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AR MR for Managerial Economics Mcom Delhi University

AR MR for Managerial Economics Mcom Delhi University

AR MR for Managerial Economics Mcom Delhi University

Managerial economics is the “application of the economic concepts and economic analysis to the problems of formulating rational managerial decisions”. It is sometimes referred to as business economics and is a branch of economics that applies microeconomic analysis to decision methods of businesses or other management units. As such, it bridges economic theory and economics in practice. It draws heavily from quantitative techniques such as regression analysis, correlation and calculus If there is a unifying theme that runs through most of managerial economics, it is the attempt to optimize business decisions given the firm’s objectives and given constraints imposed by scarcity, for example through the use of operations research, mathematical programming, game theory for strategic decisions, and other computational methods.

Managerial decision areas include:

  • assessment of investible funds
  • selecting business area
  • choice of product
  • determining optimum output
  • sales promotion.

Almost any business decision can be analyzed with managerial economics techniques, but it is most commonly applied to:

  • Risk analysis – various models are used to quantify risk and asymmetric information and to employ them in decision rules to manage risk.
  • Production analysis – microeconomic techniques are used to analyze production efficiency, optimum factor allocation, costs, economies of scale and to estimate the firm’s cost function.
  • Pricing analysis – microeconomic techniques are used to analyze various pricing decisions including transfer pricing, joint product pricing, price discrimination, price elasticity estimations, and choosing the optimum pricing method.
  • Capital budgeting – Investment theory is used to examine a firm’s capital purchasing decisions.

At universities, the subject is taught primarily to advanced undergraduates and graduate business students. It is approached as an integration subject. That is, it integrates many concepts from a wide variety of prerequisite courses. In many countries it is possible to read for a degree in Business Economics which often covers managerial economics, financial economics, game theory, business forecasting and industrial economics.

AR MR for Managerial Economics Mcom Delhi University

The relation between average revenue and marginal revenue can be discussed under pure compe­tition, monopoly or monopolistic competition or imperfect competition.

(1) Under Pure Competition:

The average revenue curve is a horizontal straight line parallel to the A-axis and the marginal revenue curve coincides with it. This is because under pure (or perfect) competition the number of firms selling an identical product is very large.

The price is determined by the market forces of supply and demand so that only one price tends to prevail for the whole industry

AR MR for Managerial Economics Mcom Delhi

It is OP as shown in panel (A) of Figure 1. Each firm can sell as much as it wishes at the market price OP. Thus the demand for the firm’s product be­comes infinitely elastic. Since the demand curve is the firm’s average revenue curve, the shape of the AR curve is horizontal to the А-axis at price OP, as shown in panel (B) and the MR curve coincides with it. This is also shown in Table 1 where AR and MR remain constant at Rs 20 at every level of output. Any change in the demand and supply conditions will change the market price of the product, and consequently the horizontal AR curve of the firm.

AR MR for Managerial Economics Mcom Delhi University

AR MR for Managerial Economics Mcom Delhi University

Under Monopoly or Imperfect Competition:

The average revenue curve is the downward sloping industry demand curve and its correspond­ing marginal revenue curve lies below it. The relation between the average revenue and the marginal revenue under monopoly can be understood with the help of Table 2. The marginal revenue is lower than the average revenue.

AR MR for Managerial Economics Mcom Delhi University

Given the demand for his product, the monopolist can increase his sales by lower­ing the price, the marginal revenue also falls but the rate of fall in marginal revenue is greater than that in average revenue. In Table 2, AR falls by Rs. 2 at a time whereas MR falls by Rs. 4. This is shown in Figure 2, in which the MR curve is below the AR curve and lies half way on the perpendicular drawn from AR to the T-axis. This relation will always exist between straight line downward sloping AR and MR curves.

AR MR for Managerial Economics Mcom Delhi University

AR MR for Managerial Economics Mcom Delhi University

In order to prove it, draw perpendiculars CA and CM to the У-axis and X-axis respectively from point С on the AR curve. CA cuts MR at В and CM at D. We have to prove that AB = BC. In Figure 2, the rectangle ACMO is the total revenue of OM output at CM price and the area PDMO also represents total revenue in terms of aggregate marginal revenue ( MR) at OM output.

ACMO = PDMO

or ABDMO + BCD = ABDMO + PAB

or BCD = PAB

But <PAB = <BCD, being right <s.

And <PBA = <CBD, being vertically opposite <s.

Thus BCD = PAB

Hence AB = BC.

Thus the MR curve will lie half way on the perpendicular drawn from the AR curve.

In case the AR curve is convex to the origin as in Figure 3 (A), the MR curve will cut any perpendicular from a point on the AR curve at more than half-way to the T-axis. MR passes to the left of the mid-point В on CA.

AR MR for Managerial Economics Mcom Delhi University

(3) Under Monopolistic Competition:

This relationship between AR and MR curves holds under mo­nopolistic competition with one exception that the AR curve is some­what more elastic than under monopoly.

AR MR for Managerial Economics Mcom Delhi University

This is shown in Figure 6. That is why, goods are close sub­stitutes under it. The firm can increase its sales by reducing the price a little.

AR MR for Managerial Economics Mcom Delhi University

Under Oligopoly:

The average and marginal revenue curves do not have a smooth downward slope. They possess kinks. Since the number of sellers under oligopoly is small, the effect of a price cut or price increase on the part of one seller will be followed by some changes in the behaviour of other firms. If a seller raises the price of his product, the other sellers will not follow him in order to earn large profits at the old price.

AR MR for Managerial Economics Mcom Delhi University

So the price-raising seller will experience a fall in the demand for his product. His average revenue curve in Figure 7(A) becomes elastic after К and its corresponding MR curve rises discontinuously from a to b and then continues its course at the new higher level.

On the other hand, if the oligopolistic seller reduces the price of his product, his rivals also follow him in reducing the prices of their products so that he is not able to increase his sales. His AR curve becomes less elastic from К onwards as in Figure 7(B). The corresponding MR curve falls vertically from a to b and then slopes at a lower level.

AR MR for Managerial Economics Mcom Delhi University

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