costs. We need just refer to total costs. It is also to be borne in mind that there is no distinction between average total costs and average variable costs. Instead we can use the term "Long Run Average Cost" or LAC. Marginal cost in the long run may be termed as LMC.

Let us see what are the shapes of LAC and LMC. Why do they assume such shapes? What are the relationships between them? All these are relevant questions which have to be answered.

We have seen that the marginal cost curve and average cost curve are 'U' shapes in the short-run. In the long run also LAC and LMC are 'U' shaped. The LMC curve cuts the LAC curve its minimum point. But the reason behind the 'U' shape is not the law of diminishing returns. In the long run all inputs are 'U' shape is not the law of diminishing returns. In the long run all inputs are variable. The 'U' shape of these of the curves id determined by the pattern of 'Returns to scale'.

When inputs are increased by 10% and output increases by 15% (more than proportionately) the increasing returns to scale in operation. In this case the average cost curve fails as output expands. When output expands, and average cost rises, decreasing returns to scale operates. If average cost remains constant even if output expands, returns to scale are constant.

When increasing returns to scale operate LAC decreases with expansion in output.
When decreasing returns to scale operation, LAC increase with output.
When constant returns to scale in operation. LAC remains constant with output.

Monopolistic Competition

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Monopolistic competition is a market situation characterised by competition among fairly large number of firms selling differentiated products which are cose substitutes

Monopolistic competition is a form of imperfect competition and can be found in many real world markets ranging from clusters of sandwich bars, other fast food shops and coffee stores in a busy town centre to pizza delivery businesses in a city or hairdressers in a local area.

Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes. In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. In the presence of coercive government, monopolistic competition will fall into government-granted monopoly. Unlike perfect competition, the firm maintains spare capacity. Models of monopolistic competition are often used to model industries. Textbook examples of industries with market structures similar to monopolistic competition include restaurants, cereal, clothing, shoes, and service industries in large cities. The "founding father" of the theory of monopolistic competition is Edward Hastings Chamberlin, who wrote a pioneering book on the subject, Theory of Monopolistic Competition (1933). Joan Robinson published a book The Economics of Imperfect Competition with a comparable theme of distinguishing perfect from imperfect competition.

Monopolistically competitive markets have the following characteristics:
There are many producers and many consumers in the market, and no business has total control over the market price.
Consumers perceive that there are non-price differences among the competitors' products.
There are few barriers to entry and exit.
Producers have a degree of control over price.
The long-run characteristics of a monopolistically competitive market are almost the same as a perfectly competitive market. Two differences between the two are that monopolistic competition produces heterogeneous products and that monopolistic competition involves a great deal of non-price competition, which is based on subtle product differentiation. A firm making profits in the short run will nonetheless only break even in the long run because demand will decrease and average total cost will increase. This means in the long run, a monopolistically competitive firm will make zero economic profit. This illustrates the amount of influence the firm has over the market; because of brand loyalty, it can raise its prices without losing all of its customers. This means that an individual firm's demand curve is downward sloping, in contrast to perfect competition, which has a perfectly elastic demand schedule.

Equilibrium in the Long Run

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We have seen that under perfect competiton, firms will make only normal profit in the long run. Freedom in the long run. Freedom of entry and exit will ensure that there will be only normal profit in the long run. A firm under perfect competition is only price a price taker. Under monopoly the firm is a price maker. This is the reason why consumers prefer competition. This is the reason why governments are enacting policies that control monopolies and encourage competiton.

Under perfect competition, super normal profit will disappear in the long run. Entry of new firms attracted by super normal profit will ensure this. what about monopoly ?
Monopoly is characterised by a single firm. And, there is no freedom of entry. The monopolist will create entry barriers. This will ensure that super normal profits continue in the long run also. This is the theoretical situation. Practically, the situation can be different. In the practical world most products have substitutes. Availability of substitutes reduces monopoly power, Threat of competition deters firms from making super normal profit. Similarly, threat of government takeovers and price controls are other restraining factors. One arguments in favour of monopoly is the large monopoly firms with high level of profits can invest money in research and development thereby, contributing to rechnical progress. Small firms under perfect competition will not have the resources for R & D

Global experience is that private monopolies are bad. That is why governments control monopolies through anti-monopoly laws and encourage competition through competition policies.The practice of charging different prices for the same product or service is called price discrimination.

Sometimes a monopolist may charge different prices from different customers. For examples, the state electricity board charges different rates for electricity used by agriculturists, industrialists and domestic consumers. This practice of charging different prices from different customers is called price discrimination. The monopolist who practises price discrimination is a discriminating monopolist. This form of monopoly is called discreiminating monopoly.

Demand Forecasting for New Products

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Demand forecasting for new products is a challenging task. Here, there is no reliable data to base demand calculations. Experiences of other firms also are not available Therefore, firms introducing new products will have to rely on new techniques of demand forecasting. The important methods of demand forecasting for new products are the following:

1. Test marketing : This is a proven method of demand forecasting for new products Test marketing involves marketing the new products as a test case in some chosen markets. For test marketing, the product is either produced in small quantities , or imported. If test marketing is successful, then method forecasting is done on the basic of the data obtained in test marketing.There have been many instances where certain products with were successful in some countries did not succeed in other countries. That is why test marketing is done to forecast demand.

2. Opinion poll : If the new products is a capital good with a few potential customers, instead of test marketing, the potential buyers can be directly approached and asked whether they would be interested in buying the products, Since the opinion of the potential buyers is polled in this approach, it is called opinion poll approach.

3. Evolutionary approach : In the evolutonary approach, as the name implies, the new product is seen as evolution from an existing product. In computers, the lap top is an evolution from desk top and the tablet is an evolution is an evolution from lap top

4. Substitute approach : Substitute approach of demand forecasting is used when the new products is a substitute for an existing products. For example : liquid soap is a substitute for toilet soap cake , liquid mosquito vapouriser is a substitute for mosquito coil

5. Vicarious approach : Vicarious approach relies on gut feeling. This approach relies on the product knowledge and experience of the dealers of products. Since dealers come into contact with thousands of customers. they know from experience dealer with be in a position to say whether a new product

Demand Estimation

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An estimate is forming a tentative idea of the future. Demand estimation is an attempt to arrive at future demand. As the name implies demand estimation is an attempt to have a probable idea of the future demand situation. In all kinds of businesses businessmen try to estimate future demand based on their past experiences. in the case of products with seasonal demand it is possible to arrive at a near accurate idea of demand based on past experiences. For examples firms in the business of umbrella. school uniforms, bags etc know that the demand will past demand, future demand can be estimated fairly accurately. This kind of advanced statistical models. Here practical experince, intuition and practical knowledge of the market are crucial, Many traditional businesses succeed and prosper because of this practical knowledge and experence.

Estimation and forecasting are done in many areas. Weather forecast is a good example. It is possible that the actual situation may vary from the forecast and the estimate. Yet, estimation and forecasting is done to foresee a situation close to the actual. If the future can be anticipated and forward planning and decision making are done to meet the future situation. then will lead to success.

The modern world is dynamic. Business situations, tastes and preferences of the peoples, demand environment etc change, very fast. In such a fast changing environment business becomes highly risky, production happens in the present for sale in the future. If the future turns out to be very different from the present businesses will incur huge loss. Demand estimation and demand forecasting are done to avoid this risk. If demand estimation and forecasting turn out to be correct, that can lead to huge profits. This is the rationale of demand estimation and forecasting. There will be scope for expansion and modernization for most firms in the industry.

Definition and Characteristics of Managerial Economics

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The term managerial economics was coined by Joel Dean, in 1951 Joel Dean wrote a book titles Managerial Economics. As the term implies, managerial economics is economics applied in business management. The purpose of the managerial economics is to show how economics analysis can be used in formulating business policies

Definition of Managerial Economics:

Let us examine some of the important definitions of managerial economics. According to Mc Nair and Meriam, "Managerial economics consists of the use of economics modes of thought to analyze business situations."price theory in the service of business executives."
A popular and widely accepted definition of managerial economics came from Milton Spencer and Louis Siegelman. They defined managerial economics as. "managerial economics is the intergration of economics theory with business practice for the purpose of facilitating decision making and forward planning by management." All these definitions emphasize the essential character of managerial economics as the application of economics principles and tools in business. From these definitions we can derive the essential characteristics of managerial economics

Characteristics of Managerial Economics:

The characteristics of managerial economics can be summarized as follows:
Managerial economics is essentially micro economic in character:Managerial economics is essentially a study of the firm.
Though essentially micro economics it also relies on macro economics:Since business firms exist in the macro economy, macro economics issues impact business. For instance, businesses are impacted by business cycles. Therefore, managerial economics studies macro economics issues also
It is pragmatic: Pure economics is theoretical. Managerial economics is practical.
It is normative: Economics theory deals with 'what is'. Managerial economics is concerned with norms like 'what ought to be'. Therefore, it is normative
It is management oriented:Since managerial economics is the intergration of economic theory with business practice. it is oriented
Managerial economics is multi-disciplinary: Managerial economics incorporates many disciplines like economics, management, statistics, mathaematics, planning etc. Therefore, it is multi-disciplinary