Q:1- distinguise between economics & manegerial economics.

Discuss the role of Managerial Economics

in Management decision Making?
Answer:
Managerial Economics covers the practical application of economic analysis in the management of a
business or enterprise. Economics does not cover the application of the knowledge other than through
some case studies or examples from time to time. It's more concerned with theory and models and
methods of analysis.

If you use research as a parallel, managerial economics is to applied research, as economic is to basic
research.

If your goal is to become an economist, either as an academic, or working for a very large organization,
then take regular economics. If you are looking at a career in business and wish to become a CEO some
day, take managerial economics.

role
The following aspects may be said to be inclusive under managerial economics:
Demand analysis and forecasting.
Cost and production analysis.
Pricing decisions, policies and practices.
Profit management.
Capital management.
These aspects may also be defined as the Subject-Matter of Managerial Economics. In recent
years, there is a trend towards integrations of managerial economics and operations research.
Hence, techniques such as linear programming, inventory models and theory of games have
also been regarded as a part of managerial economics.

Demand Analysis and Forecasting
A business firm is an economic organization, which transforms productive resources into goods
that are to be sold in a market. A major part of managerial decision-making depends on
accurate estimates of demand. This is because before production schedules can be prepared
and resources are employed, a forecast of future sales is essential. This forecast can also guide
the management in maintaining or strengthening the market position and enlarging profits. The
demand analysis helps to identify the various factors influencing demand for a firms product
and thus provides guidelines to manipulate demand. Demand analysis and forecasting, thus, is
essential for business planning and occupies a strategic place in managerial economics. It
comprises of discovering the forces determining sales and their measurement. The chief topics
covered in this are:
Demand determinants
Demand distinctions
Demand forecasting.

Cost and Production Analysis
A study of economic costs, combined with the data drawn from the firms accounting records,
can yield significant cost estimates. These estimates are useful for management decisions. The
factors causing variations in costs must be recognised and thereby should be used for taking
management decisions. This facilitates the management to arrive at cost estimates, which are
significant for planning purposes. An element of cost uncertainty exists in this because all the
factors determining costs are not always known or controllable. Therefore, it is essential to
discover economic costs and measure them for effective profit planning, cost control and sound
pricing practices. Production analysis is narrower in scope than cost analysis. The chief topics
covered under cost and production analysis are:
Cost concepts and classifications
Cost-output relationships
Economics of scale
Production functions
Cost control.

Pricing Decisions, Policies and Practices
Pricing is a very important area of managerial economics. In fact price is the origin of the
revenue of a firm. As such the success of a business firm largely depends on the accuracy of
price decisions of that firm. The important aspects dealt under area, are as follows:
Price determination in various market forms
Pricing methods
Differential pricing product-line pricing and price forecasting.

Profit Management
Business firms are generally organized with the purpose of making profits. In the long run,
profits provide the chief measure of success. In this connection, an important point worth
considering is the element of uncertainty existing about profits. This uncertainty occurs because
of variations in costs and revenues. These are caused by factors such as internal and external. If
knowledge about the future were perfect, profit analysis would have been a very easy task.
However, in a world of uncertainty, expectations are not always realized. Thus profit planning
and measurement make up the difficult area of managerial economics. The important aspects
covered under this area are:
Nature and measurement of profit.
Profit policies and techniques of profit planning.

Capital Management
Among the various types and classes of business problems, the most complex and troublesome
for the business manager are those relating to the firms capital investments. Capital
management implies planning and control and capital expenditure. In this procedure, relatively
large sums are involved and the problems are so complex that their disposal not only requires
considerable time and labor but also top-level decisions. The main elements dealt with cost
management are:
Cost of capital
Rate of return and selection of projects.

The various aspects outlined above represent the major uncertainties, which a business firm
has to consider viz., demand uncertainty, cost uncertainty, price uncertainty, profit uncertainty
and capital uncertainty. We can, therefore, conclude that the role of managerial economics is
mainly concerned with applying economic principles and concepts to adjust with the various
uncertainties faced by a business firm.

Q:2 --explain why economic profit is not always equal to accounting profit?


nswer
Simply stated Accounting Profit equals Sales Revenue minus all costs except the cost of equity
capital, while Economic Profit is Sales Revenue munus all costs including the opportunity cost of
equity capital. Thus economic profit may be lower than the accounting profit. If accounting
profit equals the opportunity cost of equity capital, economic profit is zero. Only when
accounting profit is greater than the opportunity cost of equity capital, economic [profit is
positive. Under perfect competition, all firms in the longrun earns zero economic profit.

Revenue Acct Costs = Acct Profit
Revenue Econ Costs = Econ Profit
Revenue Explicit Costs = Acct Profit
Revenue (Explicit + Implicit costs) = Econ Profit
Acct Profit Implicit Costs = Econ Profit
True or False: Economic profits are always less than or equal to accounting profits.
TRUE
If some implicit costs exist
economic cost > accounting cost
economic profit < accounting profit
(ie: we are subtracting more costs from the same revenue)

Notes:
1.Profit generally is the making of gain in business activity for the benefit of the owners of the
business. The word comes from Latin meaning "to make progress", is defined in two different
ways, one for economics and one for accounting.
Pure economic profit is the increase in wealth that an investor has from making an investment,
taking into consideration all costs associated with that investment including the opportunity
cost of capital. Accounting profit is the difference between price and the costs of bringing to
market whatever it is that is accounted as an enterprise (whether by harvest, extraction,
manufacture, or purchase) in terms of the component costs of delivered goods and/or services
and any operating or other expenses. A key difficulty in measuring either definition of profit is
in defining costs. Pure economic monetary profits can be zero or negative even in competitive
equilibrium when accounted monetized costs exceed monetized price.
In economics, a firm is said to be making a normal profit when total revenues equal total costs.
These normal profits then match the rate of return that is the minimum rate required by equity
investors to maintain their present level of investment. Economically, the "normal profit" is
thus treated as a cost, and recognized as one of the two components of the cost of capital.
An economic profit arises when its revenue exceeds the total (opportunity) cost of its inputs,
noting that these costs include the cost of equity capital that is met by "normal profits." A
business is said to be making an accounting profit if its revenues exceed the accounting cost the
firm "pays" for those inputs.[1] Economics treats the normal profit as a cost, so when deducted
from total accounting profit what is left is economic profit (or economic loss).
All enterprises can be stated in financial capital of the owners of the enterprise. The economic
profit may include an element in recognition of the risks that an investor takes. It is often
uncertain, because of incomplete information, whether an enterprise will succeed or not. This
extra risk is included in the minimum rate of return that providers of financial capital require,
and so is treated as still a cost within economics. The size of that return is commensurate with
the riskiness associated with each type of investment, as per the risk-return spectrum.
"Normal profits" arise in circumstances of perfect competition when economic equilibrium is
reached. At equilibrium, average cost = marginal cost at the profit-maximizing position. Since
normal profit is economically a cost, there is no economic profit at equilibrium. In a single-
goods case, a positive economic profit happens when the firm's average cost is less than the
price of the product or service at the profit-maximizing output. The economic profit is equal to
the quantity output multiplied by the difference between the average cost and the price.
Economic profit does not occur in perfect competition in long run equilibrium. Once risk is
accounted for, long-lasting economic profit is thus viewed as the result of constant cost-cutting
and performance improvement ahead of industry competitors, or an inefficiency caused by
monopolies or some form of market failure.
Positive economic profit is sometimes referred to as supernormal profit or as economic rent.
The social profit from a firm's activities is the normal profit plus or minus any externalities that
occur in its activity. A polluting oil monopoly may report huge profits, but by doing relatively
little for the economy and damaging the environment. It would exhibit high economic profit but
low social profit.
Accounting definitions of profit
In the accounting sense of the term, net profit (before tax) is the sales of the firm less costs
such as wages, rent, fuel, raw materials, interest on loans and depreciation. Costs such as
depreciation, amortization, and overhead are ambiguous. Revenue may also be ambiguous
when different products are sold as a package, or "bundled." Within US business, the preferred
term for profit tends to be the more ambiguous income.
Gross profit is profit before Selling, General and Administrative costs (SG&A), like depreciation
and interest; it is the Sales less direct Cost of Goods (or services) Sold (COGS),
Net profit after tax is after the deduction of either corporate tax (for a company) or income tax
(for an individual).
Operating profit is a measure of a company's earning power from ongoing operations, equal to
earnings before the deduction of interest payments and income taxes.
To accountants, economic profit, or EP, is a single-period metric to determine the value created
by a company in one period - usually a year. It is the net profit after tax less the equity charge, a
risk-weighted cost of capital. This is almost identical to the economist's definition of economic
profit.
There are commentators who see benefit in making adjustments to economic profit such as
eliminating the effect of amortized goodwill or capitalizing expenditure on brand advertising to
show its value over multiple accounting periods. The underlying concept was first introduced by
Schmalenbach, but the commercial application of the concept of adjusted economic profit was
by Stern Stewart & Co. which has trade-marked their adjusted economic profit as EVA or
Economic Value Added.

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In economics, the law states that, all else being equal, as the price of a product increases,
quantity demanded falls; likewise, as the price of a product decreases, quantity demanded
increases.

In other words, the law of demand states that the quantity demanded and the price of a
commodity are inversely related, other things remaining constant. If the income of the
consumer, prices of the related goods, and preferences of the consumer remain unchanged,
then the change in quantity of good demanded by the consumer will be negatively correlated
to the change in the price of the good.[1] There are, however, some possible exceptions to this
rule (see Giffen goods and Veblen goods).

1. Giffen goods:

Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of this
category like bajra, cheaper vegetable like potato come under this category. Sir Robert Giffen or
Ireland first observed that people used to spend more their income on inferior goods like
potato and less of their income on meat. But potatoes constitute their staple food. When the
price of potato increased, after purchasing potato they did not have so many surpluses to buy
meat. So the rise in price of potato compelled people to buy more potato and thus raised the
demand for potato. This is against the law of demand. This is also known as Giffen paradox.

2. Conspicuous Consumption:

This exception to the law of demand is associated with the doctrine propounded by Thorsten
Veblen. A few goods like diamonds etc are purchased by the rich and wealthy sections of the
society. The prices of these goods are so high that they are beyond the reach of the common
man. The higher the price of the diamond the higher the prestige value of it. So when price of
these goods falls, the consumers think that the prestige value of these goods comes down. So
quantity demanded of these goods falls with fall in their price. So the law of demand does not
hold good here.

3. Conspicuous necessities:

Certain things become the necessities of modern life. So we have to purchase them despite
their high price. The demand for T.V. sets, automobiles and refrigerators etc. has not gone
down in spite of the increase in their price. These things have become the symbol of status. So
they are purchased despite their rising price. These can be termed as U sector goods.

4. Ignorance:

A consumers ignorance is another factor that at times induces him to purchase more of the
commodity at a higher price. This is especially so when the consumer is haunted by the phobia
that a high-priced commodity is better in quality than a low-priced one.

5. Emergencies:

Emergencies like war, famine etc. negate the operation of the law of demand. At such times,
households behave in an abnormal way. Households accentuate scarcities and induce further
price rises by making increased purchases even at higher prices during such periods. During
depression, on the other hand, no fall in price is a sufficient inducement for consumers to
demand more.

6. Future changes in prices:

Households also act speculators. When the prices are rising households tend to purchase large
quantities of the commodity out of the apprehension that prices may still go up. When prices
are expected to fall further, they wait to buy goods in future at still lower prices. So quantity
demanded falls when prices are falling.

7. Change in fashion:

A change in fashion and tastes affects the market for a commodity. When a broad toe shoe
replaces a narrow toe, no amount of reduction in the price of the latter is sufficient to clear the
stocks. Broad toe on the other hand, will have more customers even though its price may be
going up. The law of demand becomes ineffective.

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The law of supply is a fundamental principle of economic theory which states that, all else
equal, an increase in price results in an increase in quantity supplied.[1] In other words, there is
a direct relationship between price and quantity: quantities respond in the same direction as
price changes. This means that producers are willing to offer more products for sale on the
market at higher prices by increasing production as a way of increasing profits.[2]

There is direct relationship between the price of a commodity and its quantity offered fore sale
over a specified period of time. When the price of a goods rises, other things remaining the
same, its quantity which is offered for sale increases as and price falls, the amount available for
sale decreases. This relationship between price and the quantities which suppliers are prepared
to offer for sale is called the law of supply.


the law of supply states that other things being equal, the supply of a commodity extends with
a rise in price and contracts with a fall in price. There are however a few exceptions to the law
of supply.

1. Exceptions of a fall in price

If the firms anticipate that the price of the product will fall further in future, in order to clear
their stocks they may dispose it off at a price that is even lower than the current market price.

2. Sellers who are in need of cash

If the seller is in need of hard cash, he may sell his product at a price which may even be below
the market price.

3. When leaving the industry

If the firms want to shut down or close down their business, they may sell their products at a
price below their average cost of production.

4. Agricultural output

In agricultural production, natural and seasonal factors play a dominant role. Due to the
influence of these constraints supply may not be responsive to price changes.

5. Backward sloping supply curve of labor

The rise in the price of a good or service sometimes leads to a fall in its supply. The best
example is the supply of labor. A higher wage rate enables the worker to maintain his existing
material standard of living with less work, and he may prefer extra leisure to more wages. The
supply curve in such a situation will be backward sloping SS1 as illustrated in figure 3.


GDP vs GNP
The difference between GDP (Gross Domestic Product) and GNP (Gr oss National Product) is that GNP
includes net foreign income rather than net export and imports. Essentially GNP adds net foreign
investment income.

GDP measures the nations economys performance because it is determined by the market value of all
final goods and services made within the borders of the nation. GDP is focused on output rather than
who produced it, GDP measures all domestic production.

GDP (Gross Domestic Product) = C + I + G + (X M)

GNP is basically the GDP of the country plus income earned from overseas investments by residents,
minus income earned within the domestic economy by overseas residents. GNP is focused on who owns
the production regardless of where the production takes place. GNP calculates the value of output
produced by the people (nationals) of the region.

The more different GDP and GNP are, the more the country is involved in international trade and
finances. A great example of this would be Japan.

Inflation vs Deflation
Inflation, though it leads to increase in prices and redistribution of income in favor of the rich, is a lesser
of the evil than deflation.
Inflation does not lead to lowering of national income which deflation does
Deflation causes wide scale unemployment which inflation does not
As deflation causes profits to tumble, pessimism sets in thus leading to a slowing down of economy and
output
It is possible to control inflation through many monetary policies while it is very difficult to reverse the
process of deflation
In fact, mild inflation has been seen as good for economy as it leads to economic development. All
economists however feel that inflation should not be let out of control which can have devastating effects
on economy.