UNIT I 
                           
            GENERAL FOUNDATION OF MANAGERIAL ECONOMICS 
                           
          Economics can be broadly divided into two categories namely, microeconomics 
          and macroeconomics.  Macroeconomics studies the economic system in 
          aggregate on the other hand micro-economics studies the behavior of an 
          individual decision-making economic unit like a firm, a consumer, or an 
          individual supplier of some factor of production. 
             Macroeconomics relates to issues such as determination of national 
          income, savings, investment, employment at aggregate levels, tax collection, 
          government expenditure, foreign trade, money supply and price level, etc. 
             In simple terms, managerial economics can be taken as applied micro-
          economics.  It is an application of that part of micro-economics which is directly 
          related to decision making by a manager.  Thus, managerial economics analyses 
          the process through which a manager uses economic theories to address the 
          complex problems of business world, and then take ‘rational’ decisions in such 
          a way that the preconceived objectives of the concerned firm may be attained    
          (Barla: 2000).     
          Like an economy, the manager of a firm also faces five basic issues:- 
          (1) Choice of product, i.e., the products a firm has to produce - A manager has to 
          allocate the available resources so as to maximize the profit of the firm. 
          (2) Choice of inputs – After determining the profit maximising level of output, 
          the manager has to identify the input-mix which would produce the profit 
          maximizing level of output at a minimum cost. 
          (3) Distribution of the firms’ revenue – The revenue received by the firm 
          through sales has to be distributed in a just and fair manner by the manager.  
          Workers, owner of factory building, bankers, and all those who have contributed 
          their materials and services in the process of production, storage and 
          transportation, have to be paid remunerations according to the terms and 
          conditions already agreed upon.   The residual after such payments constitutes 
          the firm’s profit which has to be distributed among the owners of the firm after 
          tax payment. 
          (4) Rationing - This constitutes an important function of a manager.  He/she 
          should utilize the scarce resources optimally, which involves expenditure.  As 
          the manager has to often look after several plants simultaneously, he/she must 
          prioritize not only the allocation of resources but also the time. 
          (5) Maintenance and expansion – In addition, the manager has to plan strategies 
          to ensure that the level of output is maintained, the efficiency of the firm is 
          retained over time, and also to plan the future expansion of the firm.  Expansion 
          of the firm involves making adequate provisions for mobilizing additional 
          capital from the market and/or borrowing money from banks.  A dynamic 
          manager always aspires to expand the firm’s scale of operation so as to increase 
          the profits. 
          1.1 Circular Flow of Economic Activities 
          Economic analysis attempts to explain the working of economic systems. 
          Assume a simple economic system consisting of two sectors, whose activities 
          are systematically connected with one another. (there is no link between both the 
          sentence) The economic activities performed by economic agents are generally 
          classified into three inter-related activities:- 
          (a)  Supplying factor inputs like land, labour, capital, organisation and 
          enterprise,  which enable the agents to earn  income which in turn could  be used 
          for purchasing consumable goods; 
          (b)  Using the factor inputs like raw materials, machines, labour, land, 
          etc., for producing goods to be supplied to the consumers; and 
          (c)  Providing intangible and specialized services directly to the people 
          (example, lawyers, teachers, doctors, and porters) or working for the 
          government (example, soldiers, judges, police, etc.). 
          The nature and dimensions of economic activities are generally determined by 
          the extent of overall economic development.  For instance, a developed 
          economic system like that of the United States or Japan, has more specialized 
          activities and division of labour, as compared to a traditional economic system. 
          In an extremely primitive economic system, the extent of interdependence 
          among economic agents tends to be limited, with some kind of division of 
          labour in them. 
             The extent of monetization and foreign trade also determine the nature 
          and scope of economic activities in a country.  Foreign trade adds various 
          dimensions to the process of identification of economic activities.  Further, the 
          extent of government intervention also complicates this process.  Hence, to 
          study the flow of income among different economic agents, a simplified 
          economy with non-existent government economic activities and foreign trade 
          may be considered, wherein the inflow and outflow of income among different 
          economic agents are always equal. 
           
           
                                 
                                        expenditure on commodities
                                               Commodities
                         households                                           firms
                                               factor services
                                               money income
                             Diagram – 1 Circular flows in a two-sector economy            
                      
                     1.2 Forms of Organisation 
                            In modern times, organisation of business assume several forms, viz., 
                     sole proprietorship, individual entrepreneur or one-man business, partnership, 
                     joint–stock companies, industrial combination, co-operative enterprises and state 
                     enterprises. 
                     a) Individual Entrepreneur: Under the ‘one-man’ concern, organiser invests 
                     his/her own capital and may also borrow some.  He/she rents a shop and 
                     employs a worker, if necessary.  He/she personally make purchases and attend to 
                     the sales, and who also takes the entire risks.  Thus, an entrepreneur organizes, 
                     directs all economic activity and takes the full risks, and is the sole proprietor.  
                     b) Partnership: In partnership firm, two, three or more people join together, 
                     contribute capital, and share the profits and risks of losses in agreed proportions. 
                     c) Joint-stock company: It is the most important type of business organisation 
                     today.  It overcomes the disadvantages of the partnership arising out of small 
                     financial resources and limited business talent.