Wednesday 13 February 2013

MANAGERIAL ECONOMICS


MANAGERIAL ECONOMICS
MODULE 1
Managerial Economics and Business economics are the two terms, which, at times have been used interchangeably. Of late, however, the term Managerial Economics has become more popular and seems to displace progressively the term Business Economics.

It is sometimes referred to as business economics and is a branch of economics that applies microeconomic analysis to decision methods of businesses or other management units. As such, it bridges economic theory and economics in practice.

Definition of Managerial Economics

Managerial Economics
}  "concerned with application of economic concepts and economic analysis to the problems of formulating rational managerial decision”.
Edwin Mansfield

We may, therefore define Managerial Economics as the discipline which deals with the application of economic theory to business management. Managerial Economics thus lies on the borderline between economics and business management and serves as a bridge between economics and business management.


Scope of Managerial economics
Managerial economics to a certain degree is prescriptive in nature as it suggests course of action to a managerial problem. Problems can be related to various departments in a firm like production, accounts, sales, etc.
·         Demand decision
·         Production decision

Production decision

A firm needs to answer four basic questions - what to produce, how to produce and how much to produce and for whom to produce.

What to produce?

A firm will produce according to its perception of the customer demand. It can either produce consumer goods like food, clothing etc. (which are for consumption purpose) or it can produce capital goods like machinery etc. (which are for investment purposes).

How to produce?

Goods can be produced by certain techniques. Firms have the option of producing goods by labour intensive technique and capital intensive technique. Labour intensive technique is the one in which manual labour is used to produce goods. Capital intensive technique is the one in which machinery like forklift, assembly belts etc. are used to produce goods.

How much to produce?

A firm has to decide its production capacity and also how much of their good a consumer needs and produce accordingly.

For whom to produce?

A firm has to decide its target population (i.e. to whom they will serve products and/or services). Example, it will not be viable to produce luxurious goods or middle income or low income group if they can't afford it and produce basic necessity goods for rich class if they don't need it. Therefore, a firm needs to match its produce according to the target population it is serving

Demand decision

}  Demand refers to the willingness to buy a commodity. Demand, here, defines the market size for a commodity i.e. who will buy the commodity. Analysis of the demand is important for a firm as its revenue, profits, income of the employees depend on it.

Importance of Managerial Economics

The application of economics to business management or the integration of economic theory with business practice, as Spencer and Siegelman have put it, has the following aspects :-

1.      Reconciling traditional theoretical concepts of economics in relation to the actual business behavior and conditions. In economic theory, the technique of analysis is one of model building whereby certain assumptions are made and on that basis, conclusions as to the behavior of the firms are drown. The assumptions, however, make the theory of the firm unrealistic since it fails to provide a satisfactory explanation of that what the firms actually do. Hence the need to reconcile the theoretical principles based on simplified assumptions with actual business practice and develops appropriate extensions and reformulation of economic theory, if necessary.
2.      Estimating economic relationships, viz., measurement of various types of elasticities of demand such as price elasticity, income elasticity, cross-elasticity, promotional elasticity, cost-output relationships, etc. The estimates of these economic relationships are to be used for purposes of forecasting.
3.      Predicting relevant economic quantities, eg., profit, demand, production, costs, pricing, capital, etc., in numerical terms together with their probabilities. As the business manager has to work in an environment of uncertainty, future is to be predicted so that in the light of the predicted estimates, decision making and forward planning may be possible.
4.      Using economic quantities in decision making and forward planning, that is, formulating business policies and, on that basis, establishing business plans for the future pertaining to profit, prices, costs, capital, etc. The nature of economic forecasting is such that it indicates the degree of probability of various possible outcomes, i.e. losses or gains as a result of following each one of the strategies available. Hence, before a business manager there exists a quantified picture indicating the number o courses open, their possible outcomes and the quantified probability of each outcome. Keeping this picture in view, he decides about the strategy to be chosen.
5.      Understanding significant external forces constituting the environment in which the business is operating and to which it must adjust, e.g., business cycles, fluctuations in national income and government policies pertaining to public finance, fiscal policy and taxation, international economics and foreign trade, monetary economics, labour relations, anti-monopoly measures, industrial licensing, price controls, etc. The business manager has to appraise the relevance and impact of these external forces in relation to the particular business unit and its business policies.

 Basic Economic Problems
The fundamental problems faced by an economy can be summed up as follows:
What to Produce?
The first major economic decision of any economy relates to the type and the range of goods to be produced. Since resources are limited, one must choose between different alternative combinations of goods and services that may be produced. Allocation of resources between the different types of goods, e.g., consumer goods and capital goods, is another major concern to any economy. At firm level, this decision would involve review of market demand and availability of raw materials and technology. This can also be referred to as the problem of choice.  
How to Produce?
Having decided on what to produce, the economy must determine the techniques of production to be used. This can also be viewed as the problem of efficiency; efficiency is maximized when the limited stock of resources yields the maximum possible volume of goods and services, or renders the maximum benefit to the society. We would discuss the concept of efficiency subsequently in detail.
For whom to Produce?
This means how the national product should be distributed. This is essentially the problem of distribution. Once the goods are produced, they need to be distributed among the various economic agents. In a market economy such a distribution is done on the basis of “ability to pay” principle; this implies that those who have more in terms of wealth and income would have more of the commodities than those who have less. However, in a command economy such a distribution is done on the basis of “according to need” principle; this implies that people would be rewarded according to their needs and not their ability to pay.
Are Resources used economically?
In a world of scarcity, resources need to be efficiently employed. This is the problem of economic efficiency or welfare maximization, dealt with by the branch of economics known as welfare economics, the purpose of which is to explain how a socially efficient allocation of resources can be identified and achieved. At his level, let us be contended with the idea that resources would be fully and efficiently employed if it is NOT possible to increase the output of one commodity without reducing the output of another commodity. We would also let you get a touch of this problem while discussion price and output determination under different market forms.
Are Resources Fully Employed?
An economy must Endeavour to achieve the fullest possible use of its available resources, as unemployment of resources is equivalent to economic waster. The economy should be so organized as to keep all factors of production (including labour) fully employed. Keynes defined full employment as a situation in which involuntary unemployment is reduced to the minimum possible level. Modern economists like Marshall are of opinion that full employment should be a goal of economic policy.
Is the Economy Growing? 
Another problem of any economy is to make sure that it keeps expanding or developing with time, and that its productive capacity continues to increase, so that it maintains conditions of stability. An economy seeks to achieve economic growth mainly to improve the standards of living of its people, it is through economic growth that an economy can get more of everything, without having less of anything. There economic growth that an economy can get more of everything, without having lees of anything. There are three major sources of growth: growth of labour force, capital   formation and technological progress.
Characteristics of Managerial Economics

1.      Managerial Economics is micro-economic in character.
2.      Managerial Economics largely uses that body of economic concepts and principles, which is known as 'Theory of the firm' or 'Economics of the firm'. In addition, it also seeks to apply Profit Theory, which forms part of Distribution Theories in Economics.
3.      Managerial Economics is pragmatic. It avoids difficult abstract issues of economic theory but involves complications ignored in economic theory to face the overall situation in which decisions are made. Economic theory appropriately ignores the variety of backgrounds and training found in individual firms but Managerial Economics considers the particular environment of decision making.
4.      Managerial Economics belongs to normative economics rather than positive economics (also sometimes known as Descriptive Economics). In other words, it is prescriptive rather than descriptive. The main body of economic theory confines itself to descriptive hypothesis, attempting to generalize about the relations among different variables without judgment about what is desirable or undesirable. For instance, the law of demand states that as price increases. Demand goes down or vice-versa but this statement does not tell whether the outcome is good or bad. Managerial Economics, however, is concerned with what decisions ought to be made and hence involves value judgments.

Fundamental Concepts/Basic Economic Tools
        i.            Principle of Opportunity cost
      ii.            Principle of Incremental cost
    iii.            Principle of Time perspective
    iv.            Principle of Discounting
      v.            Equimarginal Principle
Principle of Opportunity cost
By the opportunity cost of a decision is meant the sacrifice of alternatives required by that decision.
For e.g.
a)      The opportunity cost of the funds employed in one’s own business is the interest that could be earned on those funds if they have been employed in other ventures.
b)      The opportunity cost of using a machine to produce one product is the earnings forgone which would have been possible from other products.
c)      The opportunity cost of holding Rs. 1000as cash in hand for one year is the 10% rate of interest, which would have been earned had the money been kept as fixed deposit in bank.
It’s clear now that opportunity cost requires ascertainment of sacrifices. If a decision involves no sacrifices, its opportunity cost is nil. For decision making opportunity costs are the only relevant costs.
Principle of Incremental cost
It is related to the marginal cost and marginal revenues, for economic theory. Incremental concept involves estimating the impact of decision alternatives on costs and revenue, emphasizing the changes in total cost and total revenue resulting from changes in prices, products, procedures, investments or whatever may be at stake in the decisions.
The two basic components of incremental reasoning are
·         Incremental cost
·         Incremental Revenue
The incremental principle may be stated as under:
“A decision is obviously a profitable one if –
   it increases revenue more than costs
   it decreases some costs to a greater extent than it increases others
   it increases some revenues more than it decreases others and
   it reduces cost more than revenues”
Principle of Time perspective
Managerial economists are also concerned with the short run and the long run effects of decisions on revenues as well as costs. The very important problem in decision making is to maintain the right balance between the long run and short run considerations.
For example;
Suppose there is a firm with a temporary idle capacity. An order for 5000 units comes to management’s attention. The customer is willing to pay Rs 4/- unit or Rs.20000/- for the whole lot but not more. The short run incremental cost(ignoring the fixed cost) is only Rs.3/-. Therefore the contribution to overhead and profit is Rs.1/- per unit (Rs.5000/- for the lot).
Analysis:
From the above example the following long run repercussion of the order is to be taken into account:
1) If the management commits itself with too much of business at lower price or with a small contribution it will not have sufficient capacity to take up business with higher contribution.
2) If the other customers come to know about this low price, they may demand a similar low price. Such customers may complain of being treated unfairly and feel discriminated against.
In the above example it is therefore important to give due consideration to the time perspectives. “a decision should take into account both the short run and long run effects on revenues and costs and maintain the right balance between long run and short run perspective”.
Principle of Discounting
One of the fundamental ideas in Economics is that a rupee tomorrow is worth less than a rupee today. Suppose a person is offered a choice to make between a gift of Rs.100/- today or Rs.100/- next year. Naturally he will chose Rs.100/- today. This is true for two reasons-
i) The future is uncertain and there may be uncertainty in getting Rs. 100/- if the present opportunity is not availed of
ii) Even if he is sure to receive the gift in future, today’s Rs.100/- can be invested so as to earn interest say as 8% so that one year after Rs.100/- will become 108.

Equimarginal Principle
The equi-marginal principle was originally associated with consumption theory and the
law is called ‘the law of equi-marginal utility’. The law of equi-marginal utility states that
a utility maximizing consumer distributes his consumption expenditure between various
goods and services he/she consumes in such a way that the marginal utility derived
from each unit of expenditure on various goods and services is the same. The pattern
of consumer’s expenditure maximizes a consumer’s total utility.

The law of equi-marginal principle has been applied to the allocation of resources
between their alternative uses with a view to maximizing profit in case a firm carries out
more than one business activity
. This principle suggests that available resources
(inputs) should be so allocated between the alternative options that the marginal productivity gains (MP) from the various activities are equalized. 
Suppose, a firm has 100 units of labor at its disposal. The firm is engaged in four activities which need labors services, viz, A, B, C and D. it can enhance any one of these activities by adding more labor but only at the cost of other activities.
Thus, a manger can make rational decision by allocating/hiring resources in a manner which equalizes the ratio of marginal returns and marginal costs of various uses of resources in a specific use.

Question Paper : Accounting for Management


MARIAN ACADEMY OF MANAGEMENT STUDIES
Marian Village, Puthuppady P.O, Kothamangalam-686 673
M.B.A DEGREE MODEL EXAMINATION DECEMBER 2012
First Semester
Time: 3 hours             ACCOUNTING FOR MANAGEMENT         Marks – 60
Answer all questions all questions carry equal marks.
1.      a) Describe the various accounting concepts used
Or
b) The following are the summarized Balance Sheets of Ram Ltd. As at 31st December 1999 and 2000, prepare a statement showing changes in working capital.
BALANCE SHEET
Liabilities
1999
Rs.
2000
Rs.
Assets
1999
Rs.
2000
Rs.
Capital:
  Equity Shares
  Preference
Shares
General Reserve
Profit and Loss
Current Liabilities

Creditors
Bills Payable
Overdraft
Taxation Provision
Proposed  Dividend

1,00,000



30,000
25,000

20,000
-
3,000
7,000
10,000

1,00,000



40,000
70,000

10,000
2,000
-
12,000
16,000
Fixed Assets
Investments
Current Assets:


                  Stock
                 Debtors
                 B/R
Prepaid Expenses
Cash
Advances
95,000
-



40,000
20,000
5,000
5,000
20,000
10,000
1,20,000
10,000



60,000
40,000
2,000
18,000
10,000
40,000



1,95,000
3,00,000

1,95,000
3,00,000

2.      a)  What are the advantages and disadvantages of ratio analysis?
Or
b)      Briefly explain the different types of cost in cost accounting

3.      a) How will you calculate cash from operations in a cash flow statement?
Or
           b) Assuming that the cost structure and selling prices remain the same in periods I and II.       Find Out:
(a)                Profit Volume Ratio : (b) Fixed Cost : (c) Break Even Point for Sales: (d) profit when Sales are Rs.1,00,000; (e) Sales required to earn a Profit of Rs.20,000; and (f) Margin of Safety at a Profit of Rs.15,000; (g) Variable Cost in Period II
Period
Sales
Cost
Profit
I
1,20,000
1,11,000
9,000
II
1,40,000
1,27,000
13,000


4.      a) Write a brief note on various types of variance analysis
Or
            b) A company expects to have Rs. 37,500 cash in hand on 1st April, and requires you to prepare an estimate of cash position during the three months, April, May and June. The following information is supplied to you:

Sales
Purchases
Wages
Factory Expenses
Office Expenses
Selling Expenses

Rs.
Rs.
Rs.
Rs.
Rs.
Rs.
February
75,000
45,000
9,000
7,500
6,000
4,500
March
84,000
48,000
9,750
8,250
6,000
4,500
April
90,000
52,500
10,500
9,000
6,000
5,250
May
1,20,000
60,000
13,500
11,250
6,000
6,570
June
1,35,000
60,000
14,250
14,000
7,000
7,000

Other information:
1.      Period of credit allowed by suppliers 2 months.
2.      20% of sales is for cash and period of credit allowed to customers for credit is one month.
3.      Delay in payment of all expenses – 1 month.
4.      Income tax of Rs.57,500 is due to be paid on June 15th
5.      The company is to pay dividends to shareholders and bonus to workers of Rs. 15,000 and Rs.22,500 respectively in the month of April
6.      Plant has been ordered to be received and paid in May. It will cost Rs.1,20,000

5.      Compulsory
From the following prepare final account for the year 2009:-

Rs.

Rs.
Capital
92,000
Cash at bank
14,534
Creditors
18,852
Bills receivable
5,844
Bills payable
6,930
Purchases
85,522
Sales
1,21,850
Carriage
2,091
Reserve for doubtful debts
1,320
General expenses
6,085
Interest (Cr.)
340
Insurance
783
Buildings
70,000
Bad debts
613
Motor trucks
12,000
Audit fees
400
Furniture
1,640
Rent
325
Debtors
15,600
Discount (Dr.)
620
Opening stock
15,040
Sales return
285
Cash in hand
988
Investments
8,922

Adjustment:
a)      Closing stock Rs. 15,500
b)      Depreciate motor trucks by 10% and fixture by 5%.
c)      Write off a further Rs.140 on bad debts and maintain reserve at 5% on debtors.
d)     Insurance Rs.150 is still unexpired.
e)      Interest on investment outstanding Rs.120