 So, welcome to the third session of managerial economics, we are on the first module of managerial economics which deals with the introduction and fundamentals to the managerial economics. So, if you remember in the last class, we just started our discussion about the marginal analysis. So, in today's class, we will talk about the marginal and incremental analysis first. Then we talked about a model of any typical economy, how it works, what are the different sectors, how the flows works between two different sectors. And then we will focus on the basic tools of economic analysis and optimization techniques. So, coming to the marginal analysis, as we discussed in the last class, marginal is always a unit change in any of this variable, whether the variable is cost, whether the variable is revenue, whether the variable is utility. Whenever there is a change in the output, what is the corresponding change in the cost, what is the corresponding change in the revenue or what is the corresponding change in the utility? That is the marginal cost, marginal revenue and marginal utility. So, marginal cost is the change in the total cost because there is a change in the output. Marginal revenue is the change in the total revenue because there is a change in the output, output leads to revenue and marginal utility is the change in the utility because the consumer consumes one more unit of the output or one more unit of the product. So, marginal cost or marginal revenue or marginal utility is the total cost utility revenue of the last unit of output, whatever the total cost, whatever the total utility or revenue of the last unit of output that is the marginal cost, marginal revenue and marginal utility of the corresponding unit. So, if you consider, if you need to identify what is the marginal cost of any unit, then it is the total cost of any unit minus total cost of n minus 1 minute, where n is the number of unit of output. So, this marginal cost of any unit is nothing but the total cost, whatever comes in the last unit of the last unit of the output. So, we know that profit is the difference between the revenue and the cost. Whenever there is a change in the total revenue due to unit change in the output that we get as the marginal revenue. So, mathematically we can find this by taking the first order derivative of total revenue function with respect to Q that is output and geometrically this is the slope of the total revenue curve. Similarly, change in the total cost coming from the unit change in the output that gives us the marginal cost and mathematically we find marginal cost by change in the total cost with respect to change in the Q or that is output. So, similarly the geometrically the slope of the total cost curves gives us the marginal cost curve. We will take an example to understand all this concept particularly with respect to marginal analysis. So, if you look at in the table this is a hypothetical table. So, this is not a information relevant to the real world. So, there are 6 units of output 1, 2, 3, 4, 5, 6. The second columns gives us the total revenue. The third columns gives us the marginal revenue. The fourth column gives us the total cost. The fifth column gives us the marginal cost and the last column gives us the profit. As we know the total revenue is equal to sorry total profit is equal to total revenue minus total cost. So, if you look at if there is when there is one unit of output the total revenue is 20,000 and total cost is 4000. So, the profit comes as 16,000. Since there is only one unit there is no marginal revenue associated with this unit of output. When there are 2 units of output the total revenue is 34,000, marginal revenue is 14,000. Now, how this marginal revenue comes? This marginal revenue is the difference between the second unit and the first unit. Similarly, what is the total cost? Total cost is 8,000. Here the cost is fixed because for one unit if it is 4000 and for the second unit it is 2 units it is 8,000 then the cost remain constant. So, if you look at we will get a constant marginal cost because the per unit cost is remain constant. So, in this case total cost is 8,000 for 2 units and marginal cost is 4000. Now, how we get this marginal cost is 4000? That is the difference between the second unit of output the cost associated with the second unit of output and cost associated with the first unit of output. So, this is 8,000 minus 4,000. So, marginal cost comes to 4,000. In this case how we will find out the profit? The profit is total revenue is 34,000 and total cost is 8,000. So, 34,000 minus 8,000 that gives us 26,000 as the profit for second unit or the 2 units of the output. Similarly, for the third unit of output total revenue is 42,000, marginal revenue is 8,000. How we get the marginal revenue here? The difference between the third unit of the total revenue and second unit of the total revenue. So, 42,000 minus 34,000 that gives us 8,000 as the marginal revenue for the third unit of the output or the for 3 units of the output. Now, what is the cost over here? Considering unit cost remain constant for 3 units it should be 12,000. So, if it is for 1 unit it is 4,000 for the third unit it is 12,000 where there are 3 units of output. Marginal cost again it is same because it is the difference between the third unit of the total cost and second unit of the total cost. So, 12,000 minus 8,000 that gives us 4,000. Now, what is the profit over here? Total revenue minus total cost. So, that comes to 30,000 that is 42,000 minus 12,000 that is 30,000 as the desired activity level. I will talk about the desired activity level a bit later once we understand the table. Now, for the fourth unit total revenue is 46,000. How we will find out what is the marginal revenue associated with the fourth unit? That is the difference between the total revenue of fourth unit and the third unit. So, total revenue of fourth unit is 46,000 total revenue of third unit is 42,000. So, 46,000 minus 42,000 that gives us 4,000 which is the marginal revenue associated with the fourth unit of output. Total cost is 16,000 for 1 unit is 4,000 considering this as a fixed cost for the fourth unit this is 16,000 marginal cost 4,000 the difference between the cost associated with the fourth unit and the third unit. So, marginal cost is 4,000 marginal revenue is 4,000. Coming to fifth unit total revenue is 42,000 total cost is 20,000 for fifth unit for one unit is 4,000. So, 5 units total cost is 20,000. Now, what is the marginal revenue and marginal cost? Marginal revenue is the difference between the fifth unit of total revenue and fourth unit of total revenue. So, this is 48,000 minus 46,000. So, that comes to 2,000 and what is the marginal cost? It is constant the difference between the cost associated with the fifth unit of output and fourth unit of output. So, marginal cost comes to 4,000 for fifth unit. Then it comes to sixth unit, sixth unit total revenue is 49,000. How to find out the marginal revenue? Again the difference between the sixth unit and the fifth unit. So, in that case if you look at there is a difference of 1,000 over here as the marginal revenue. Cost is 24,000 given 4,000 as the per unit cost when it were using 6 units. So, this becomes 24,000. So, the marginal cost is the difference between the cost associated with the sixth unit and fifth unit. So, that comes to 4,000. Now, what is the profit in the case of fifth unit and sixth unit? For profit is 28,000 in case of fifth unit that is 48,000 minus 20,000 and for sixth unit this is the difference between the total revenue 49,000 and the total cost 24,000 where the profit is 25,000. So, this is a hypothetical scenario where we are getting whatever the number of unit of output we are getting total revenue, we are getting total cost, we are getting marginal revenue, we are getting marginal cost. From the difference between the total revenue and total cost we are getting the profit. Now, for any producer what should be the desired activity level and what should be the absolute activity level? Now, what is the difference between the desired activity level and absolute activity level that is on the basis of the profit and on the basis of the what is the value of marginal revenue and marginal cost? So, if you look at the cost remain constant, marginal cost remain constant, marginal revenue is going on decreasing. It started with 14,000 and it reached to 1,000 and marginal cost remain constant because the per unit total cost is remain constant that is at 4,000. So, in the first case the producer is getting profit as 16,000, second case it is 26,000, third case it is 30,000, fourth case it is 30,000. Now, between third unit and fourth unit, one is desired activity level and second one is the absolute activity level. Now, why this is a desired activity level? If you look at in the third unit still the marginal revenue is greater than the marginal cost. It means the per unit revenue by the third unit is more than the per unit cost associated with the third unit. So, still it is profitable for the producer to go further because by producing one more unit he is getting a profit same level of profit, but the marginal revenue is still greater than the marginal cost. So, when he is operating in the fourth unit the marginal revenue is 4,000 and marginal cost is also 4,000. So, this is the point the marginal revenue equal to marginal cost. If the producer is going beyond fourth unit then the revenue is decreasing cost remain constant. So, the marginal revenue is less than the marginal cost. What does it imply? It implies that whatever the last unit revenue by producing one more unit of output whatever the revenue generated at the last unit that becomes less as compared to the whatever the cost incurred by the last unit. So, marginal revenue is less than marginal cost. Now, what happens in case of second unit or third unit? In case of second unit and third unit the marginal revenue is greater than the marginal cost. It means still there is a scope for the producer to produce more because the per unit revenue generated in the last unit is more than the per unit cost associated with the last unit. So, unit 4 is the point where the marginal cost is equal to marginal revenue any unit above this the marginal revenue is greater than marginal cost any unit below this the marginal cost is greater than marginal revenue. So, the choice between the producer is to operate whether in the third unit or whether it in the fourth unit. So, using marginalist principle we will say which one is the ideal level whether it is third unit or whether it is the fourth unit. So, to maximize the profit output should be increased up to the point where marginal revenue is equal to marginal cost. So, if you are going by this policy or this rule this marginal revenue equal to marginal cost that is at the fourth unit where the marginal revenue is equal to 4000 and the marginal cost is equal to 4000. So, at this point marginal revenue is equal to marginal cost. So, even if the profit remains same between unit 3 and unit 4 the revenue is more in case of fourth unit and going by the marginalist principle we have to maximize the profit the output should be increased up to the point where marginal revenue is equal to marginal cost. So, in this case fourth unit is that level of output what the producer should produce to maximize the profit. So, one possibility when marginal revenue is equal to marginal cost there are two other possibility where we are getting that at some point or at any level of output either marginal revenue is greater than marginal cost and the marginal or the marginal cost is greater than the marginal revenue. Now, we will check when we are encountering the position or we are encountering the possibility where marginal revenue is greater than m c and when the marginal revenue is less than m c. What does it imply when marginal revenue is greater than m c? It means the last unit of output increased revenue more than the increased cost. So, this is profitable for the producer to produce more because the last unit of output is generating more revenue than the cost. Now, what is the other possibility? Marginal revenue is less than marginal cost. It means the last unit of the output increased cost more than its increased revenue. So, the cost incur in the last unit is more than the revenue generated. So, it is not it may not be the profitable for the producer to go beyond this or produce at this level because they are not generating extra revenue rather they are generating extra cost and whatever the extra revenue they are generating that is less than the extra cost. So, marginalist principle is always marginal revenue is equal to marginal cost and this is the profit maximization principle and this we are going to follow in case of our managerial economics that in order to maximize the profit there should be equality between the marginal revenue and the marginal cost. So, in the last few minutes we are discussing about the marginal analysis. So, what is the basic understanding about the marginal analysis? What is the change in the revenue? What is the change in the cost or what is the change in the utility? It is total revenue, total cost and total unit when there is a per unit change in the output. So, basically marginal analysis deals with per unit change in the variable. When you take this to a real life example, maybe we we get some situation, we get some examples where per unit change is not possible. The change is not per unit the change is junk. If it is a per unit change sometimes there is a difficulty in evaluating sometimes difficulty in estimating. So, the particularly in those time period the change is not per unit change is in a chunk. So, in reality variable may not be subject to unit change always and specifically at those situations we need the incremental concept in order to analyze whatever the change and how it affects the other variable due to this change. So, incremental concept is applied when change is not necessarily in term of single unit, but in a bulk unit. So, marginally specifically per unit change and when there is no per unit change in this case we use the term incremental concept for the change in bulk not change in the single unit. Now, it estimate the impact of decision alternatives. Sometimes some decisions that may not lead to per unit change the change is in term of bulk. So, in that respect incremental analysis estimate the impact of the decision alternatives. Now, we will check what is incremental cost and what is incremental revenue. Incremental cost is the change in the total cost as a result of change in the level of output or investment whatever may be the variable. What is incremental revenue? This is the change in the total revenue resulting from a change in the level of output or the price. So, when there is a change in the level of output, when there is a change in the level of price what is the change in the revenue that is incremental revenue and what is incremental cost when there is a change in the total cost as a result of change in the level of output or the investment. And how the manager decides like marginalist principle the profit makes measure rule is marginal cost is equal to marginal revenue. Similarly, in case of incremental analysis how the manager decides whether whether the decision is profitable or whether the decision is not profitable. Managers always decides determines the worth of a decision on the basis of the criteria that is incremental revenue is incremental cost. So, whatever the decision is taken the outcome should be that incremental revenue should be greater than the incremental cost because of this typical decision or because of this typical change. So, if you look at marginal also deals with change incremental also deals with change. Marginal analysis deals with change for one unit and incremental analysis deals with change in the in unit change in the bulk not the single unit. So, we will take an example in order to understand the incremental analysis. Suppose the firms decides that they will go for online selling. They feel that or they adopt a strategy that if they are going for online selling it will be profitable for their firm. So, this is one kind of decision taken by the firm that they are going for online selling in order to increase the revenue or in order to increase the sales which will increase the revenue. So, after going for online selling there is a increase in the sales of the firms. Now, what is incremental revenue here? Incremental revenue is that there is a increase in the sales of firm due to introduction of online selling. Online selling is the decision due to online selling there is a increase in the sales of firm that leads to increase in the revenue. So, increase in the total revenue due to increase in the sales of firm that is incremental revenue. Now, what is cost here? Cost of launching the online selling mechanism. When they have taken a decision for introduction of online selling it involves some amount of cost that increases the total cost of product. So, cost of launching the online selling mechanism is the incremental cost. Increase in the revenue due to sales of firm due to increase in the sales of firm is the incremental revenue. So, if incremental revenue is greater than incremental cost decision of introducing online mechanism is right. Now, manager on what basis he will take a call that whether he should go with the whether he should continue with the online marketing, online selling or he should stop it. For him the decision criteria is that till the time the incremental revenue is greater than incremental cost the decision of introducing online mechanism is right and the manager will continue with this decision. If it is not then if the incremental revenue is not greater than incremental cost then this decision is not bringing any profit to the firm and the manager will discontinue this online selling. So, incremental analysis the decision rule is incremental revenue should be greater than incremental cost in order to bring the whatever the decision taken by the firm to be profitable. So, as we discuss if you compare between the marginal versus incremental analysis always the marginal analysis is relates to one unit of output and incremental analysis relates to one managerial decision it may involve multiple unit of output. So, marginally strictly deals with one unit of output and incremental is always deals with the decision which involves more than one unit of output. Then we will come to take a typical model of an economy and we will see what are the different factors, what are the different sectors here and how it works or what is the money flow, what is the real flow for each sectors and how generally typical economy works here. So, if you look at in a typical economy there are four sectors. One is factor market, second is product market, third is household and fourth one is business firm and fifth one is government sector. So, if you look at if you are not considering market as the sector there are typically three sectors, one is household, second one is government and third one is business firm. So, household sector is basically deals with providing manpower to the business firm and in return of that they get the goods and services produced by the firm what they purchase. Government sector does a transfer payment to both the household sector and the business firm and in return of that they get a tax and fee from the both the household firm and the business firm. So, let us first analyze the flows between two sector household and the government sector. Now, household provide manpower to the government sector and in return of it they gets the wages and the salaries. Now, what the government sector gets out of it, the government sector gets taxes and fees, what is the revenue of the government sector, what they gets from the household sector. Now, the third sector is business firm, now what is the relationship between the government sector and the business firm, they get a business firm gives a transfer payment to the government and governments pay for their purchases of their goods and services produced by the business firm and also the business firm gives tax and fees to the government sector which is their revenue. Now, what is the relationship between the household sector and the business firm, households provide the input in term of manpower to the business firm to produce the goods and services. In return of that they get the wages and salary and what is the outcome of the business firm or what is the output of the business firm, they produce goods and services they sell it in the open market and they get a payments for their purchases from the household sector and from the government sector. So, if you simplify it household sector and business sector how they are related, if you are considering it is a two economy there is only household sector and the business sector in case of household sector they provide the manpower to produce goods and services by the business sector, in return of that they get the wages and salaries from them. Business sector use the manpower from the household sector, they utilize that for the production of goods and services what they sell it to the household sector and in return of that they get a payment for their purchases of the goods and services. How household sector and government sector they are dependent, household sector again provide manpower for the to the government sector in return of that they get the wages and the salaries, they pay tax and fees to the government which is revenue of the government and government sector provides transfer payment to the household in term of the pension and different type of payments benefit. Now, in order to facilitate this payments of the, in order to facilitate the sales of goods and services of business firm to the household and the government sector there is product market. So, business firm after producing the product they send it to the product market in order to sell those goods and services. So, there is a product flow from the business firm to the product market, product market determines the product price which is consumed by the household. So, household buys the product from the product market there is a product flow of goods and services from the product market to the household in term of that household gives the payment to the product market which goes finally, to the business firm who are the producer of the goods and services. Now, in order to facilitate the input market like in order to produce the product the business firm needs certain factor of production or certain inputs that he gets through the factor market rather than getting directly from the household. So, household gives provides labour and capital to the factor market which gets used by the business firm in order to produce the product. Now, the factor market determines the factor price since household is providing a factors to the business firm they are getting a factor income which is in term of wage and interest. So, wage is the payment for labour and interest is the payment for the capital. Now, after using the factors labour and capital the business firm gives back the wage and interest to the factor market which finally, goes to the household as the factor income. So, how factor market and business firm they are related factor market is facilitating the factor requirement for the business firm getting it from the household and providing it to the business firm. Business firm using the factor provided by the household produce the product give it to the product market and product market is sending this to household what the household buys from the product market and get a payment for it what is finally goes to the business firm. So, if you look at apart from the government sector there are two major factors two major sectors one is household and second one is business firm. Household provides the factor input to the business firm, business firm produce the product and the household again buys it from the product market and gives back the price of the product as the income of the business firm. Similarly, what is the income of the household? The income of the household is that whatever the factor they are providing to the business firm the payment made for that if they are providing labour it is wage and if it is providing capital then this is interest. So, if you look at the income of the household become expenses of the business firm and the income of the business firm becomes the expenses of the household. So, all the sector they are interrelated with each other when it is comes to the economic activity of the economy. Government sector is there and it is interlinked with both the household sector and the business firm. They provide transfer payment to household sector get the transfer payment from the business firm. They do the purchases from the business firm and make a payment for it. They take the help of the manpower to operate the government sector and in term of that they pays the wages and salaries to the household. And what is the revenue of the government sector? Whatever the tax and fees they get from the household sector and the business firm that becomes the income of the government sector. So, basically there are three sector one is household sector, second one is the business firm sector and third one is the government sector and all the three firms are related with each other. There are two market one is factor market it is deals with sales and purchase of the input and the second market is product market it deals with sales and purchase of the goods and services. So, business firm sell their product through the product market and get their factors through the factor market. Household sell their factors through the factor market and buy their product from the product market. Now, there are two kind of flows here one is real flows that is the real transfer of goods and services from product market to household and the real transfer of labor and capital from as a factor flow from the factor market to business firm. And second kind of flows is money flows it is the income the real transfer of income from factor market to household in term of factor income and real transfer of income from product market to business firm that is for the from the payment of the product that is made by the household sector. So, there is a inter linkages between all these three sectors and there are two markets which facilitates the transaction one is factor market and second one is product market. So, whatever we discussed in the last class and this marginal analysis few opportunity cost few other concept and this marginal and increment analysis these are the session references.