There are certain concepts which are significant in Managerial Economics.
Incremental
Reasoning
The concept of
incremental reasoning involves estimating the impact of a decision alternative
on cost and revenues, emphasizing the change in total cost and total revenue
resulting from variations in products, prices, procedures, investments or
whatever at stake in the decision. Incremental cost and incremental revenue are
the two basic components of incremental reasoning. Incremental cost or
incremental revenue is the variation in total cost due to a particular
decision.
Discounting
Principle
Discounting
originates from the concept of opportunity cost and time perspective. In Managerial Economics, investment planning
or capital budgeting are the major decision areas where the concept of
discounting is most useful. A manager should know that if a decision impinges
on costs and returns over a period of time, it is important that the future
stream of costs and returns are discounted at appropriate rates to reflect the
opportunity cost of capital. A valid comparison among relevant alternatives is
certainly facilitated by this approach.
Opportunity
Cost
The resources natural as well as
man-made are scarce in relation to their demand to meet the ever- increasing
human needs. These resources can be put to alternative uses. The scarcity and
the alternatives uses of the resources gives rise to the idea of opportunity
cost. The opportunity cost principle may be stated as: The cost involved in any
decision consists of the sacrifices of alternatives required by that decision.
If a decision involves no sacrifice, it commands no opportunity cost. It
measures the value of the opportunity, which is lost or sacrificed when the
cost of one course of action requires that an alternative course of action be left. The concept can be applied to all other
kinds of business decisions where there are at least two alternative options
involving costs and benefits. The following examples can explain the concept:
·
The opportunity cost of funds used in
one’s own business is the interest that one could earn on those funds had they
been used in other ventures.
- The opportunity cost of producing a unit of commodity X is the amount of commodity Y that must be sacrificed in order to use resources to produce X rather than Y.
- The opportunity cost of going to 8 A.M. class rather than sleeping in is the lost sleep from getting up early.
- If a worker on a farm can produce either 1000 tonnes of wheat or 2000 tonnes of barley, then the opportunity cost of producing 1000 tonnes of wheat is the 2 000 tonnes of barley forgone.
- The opportunity cost of holding Rs.1000 as cash in hand for a year is 10% interest, which could have been earned had it been kept in the form of fixed deposit in the bank.
- If you choose Cornetto ice cream out of
a list of possible flavors, then the opportunity cost is the sacrifice from not
being able to consume the next best flavor perhaps Vadilal. Choice
involves sacrifice.
The opportunity cost of buying a textbook is the lavish dinner you wanted to have with your girlfriend that you had to go without. - The opportunity cost of working overtime is the leisure you have sacrificed.
Opportunity
costs are not measured in accounting records.
In most situations, it is extremely difficult to make estimation what,
if any, additional product could be acquired if the resources in question were
devoted to some other use. Decisions of a manager must be based on a clear
understanding of the cost of alternative decision and how relevant these costs
are in a situation.”. An opportunity cost occurs all the time whenever there is
a choice. For example, in several cases involving choice and scarcity, where
there are more than two things to choose from. The sacrifice of alternatives in
the production (or consumption) of a good is known as its opportunity cost.
We should keep in mind the
following:
(a)
All decisions, which involve choice,
must involve calculation of opportunity cost.
(b) The opportunity cost may be either real or
monetary, either implicit or explicit, either non-quantifiable or quantifiable.
Managers
confront many different decision areas where the concept of opportunity cost is
directly applicable as make or busy decision, breakdown or preventive
maintenance of machines, replacement or new investment decision etc.
Time
Perspective
Management
executives are also concerned with the short-run and long- run effects of
decisions on costs and revenues. A decision may be made on the basis of short
run considerations, but may have long run repercussions. A decision taken may
have short run and long run effects on revenue as well as costs. A decision
made on the basis of short run considerations may have long run repercussions, making
it more or less profitable than it at first appeared.
The business
decision-making process has become increasingly complex due to growth of large-
scale industries, diversification and expansion of business activities,
emergence of multinational enterprises, and mergers and acquisitions. In such a complex and dynamic business
environment the application of economic concepts, models, theories and tools of economic analysis has
became inevitable for business decision- making. This requires a clear
understanding of different market conditions and a thorough analysis of
product, input and financial markets. So the managerial problems are related to
getting the most out of scarce resources.
Forward planning
is a fundamental process that can be adapted to all planning activities at all
organizational levels and becomes an integral part of the managerial function.
Managerial economics is the combination of Management and Economics. It is
concerned with the application of economic principles and methodologies to the
decision-making process within the firm or organization under conditions of
uncertainty.
The major concepts
of managerial economics include Incremental Reasoning, Discounting Principle,
Opportunity Cost and Time Perspective
No comments:
Post a Comment