The concept of opportunity cost implies three things: Opportunity cost, therefore, represents the benefits or revenue forgone by pursuing one course of action rather than another. Sacrifice of alternatives is involved when carrying out a decision requires using a resource that is limited in supply with the firm. Opportunity cost of a decision is the sacrifice of alternatives required by that decision. We are, therefore, forced to make a choice. For the production of one commodity, we have to forego the production of another commodity. Resources are scarce, we cannot produce all the commodities. In Managerial Economics, the opportunity cost concept is useful in decision involving a choice between different alternative courses of action. In everyday life, we apply the notion of opportunity cost even if we are unable to articulate its significance. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price.īoth micro and macro economics make abundant use of the fundamental concept of opportunity cost. The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. Marginal cost refers to change in total costs per unit change in output produced (While incremental cost refers to change in total costs due to change in total output). Marginal revenue is change in total revenue per unit change in output sold. Marginal generally refers to small changes. Marginal analysis implies judging the impact of a unit change in one variable on the other. (iv) It reduces costs more than revenues. (iii) It increases some revenues more than it decreases others. (ii) It decreases some cost to a greater extent than it increases others. (i) It increases revenue more than costs. The incremental principle may be stated as follows:Ī decision is clearly a profitable one if Incremental cost denotes change in total cost, whereas incremental revenue means change in total revenue resulting from a decision of the firm. The two major concepts in this analysis are incremental cost and incremental revenue. Incremental concept is closely related to the marginal cost and marginal revenues of economic theory. The incremental concept is probably the most important concept in economics and is certainly the most frequently used in Managerial Economics. There are six basic principles of managerial economics. The contribution of economics to managerial economics lies in certain principles which are basic to managerial economics. Therefore, it would be useful to examine the basic tools of managerial economics and the nature and extent of gap between the economic theory of the firm and the managerial theory of the firm. In fact, actual problem solving in business has found that there exists a wide disparity between economic theory of the firm and actual observed practice. This is not to say that economics has all the solutions. Before the substantive decision problems which fall within the purview of managerial economics are discussed, it is useful to identify and understand some of the basic concepts underlying the subject.Įconomic theory provides a number of concepts and analytical tools which can be of considerable and immense help to a manager in taking many decisions and business planning. Managerial Economics is both conceptual and metrical.
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