Basic

Economic
Problem
Limited Resources
Land
Labour
Capital
Entrepreneur
Unlimited Wants
Allocation of
limited resources
to fulfill unlimited
wants
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Economics revolves around methods and possibilities
of solving this fundamental economic problem.

Allocation
of
resources
Need
Necessary for survival
Want
Driving force for demand of
goods and services
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Economic
problem
Problem of
allocation of
resources
Problem of
economic
efficiency
Problem of full
employment
of resources
Problem of
economic
growth
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Individuals/
Households
Firms
Product
markets
Factor
markets
Economic resources Economic resources
Goods & Services Goods & Services
Factor payments Income
Purchase of Goods & Services Income
Rationale of firm
To attain economies of scale
To procure funds for production activities
To organise the production process
Rationale of firm (Ronald Coase, 1937)
Lower transaction costs
Higher productivity under team work with division
of labour

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Economic profit
= TR TC
stands for Economic profit (micro economics)
TR stands for total revenue and;
TC stands for total cost
The profit maximisation model provides that
a firm can maximise its profits in following
cases.
TR more than in TC
TR, TC remaining unchanged
TC more than TR
TC, TR remaining unchanged



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Limitations
Time dimension is not incorporated in the decision
making process.
Risk and uncertainties of future are not considered
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Value of the firm (Present value of expected
future profits)





Discount rate of interest determined
by:
1. Risk and uncertainty faced by the
firm
2. Conditions in financial markets
Stream of expected future profits or
revenues generated which depend
on:
1. Demand function and marketing
strategies of the firm.
2. Costs which are determined by
production technology and prices
of inputs
Limitations
Managers seek to maximise the sales rather than
the value of the firm. (William Baumol)
Managers seek to maximise their utility rather than
maximising value of the firm. The utility of a
manager depends upon their salaries, fringe
benefits, stock options, the number of subordinate
staff under him and the extent of his control over
the company. (Olivar Williamson)
Managers in the present day scenario with great
amount of uncertainty and constraint cannot
maximise profits even if they desire so; they are
only able to satisfice, i.e., give satisfactory
performance in terms of profits, sales market share,
growth of the firm etc.
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Managers while achieving the objectives of
the firm face various constraints
Legal constraints
Input constraints
Financial constraints
The managers overcome all these constraints
to maximise value of the firm. ( Constrained
Optimisation)
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Economic profits

Profit = Total Revenue
Total Cost (Explicit costs)
Implicit costs

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Accounting profits

Profit = Total Revenue
Total Cost (Explicit costs)
Explicit cost
Payments by a firm to purchase the service of
productive resources ( wages, interest, rent).
Implicit cost
opportunity costs associated with a firms use of
resources that it owns
Opportunity cost
the value of the best alternative forgone.
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Signal to change the rate of output and to
enter or exit the market.
Incentive to innovations, productive efficiency
and risk taking.
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The unobservable market force that helps the
demand and supply of goods in a free market
to reach equilibrium automatically is the
invisible hand.

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