The O.C. 14. Incremental reasoning is closely related to two important concepts of traditional ec­onomics, viz., cost and marginal revenue. 12. The theory requires “perfect competition”: there must be many buyers and sellers; goods from competing suppliers must be indistinguishable; buyers and sellers must be fully informed; and markets must be complete—that is, there must be markets not just for bread here and now, but for bread in any state of the world. This is an unproved and probably a false belief. Moreover, the decision maker must determine when to reduce prices on plants so that they can be sold out quickly and land tied up in them can be released for other (and more profitable) uses. In fact when the order be­comes firm the situation might change, causing low-price orders to interfere with regular price business. 10/5% = Rs. A simple example will make this point clear. However, there are similarities and differences. As the market discount rates vary, bond price, vary inversely. At the place where the curves intersect, a price is set such that demand equals supply. If the market rate of interest (the discount rate here) is 10% its PV will be Rs. 30,000 per month. Suppose, the production manager has to choose between an output of 2,000 units and one of 3,000 units. Since the value of the marginal product is the highest in activity E, the company may prefer to employ all of the labour to E. How­ever, some constraint, such as a limit of the capaci­ty in E, or limits on other variable inputs required, will set a limit on the amount of labour that may be used in E. The net result of our above discussion is this: We may retain the equimarginal principle as long as diminishing returns operate at some stage of the production process; but when the values of the mar­ginal products are constant (horizontal) we make use of the following alternative principle: We have to apply inputs first to activities with higher marginal product values before mov­ing to lower values. Managerial economics is concerned with the … In other words, market failure is pervasive. Suppose, the extra cost of producing one ex­tra unit of output is Rs. It increases revenues more than it increases cost. Hence a single MC cost figure can be used over the whole range. In reality, however, the distinction between the two often gets blurred. This simple illustration re­veals the need to consider both the long-term and short-term impact of price policy. It is also implicitly assumed that there is no other profitable alternative. The same principle can be applied in case of an individual firm. Share Your PDF File 300 per month the total payroll will be Rs. 2,800. In this case MC is Rs. We will concentrate on the economies which may be achieved within a particular plant. Suppose neither extra selling cost nor extra administration cost is involved in the order. Other applications of Managerial Economics: The following two situa­tions maybe considered: (a) Decision on allocation of space in a retail store: Limited floor space may be allocated among various products on the basis of their relative con­tribution to overhead and profit above incremental cost. 9 and unit (average) MR is Rs. For example, the opportunity cost of using a machine to produce one product (say X) is the sacri­fice of earnings that would be possible from other products (Y, Z, etc.). In some cases, the new product may be a complement for, rather than a substitute, of the old product. In other words managerial economics is economics applied to the analysis of business problems and decision making. In this case we can say that the present value to the bank of the borrow­er’s promise to pay Rs. It is easy to describe incremental reasoning. By selling this output in the market at a price of Rs. There is a famous proverb that a bird in the hand is worth two in the bush’. The follow­ing two points may be noted in this context: 1. 3 at a price of Rs. Therefore, the principle should be almost the opposite to those that ap­peared at first glance. So the point where supply equals demand is “efficient”. 1. 50. Now we can convert the contribution per unit of output into contributions per machine-hour. True, ‘charging what the market will bear’ is quite consistent with instrumentalism, for it implies raising prices as long as the resulting reve­nues increase. There is another way of illustrating the dis­counting principle. 70. The corporate planning manager or his team establishes an objective (which cannot be eas­ily defined and/or reached). 105, but the incremental cost is only Rs. Disclaimer Copyright, Share Your Knowledge However, since objectives are not precisely defined, it is difficult to know when they are achieved until the event actually occurs. 95.24 today and Rs. If sales at a higher price are 8,000 units and at the lower pric­es 15,000 units, the total contribution from product E increases from Rs. In general we restrict the two terms: MC and MR to the effects of changes in out­put. For exam­ple, if V.M.P. These problems crop up in the short run when capacity is fixed. So the contribution to overhead and profit is 50 paise per unit (or Rs. (b) Decisions on advertising expenditures: In or­der to determine the optimum advertising budget it becomes necessary for a firm to measure the respon­siveness of sales to advertising, along with meas­ures of the added cost of production of a larger vol­ume. As the strategies are implemented and goals are reached, it gradually becomes easier to achieve the objectives. 10/5% = Rs. The opportunity cost of a decision means sacri­ficing alternatives. If this remains fixed in the short-run, the total wage bill can be determined in advance. In the words of T.J. Coyne, “the only costs relevant for decision making are opportunity costs.”.