Transcript Managerial Decision Making

Chapter 1 - Managerial
Decision Making
Takesh Luckho
What is Economics?
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ECONOMICS is the study of how
society decides:
What
 How
 For whom
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to produce...
What is Economics?
Early definitions
 Adam Smith who is generally regarded
as the father of economics, defined
economics as “ a science which
enquires into the nature and cause of
the wealth of nation”. He emphasized
the production and growth of wealth as
the subject matter of economics
Criticism of wealth oriented definition
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Defined wealth in a a very narrow
and restricted definition, in the
sense that it considers only material
and tangible goods.
Have given emphasis only to wealth
and reduced man to secondary
place in the study of economics.
Traditional Definition
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According to Alfred Marshall “ Economics
is on the one side a study of wealth and
on the other, a more important side, a
part of the study of man.”
According to Lord Robbins “ Economics is
the science which studies human
behaviour as a relationship between
ends and scarce means which have
alternative uses”
Modern Definition
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Wants (ends) are unlimited and resources
are limited.
Economics is the study of the allocation of
scarce/limited resources among
competing Wants (ends).
What is an economy then? == Is a
system where goods are produced and
exchanged to satisfy human wants
Significance/Advantages of
Economics
Theoretical Advantages
- Increase in Knowledge
- Developing Analytical Attitude
Practical Advantages
- Significance for the consumers
- Significance for producers
- Significance for workers
- Significance for politicians
- Significance for academicians
- Significance for administrators
- Effective man-power planning
- Helpful in fixing price
- Solving distribution problems
Impact of a change in oil Prices
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US$ per barrel
Tripled in 1973-74, and doubled again in 1979-80
… and affected people all over the world.
An increase in the price of oil
affects
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What to produce
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How to produce
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less oil-intensive products
less oil-intensive techniques
For whom to produce
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oil producers have more buying
power, importers have less
Scarcity
• A basic human dilemma
-Limited resources vs. unlimited wants
• Society has limited resources and therefore cannot
produce all the goods and services they wish to
have.
• According to Paul Samuelson, even if we combine
all the resources that exist in the world and apply the
best technique of production to them, yet, we will
not be able to satisfy all the wants of the society.
• Wants are insatiable
Choice
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Scarcity forces people to make choices
about which wants they will satisfy.
Economic decision making involves
examining the alternatives/choices that
are available, establishing criteria for the
decision
making,
evaluating
each
alternative/choice against the criteria,
and making the decision.
Opportunity Cost (Real cost)
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For every choice there is an opportunity
cost.
Opportunity cost is the next best alternative
forgone.
Helps us view the true cost of decision
making
Implies valuing different choices
The concepts of scarcity, choice and
opportunity cost can be explained by the
use of the Production Possibility Frontier
(PPF)
Why use Economics in Management?
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Managerial Economics is the integration of
economic theory with business practices for
the purpose of facilitating Decision Making
and Forward Planning by the management.
The use of Economic Analysis is to make
business decisions involving the best use
(allocation) of scarce resources.
Economic Theory helps managers to collect
the relevant information and process it in
order to arrive at the optimal decision given
the goals of a firm.
Decision Making Process
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Decision making = choosing from alternative
choices to solve a problem
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Identify the problem.
Diagnose the situation.
Collect and analyze data relevant to the issue.
Ascertain solution that may be used in solving the
problem
Analyze these alternative solutions.
Select the approach that appears most likely to
solve the problem
Implement it.
Evaluate the decision and adjust if needed
Common problem faced by a Management
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What price to sell and how much to
output to produce?
Which is the best production
technique?
What stock levels to hold?
How much advertising is needed?
Human Resource problems
Investment and Financing questions
Decisions need to be taken by managers
As a manager, you would be faced with
the following questions:
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What goods shall be produce?
What shall be its legal form?
How should the firm raise the necessary capital?
What technique shall be adopted, and what shall
be the scale of operations?
Where production is located?
How shall its product be distributed?
How shall resources be combined?
What shall be the size of output?
How shall it deal with its employees?
Types of Decision Making Process
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To answer the above questions, three type of
decision making system exists
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Organisational and personal decisions
 Organisational decision – decisions taken in the role
of a manager (e.g Strategy of the firm, approval of
plans)
 Personal decision – decisions taken not as a member
of the company (e.g Retire, quit current job)
Basic and routine decisions
 Basic decision – decisions such as selection of
product line/raw materials, choice of plant location
 Routine decision - decisions that are repetitive in
nature and have little impact on the firm (e.g
transport options, quotation format). As these type
of decision are repetitive, firms generation formulate
a list of procedures to guide managers in their
decision
Types of Decision Making Process
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Programmed and non-programmed decision
Programmed decisions – similar to routine
decisions
 Non- programmed decisions – similar to basic
decisions
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Decision Making Environment
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Decision making is also subjective to the information
environment under which the decision is being taken.
 Certainty is defined as when decision makes are fully
informed about a problem its alternative solutions,
and their respective outcomes.
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Uncertainty is defined as a situation where little or no
factual information is available about a problem, its
alternative solution, and their respective outcomes.
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That is information about the problem, process and solution
is fully available/known
That is information about the problem, process and solution
is partially or not available/known  existence of risk
Hence risk is defined as a situation where the decision
marker does not have fully knowledge of the situation
in the market before marking his decision. Success of
the decision is subjected to chance
Decision Making Models
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To solve a problem, the decision marker much define a
framework/model to find the solution. Two main types
of decision making model exists:
 Classical model – Also called the rational model, it
asserts that the manager is rational (make logical
decision) and has the following assumptions:
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The manager has completed information about the
decision situation and operations under a condition of
certainty.
The problem is clearly defined, and the decision-maker
has knowledge of all possible alternatives and their
outcomes.
Through the use of quantitative techniques, rationality,
and logic, the decision-maker evaluates the alternatives
and selects the optimum alternative -the one that will
maximize the decision situation by offering the best
solution to the problem.
Decision Making Models
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Administrative model – as known as the behavioural model
argue that people do not always make decisions with logic
and rationality (faces a situation of bounded rationality)
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Bounded rationality implies that individuals have boundaries
to their rationality level due to their values/belief, lack of
skills or lack of information.
Assumptions of the administrative model are:
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The manager has incomplete information about the decision
situation and operates under a condition of risk or
uncertainty.
The problem is not clearly defined, and the decision-maker
has limited knowledge of possible alternatives and their
outcomes.
The decision-maker satisfies by choosing the first
satisfactory alternative- one that will resolve the problem
situation by offering a good solution to the problem.
Decision Making Techniques
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Some useful techniques that has proved
valuable in the decision making process
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Marginal Analysis – marking use of the concept of
“marginal” to take a decision
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E,g: Profit maximising output is where Marginal Cost
= Marginal Revenue
Financial Analysis – In this approach, the firm
need to analyze the assets as well as liabilities,
efficiency of capital investment, choice of project
and various vital ratios.
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Cost-Benefit analysis or project appraisal (payback,
N.P.V, IRR) approach are some of the best available
option
Decision Making Techniques
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Group Techniques – decision take in consortium. Types
of group decision making:
 Brainstorming - Brainstorming is a technique in
which group members spontaneously suggest keys to
solve a problem. Its primary purpose is to generate a
multitude of creative alternatives, regardless of the
likelihood of their being implemented.
 Nominal Group Technique - it involves the use of
highly structured meeting agenda and restricts
discussion or interpersonal communication during the
decision making process. While the group members
are all physically present, they are required to operate
independently.
 Delphi Group Technique - employs a written survey
to gather expert opinions from a number of people
without holding a group meeting. Unlike in
brainstorming and nominal groups, Delphi group
participants never meet fact to face (located in
different cities)
Decision Making Tool
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Linear Programming - is a mathematical method for
determining a way to achieve the best outcome (such as
maximum profit or minimising cost) in a given
mathematical model for some list of variables
represented in linear relationships.
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Assumption of linear programming:
 Activities must be competing for limited resources.
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All relationships in the problem must be linear
E.g. Assume that a firm want to maximise its Total Profit
subject to a labour (L) and land (M) constraint (as the
amount of land and labour is limited in number)
Max Π = Π(X,Y)
subject to L1.X + L2.Y = L*
M1.X + M2.Y = M*
X ≥ 0 and Y ≥ 0
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To solve a linear programming problem, can make use of
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Graphical approach
Simplex method
Decision Making Tool
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Inventory Control is the supervision of supply,
storage and accessibility of items in order to
ensure an adequate supply is available to meet
demand and thus avoid wastage.
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Economic order quantity is one of the oldest
classical inventory model minimizes total inventory
holding costs and ordering costs. The EOQ formula is
given as
Where
Q
2*D*A
H
•Q = optimal order quantity
•D = annual demand qty
•A = Fixed cost per order
•H = Annual holding cost
Decision Making Tool
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Decision Tree – is a support tool that uses
of tree-like graph so as to make
decisions.
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Decision making is based on the use of
probabilities, revenue, outcomes, cost or
utility to make a decision.
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A decision tree consists of 3 types of nodes:
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Decision nodes - commonly represented by squares
Chance/probability nodes - represented by circles
End nodes - represented by triangles
Decision Tree
Events
Acts
A1
E1
O11
E2
O12
E1
A2
Outcomes
Chance Node
Terminal Node
O21
E2
O22
E1
O31
E2
O32
A3
Do not need this action
Decision Node
Analysis done through roll-back principle