Managerial Economics

Q1.
A. “The objective of economic analysis is not merely to discover the truth but also to assist in the solution of concrete problems.” Comment.

Economic analysis provides a systematic approach for studying the allocation of resources to achieve an organization's objectives. Techniques of economic analysis help ensure efficient operations, minimize overhead and compare costs and benefits

Function
• Economic analysis provides a systematic approach for industry, government agencies and nonprofit organizations to study their operations and how well they satisfy organizational goals.
Types
• Three main types of economic analysis include cost-effectiveness, cost-benefit and cost-minimization.
Significance
• Economic analysis is especially common in the medical and pharmaceutical industries, which use the techniques to weigh the costs and benefits and to compare the effectiveness of new drugs and therapies.
Considerations
• In cost-benefit analysis, it may be difficult, or even inappropriate, to place a monetary value on some benefits, such as longer lifespan resulting from a new medical technology.
An economic analysis is like performing a check-up on a business: it assesses internal conditions, external influences and provides recommendations for improvement. Stephen Morris, Nancy Devlin and David Parkin, authors of "Economic Analysis in Health Care," explain that this type of an analysis weighs decision-making in terms of its potential benefits or disadvantages. The ultimate goal of an economic analysis is to determine if a business is allocating their resources in the most effective manner. In most cases, a business always has room for improvement, be it through overhauling outdated computers or improving the delivery ordering system.

Identification
• An internal staff member can perform an economic analysis, though hiring a consultant to provide an outsider's view of the organization tends to be a more common approach. If a consultant is hired to give a review, she may spend months observing how the company functions. At the end of it, she drafts a report and delivers it either orally in front of the company management team or submits an extensive written evaluation. The analysis highlights the areas for improvement with regards to efficiency and what hurdles the organization might have to overcome from external economic conditions.
Internal Conditions
• An economic analysis interprets internal economic conditions facing the company. The economic goal of an organization is to maximize its output and efficiency given its constraints. Internal economic conditions affecting an organization include the quality of its labor force, machinery, capital and innovation. Common constraints include adhering to a budget and drawing from a limited labor pool. For instance, a company is not being economical by hiring MBA graduates and paying them a high salary for work that could be performed by a high school graduate for significantly less money. Similarly, hiring too many unskilled workers will inhibit growth in the long run due to a lack of innovation. An economic analysis might also reveal the company should pay to upgrade its machinery or computer systems. Such a recommendation is made after assessing the level of output, expected consumer demand and the potential profit derived from having higher-caliber machinery.
External Conditions
• External conditions include the effects of the overall economic climate, changes in technology, presence of competition and globalization. Each of these factors affects the performance and long-term well-being of the company. Hal Root and Steve Koenig, authors of "The Small Business Start-Up Guide," explain that legal issues and growth trends in the industry are other examples of factors to consider. A downturn economy decreases consumer confidence and could decrease profits. Changes in technology could render a product line of the company obsolete, as was the case for companies manufacturing cassette tapes, for example. An economic analysis pinpoints which of these external conditions pose the biggest threat to the corporation and how the company should best prepare for these impending changes.
Recommendations
• The bulk of an economic analysis is the recommendations section. In it, the person advises which tangible steps the company can take to improve its operations. These recommendations are justified with the use of graphs, equations, statistical forecasting models and flowcharts. This section also explains how to implement these recommendations by listing training requirements, possible vendors who can provide better products and the expected labor requirements to accommodate the changes.

###########################
B. Discuss and illustrate the different objectives of a firm that are essential in decision-making process.

It is very important to have an aims because it provide a focus for the business, to see what they are trying to aim for, an aim highlights key areas of development and achievement.
Objectives are more specific than aims they are broken down so that they are easier to achieve.
An objective is a sub goal. It is a short-term, step within a period of time that is moving toward achieving a long-term goal. Firms may have different objectives to achieve. However in theory, a firm should set its' objectives to increase its value for its owners. Shareholders are the owners of a firm. Therefore according to theory maximizing shareholders wealth is the fundamental objective of a firm.
Investors generally expect to earn satisfactory returns on their investments as they require increasing the value of their investments as much as possible. This is usually determined by dividend payout and or capital gains by increasing the market value of the share price. The managers of the company act on behalf of the investors, such as operating day to day activities and making decisions within the business.

However, firms may have other objectives to achieve such as maximizing of profits, growth and increasing its' markets share. When achieving these objectives of a firm, conflicts may arise as a result of ownership and control. Managers may make their decisions on their own interests rather than achieving investors' wealth.
Value of the business is measured by valuing firms' price of shares. It's essential to consider maximising of stock prices, and its' impact to the investors and the economy as a whole simultaneously.
Maximising profits is also an objective of a firm. It is determined by maximising the firm's net profits. It is also can be described as a short term objective whilst maximising the value of the company is a long term objective for a firm
Operations performance objectives
This first point made in this section of the chapter is that operations objectives are very broad. Operations management has an impact on the five broad categories of stakeholders in any organisation. Stakeholders is a broad term but is generally used to mean anybody who could have an interest in, or is affected by, the operation. The five groups are:
• Customers – These are the most obvious people who will be affected by any business. What the chapter goes on to call the five operations performance objectives apply primarily to this group of people.
• Suppliers – Operations can have a major impact on suppliers, both on how they prosper themselves, and on how effective they are at supplying the operation.
• Shareholders – Clearly, the better an operation is at producing goods and services, the more likely the whole business is to prosper and shareholders will be one of the major beneficiaries of this.
• Employees – Similarly, employees will be generally better off if the company is prosperous; if only because they are more likely to be employed in the future. However operations responsibilities to employees go far beyond this. It includes the general working conditions which are determined by the way the operation has been designed.
• Society – Although often having no direct economic connection with the company, individuals and groups in society at large can be impacted by the way its operations managers behave. The most obvious example is in the environmental responsibility exhibited by operations managers.
After making this general point about operations objectives, the rest of the chapter goes on to look at the five performance objectives of quality, speed, dependability, flexibility, and cost.
Quality
Quality is placed first in our list of performance objectives because many authorities believe it to be the most important. Certainly more has been written about it than almost any other operations performance objective over the last twenty years. Later in the book we devote two whole chapters which look at different aspects of quality. As far as this introduction to the topic is concerned, quality is discussed largely in terms of it meaning ‘conformance’. That is, the most basic definition of quality is that a product or service is as it is supposed to be. In other words, it conforms to its specifications.
There are two important points to remember when reading the section on quality as a performance objective.
• The external affect of good quality within in operations is that the customers who ‘consume’ the operations products and services will have less (or nothing) to complain about. And if they have nothing to complain about they will (presumably) be happy with their products and services and are more likely to consume them again. This brings in more revenue for the company (or clients satisfaction in a not-for-profit organisation).
• Inside the operation quality has a different affect. If conformance quality is high in all the operations processes and activities very few mistakes will be being made. This generally means that cost is saved, dependability increases and (although it is not mentioned explicitly in the chapter) speed of response increases. This is because, if an operation is continually correcting mistakes, it finds it difficult to respond quickly to customers requests. See the figure below. Speed
Speed is a shorthand way of saying ‘Speed of response’. It means the time between an external or internal customer requesting a product or service, and them getting it. Again, there are internal and external affects.
• Externally speed is important because it helps to respond quickly to customers. Again, this is usually viewed positively by customers who will be more likely to return with more business. Sometimes also it is possible to charge higher prices when service is fast. The postal service in most countries and most transportation and delivery services charge more for faster delivery, for example.
• The internal affects of speed have much to do with cost reduction. The chapter identifies two areas where speed reduces cost (reducing inventories and reducing risks). The examples used are from manufacturing but the same thing applies to service operations. Usually, faster throughput of information (or customers) will mean reduced costs. So, for example, processing passengers quickly through the terminal gate at an airport can reduce the turn round time of the aircraft, thereby increasing its utilisation. What is not stressed in the chapter is the affect the fast throughput can have on dependability. This is best thought of the other way round, ‘how is it possible to be on time when the speed of internal throughput within an operation is slow?’ When materials, or information, or customers ‘hangs around’ in a system for long periods (slow throughput speed) there is more chance of them getting lost or damaged with a knock-on effect on dependability. See the figure below. Dependability
Dependability means ‘being on time’. In other words, customers receive their products or services on time. In practice, although this definition sounds simple, it can be difficult to measure. What exactly is on time? Is it when the customer needed delivery of the product or service? Is it when they expected delivery? Is it when they were promised delivery? Is it when they were promised delivery the second time after it failed to be delivered the first time? Again, it has external and internal affects.
• Externally (no matter how it is defined) dependability is generally regarded by customers as a good thing. Certainly being late with delivery of goods and services can be a considerable irritation to customers. Especially with business customers, dependability is a particularly important criterion used to determine whether suppliers have their contracts renewed. So, again, the external affects of this performance objective are to increase the chances of customers returning with more business.
• Internally dependability has an affect on cost. The chapter identifies three ways in which costs are affected – by saving time (and therefore money), by saving money directly, and by giving an organisation the stability which allows it to improve its efficiencies. What the chapter does not stress is that highly dependable systems can help increase speed performance. Once more, think about it the other way round – ‘how can an operation which is not dependable ever promise its customers fast response?’ See the figure below. Flexibility
This is a more complex objective because we use the word ‘flexibility’ to mean so many different things. The important point to remember is that flexibility always means ‘being able to change the operation in some way’. The chapter identifies some of the different types of flexibility (product/service flexibility, mix flexibility, volume flexibility, and delivery flexibility). It is important to understand the difference between these different types of flexibility, but it is more important to understand the affect flexibility can have on the operation. Guess what! There are external and internal affects.
• Externally the different types of flexibility allow an operation to fit its products and services to its customers in some way. Mix flexibility allows an operation to produce a wide variety of products and services for its customers to choose from. Product/service flexibility allows it develop new products and services incorporating new ideas which customers may find attractive. Volume and delivery flexibility allow the operation to adjust its output levels and its delivery procedures in order to cope with unexpected changes in how many products and services customers want, or when they want them, or where they want them.
• Once again, there are several internal affects associated with this performance objective. The chapter deals with the three most important, namely flexibility speeds up response, flexibility saves time (and therefore money), and flexibility helps maintain dependability. See the figure below. Cost
The chapter makes two important points here. The first is that the cost structure of different organisations can vary greatly. Note how the different categories of cost vary in the four examples given in the chapter. Second, and most importantly, the other four performance objectives all contribute, internally, to reducing cost. This has been one of the major revelations within operations management over the last twenty years.
"If managed properly, high quality, high speed, high dependability and high flexibility can not only bring their own external rewards, they can also save the operation cost." The polar representation of performance objectives
The chapter finishes with a useful way of illustrating the relative importance of the five performance objectives – the polar diagram. It is particularly useful for illustrating the difference between different products or services. The chapter illustrates a taxi service and a bus service to show the differences between them. Of course, this is an extreme example, but within a single business different products and services can have very different profiles. In the study guide for the previous chapter we fully described the company Stagepoint. One of its founders, Richard Carleton, described how the company had two types of service,
• Hiring services - managed by the ‘Technical Services operation’.
• Producing production sets – produced by ‘Production Services’.
The polar diagram below illustrates the relative importance of each of the performance objectives for these two services. Technical Services which hires out equipment is, for some of its equipment, in a relatively competitive market and must keep its prices competitive, therefore cost is relatively important to it. So is dependability, failure to deliver a piece of equipment would have serious consequences for the customer. Occasionally also speed can be important. Quality means making sure that the equipment is in good working order every time it is sent out. Flexibility is relatively unimportant because customers know exactly what it required and if the equipment is not available there is nothing much that Stagepoint can do about it. Production Services, on the other hand, is in a less price sensitive market. Customers give Stagepoint the business primarily because of the high quality and flexibility they show in devising imaginative high quality sets. Speed is not always a major issue unless the clients are themselves late in their planning. Dependability, of course, has to be high because if the set was not finished on time the stage production or exhibition could not go ahead as planned. The main point here is that the two types of service offered by the company have very different characteristics in terms of which performance objectives are important. Any company must understand how its different products and services require different objectives.
=================================
Some important objectives, other than profit maximization are:
(a) Maximization of the sales revenue

(b) Maximization of firm’s growth rate

(c) Maximization of Managers utility function

(d) Making satisfactory rate of Profit

(e) Long run Survival of the firm

(f) Entry-prevention and risk-avoidance

Profit Business Objectives:

Profit means different things to different people. To an accountant “Profit” means the excess of revenue over all paid out costs including both manufacturing and overhead expenses. For all practical purpose, profit or business income means profit in accounting sense plus non-allowable expenses.
Economist’s concept of profit is of “Pure Profit” called ‘economic profit’ or “Just profit”. Pure profit is a return over and above opportunity cost, i. e. the income that a businessman might expect from the second best alternatives use of his resources.

Sales Revenue Maximisation: The reason behind sales revenue maximisation objectives is the Dichotomy between ownership & management in large business corporations. This Dichotomy gives managers an opportunity to set their goal other than profits maximisation goal, which most-owner businessman pursue. Given the opportunity, managers choose to maximize their own utility function. The most plausible factor in manager’s utility functions is maximisation of the sales revenue.

The factors, which explain the pursuance of this goal by the managers are following:.
• First: Salary and others earnings of managers are more closely related to sales revenue than to profits
• Second: Banks and financial corporations look at sales revenue while financing the corporation.
• Third: Trend in sales revenue is a readily available indicator of the performance of the firm.

Maximisation of Firms Growth rate: Managers maximize firm’s balance growth rate subject to managerial & financial constrains balance growth rate defined as:
G = GD – GC
Where GD = Growth rate of demand of firm’s product & GC= growth rate of capital supply of capital to the firm.
In simple words, A firm growth rate is balanced when demand for its product & supply of capital to the firm increase at the same time.
Maximisation of Managerial Utility function: The manager seek to maximize their own utility function subject to the minimum level of profit. Managers utility function is express as:
U= f(S, M, ID)
Where S = additional expenditure of the staff
M= Managerial emoluments
ID = Discretionary Investments

The utility functions which manager seek to maximize include both quantifiable variables like salary and slack earnings; non- quantifiable variables such as prestige, power, status, Job security professional excellence etc.
Long run survival & market share: according to some economist, the primary goal of the firm is long run survival. Some other economists have suggested that attainment & retention of constant market share is an additional objective of the firm’s. the firm may seek to maximize their profit in the long run through it is not certain.
Entry-prevention and risk-avoidance, yet another alternative objectives of the firms suggested by some economists is to prevent entry-prevention can be:
1. Profit maximization in the long run
2. Securing a constant market share
3. Avoidance of risk caused by the unpredictable behavior of the new firms

Micro economist has a vital role to play in running of any business. Micro economists are concern with all the operational problems, which arise with in the business organization and fall in with in the preview and control of the management. Some basic internal issues with which micro-economist are concerns:
i. Choice of business and nature of product i.e. what to produce ii. Choice of size of the firm i. e how much to produce iii. Choice of technology i.e. choosing the factor-combination iv. Choose of price i.e. how to price the commodity
v. How to promote sales vi. How to face price competition vii. How to decide on new investments viii. How to manage profit and capital ix. How to manage inventory i.e. stock to both finished & raw material
These problems may also figure in forward planning. Micro economist deals with these questions and like confronted by managers of the enterprises.