MCom I Semester Managerial Economics Risk Uncertainty Study Material Notes

//

MCom I Semester Managerial Economics Risk Uncertainty Study Material Notes

MCom I Semester Managerial Economics Risk Uncertainty Study Material Notes : Risk and Uncertainty an Introduction Kinds of Uncertainty Measure sot Be Taken For reduction risk or planing for Risk Difference Between Risk and Uncertainty Different Degrees of Uncertainty ( This Topic Wise Notes is Most Important For MCom Students )

MCom I Semester Managerial Economics Risk Uncertainty Study Material Notes
MCom I Semester Managerial Economics Risk Uncertainty Study Material Notes

MCom I Semester Analysis Statistical Quality Control Study Material Notes

RISK AND UNCERTAINTY

RISK AND UNCERTAINTY: AN INTRODUCTION

Before discussing the “Theory of Consumer Choice Under ‘risk'”, it! is necessary to understand the clear meaning of “risk” and “uncertainty”. Both are different concepts usually used as in similar sense. Thus, it is essential to know the difference between risk and uncertainty. A risky situation has more than one possible outcome and the risk-taker is aware of all possible outcomes and knows the probability of each one occurring. In an uncertain situation, the precise nature of these outcomes is not known and probability to the outcomes cannot be assigned.

RISK

Risk is the probable measurement of uncertainty. When uncertainty is reduced to a number of possible results to alternative courses of action, it is called risk. Thus, risk is a state of knowledge in which the result of every alternative is expected to be one of the certain possible results. The decision-maker can calculate the possibility of all the decisions. The term risk has been defined as under:

Milton H. Spencer, “Risk has been defined as a state of knowledge in which each alternative leads to one of a set of specific outcomes, each occurring with a probability that is known to the decision-maker.”

Haynes, Mote and Paul, “Risk refers to relatively objective probabilities which can be computed on the basis of past experience or some prior principle.”

Thus, it can be concluded that risk is a state of knowledge in which it is possible to calculate the possibilities of the result of every decision and such results can be forecasted. Risk is little more uncomfortable in comparison to the situation of certainty because under this situation, the results depend upon possibility.

Measurement of Possibility of Risk. There are two methods of measuring probability of risk-1. Priori principle or deduction method, 2. Posteriori principle or past experience method. Details in this regard are as follows:

1 Priori Principle or Deduction Method. Under this method of measuring the probability or risk, the probability of risk is measured on the basis of imaginary principles. No past experience is used for help under this method. For example, If a firm is engaged in illegal business, it is all the times possible that it will come to light and be punished sooner or later. It is always possible to loose in the transactions of speculation. Now the question arises now is the probability of risk measured ? It can be said in this regard that though there is no certainty of these measurements, however, the results of these measurements are always expected to be within a certain limit.

2. Posteriori Principle or Past Experience Method. According to this principle of measuring probability or risk, help of past experiences is taken to measure the probability of risk. This principle is based upon the assumption that ‘History repeats itself. In other words, it is assumed under this method that the past incidents will occur again. Therefore, past experience can be used to predict the probability of risk. Insurance companies determine the rate of premium on the basis of the calculation of the death rate according to this method.

Types of Risks.

There are three types of risks-business risk, financial risk and portfolio risk. Details in this regard are as follows:

1 Business Risk. Business risks are the risks which are related with the production, marketing and personnel affairs of a business firm. A firm has to face the risks at every step such as- tastes and preferences of customers, policies of competitors, quality and price of the products of competitors, business cycles, labour strikes, pricing policy of the firm etc. When uncertainty in this regard is measurable, it becomes business risk.

2. Financial Risk. Financial risks are the risks related with financial activities and decisions of a firm. Financial decisions determine the financial risk of a firm. Financial risks relate to the risk of possible fluctuations in the profit, risk of bad debts and the risk of possible insolvency etc. Effect of financial risks is reflected in the prices of shares.

3. Portfolio Risk. Portfolio risks are the risks that are derived from various investment proposals and their effect on the financial structure of a firm. Such risks are insurable.

UNCERTAINTY

Uncertainty is just opposite to the situation of certainty. Uncertainty is a situation in which the result of various decisions cannot be predicted and their probability can also not be measured. The term uncertainty has been defined as under:

“Uncertainty has been defined as a state of knowledge in which one or more alternatives result in a set of specific outcomes but where the probabilities of the outcomes are neither known nor meaningful.”

“Uncertainty is relatively subjective, there being insufficient past information, insufficient stability of the structure of variables to permit exact prediction.”

-Haynes, Mote and Paul Thus, it may be concluded that uncertainty is a situation in which the decision-maker does not know probable results of the alternatives. Uncertainty is also termed as unmeasurable risk. It is the result of imperfect knowledge about each alternative. In this situation all the decisions are taken in the atmosphere of uncertainty.

Risk Uncertainty Study Material

KINDS OF UNCERTAINTY

A large number of decisions are taken in every business firm on various issues. All the important decisions of a firm are taken by management with the advice of managerial economist. Success of a firm depends to a large extent upon the effectiveness of these decisions. However, all the decisions are taken in an atmosphere of uncertainty. Therefore, it becomes necessary to understand the types and various areas of uncertainty in which management of a business firm has to take decisions. Main areas of uncertainty are as follows:

1 Demand Uncertainty. The first and the most important uncertainty faced by management in the process of decision-making is the uncertainty regarding demand of the products of the firm. Forecasting of the demand is essential to take decisions regarding production, cost of production, capital requirements etc. management prepares a demand table and analyses it but that all is done under uncertainty and is simple a guess.

2. Production Uncertainty. Second most important uncertainty to be faced by management is regarding production. What should be the quantity of production ? What should be the production schedule? What resources should be employed in production process ? How should these resources be allocated to different production activities ? etc., are the questions that create an atmosphere of uncertainty in the process of decision-making.

3. Profit Uncertainty. As already discussed, main object of every business firm is to earn maximum profit. Profit is the difference between cost and revenue. Both the cost and revenue are uncertain. Therefore, what will be the profit of firm, is also uncertain.

4. Price Uncertainty. Determination of price for a product of the firm is the most important aspect of decision-making process. Success of a business firm depends to a large extent upon this decision, but pricing decision is affected by a large number of external factors over which the manangement can have no control. Therefore, there is an element of uncertainty in pricing decision.

5. Cost Uncertainty. Cost of production is important factor for demanding the price of the products of a firm. It is also important for determining profit of the firm. Generally, the cost estimates are based upon the historical cost data available from the records of a firm. Different elements of cost are always uncertain. Therefore, the element of uncertainty exists in this regard also.

6. Labour Uncertainty. Labour is the force that convert all the decisions and plans of a firm into actions. Regular supply and efficiency of labour are the factors that determine success of a firm. If the management faces a problem in getting required labour force at required time or if the workers do not Co-operate in the accomplishment of organisational objectives the firm cannot be successful. But the supply and efficiency of labour are always uncertain

7. Capital Uncertainty. There are many uncertainties in the field of capital also of a business firm because capital market is affected by many economical and political factors.

8. Environmental Uncertainty. Decisions of a business firm are effected by many environmental factors also. Social, economical and political circumstances in which the firm is operating affect the process of decision-making of a firm but it is never certain to predict these factors successfully

DIFFERENT DEGREES OF UNCERTAINTY

Eminent Scholars of Managerial Economists have described following three degrees of uncertainty :

1 Complete Ignorance. Complete ignorance is the situation in which a business executive does not know anything about future. He is unable in making any prediction of future events. Therefore, he can decide a problem in the manner that may not be profitable or that may cause loss also to the firm. On the contrary, his view may be highly profitable to the firm. It is to remember in this regard that in this situation, all the decisions depend upon logic and rational only. There is no scientific base of such decisions.

2. Partial Ignorance. Partial ignorance is the situation of uncertainty in which a business executive is neither fully aware nor fully ignorant of a problem. This is the state between complete knowledge and complete ignorance. In this situation, uncertainty is converted into risk.

3. Complete Knowledge. It is the situation in which a business executive has full knowledge of all the facts related with a problem but the probability of alternative results is fully uncertain. In this situation, the business executive analyses these facts with the help of statistical methods and techniques. Thus, in this situation decisions are taken with the help of analytical study of relevant facts.

Risk Uncertainty Study Material

DIFFERENCE BETWEEN RISK AND UNCERTAINTY

Some Economists are of the opinion that risk and uncertainty are synonyms to each other but it is not true. The reality is that the two are quite different from each other, Prof. Knight stated in this regard that, “Uncertainty is a unknown risk and risk is a measurable uncertainty.” Difference de risk and uncertainty may be explained as under:

1 Probability of Ouantitative Measurement. Risk is measurable and can be quantitatively measured but uncertainty cannot be measured in any form.

2. Insurability. The risk is measurable. There are certain risks which can be fully covered by taking insurance policies such as-fire, flood, draught, theft, robbery etc. On the other hand, insurance of uncertainties is not possible.

3. Transferability. A risk can be transferred into another risk but an uncertainty cannot be so transferred.

4. Element of Cost. According to Prof. Knight, “Cost of production includes the cost of risk bearing also. Enterpreneur does not get any profit for risk bearing. On the other hand, uncertainty is not included in the cost of production. The reality is that the profit is the reward of the enterpreneur for bearing uncertainty.”

5. Subjective and Objective. Risk is objective while uncertainty is subjective because risk can be measured while uncertainty can only be realised.

6. Knowledge of Alternatives. In case of risk, all the possible alternatives of a problem are known to the economists in advance but in case of uncertainty, such previous knowledge is not possible.

7. Nature of Decisions. Decisions taken under the conditions of uncertainty are more important than the decisions taken under the conditions of risk because in the case of uncertainty, measurement of alternatives is not possible.

MEASURES TO BE TAKEN FOR REDUCTION RISK Or, PLANNING FOR RISK

Planning of risk can be divided into two parts as follows:

1 Internal Planning for Risk. When a business firm makes all the possible efforts to reduce the risk on its own, it is called internal planning for risk. In this case, no external source is used to reduce the risk. For example, if in a firm, 5% of the number of raw materials introduced is wasted, the firm will prepare plan for reducing such wastage to the minimum. Similarly, internal planning is prepared for controlling the wastage of labour time and other general overheads. Internal planning for risk is also known as self-insurance.

2. External Planning for Risk. When a firm takes the help of any external source to reduce business risks, it is called external planning for risk. The best example of external planning is the insurance against the risk of flood, fire, theft, robbery etc. Similarly a firm takes the help of insurance company to reduce the risk of industrial accidents. Employees Compensation Act, 1923 provides that if any employee is injured while working in an enterprise or dies due to any indutstrial accident, a certain compensation will be paid to him. Generally, the firms take the help of insurance to provide for such risks. External planning for risk is also known as risk shifting.

Risk Uncertainty Study Material

chetansati

Admin

https://gurujionlinestudy.com

Leave a Reply

Your email address will not be published.

Previous Story

MCom I Semester Managerial Economics Theory Revealed Preference Study Material Notes

Next Story

MCom I Semester Managerial Economics Theory Consumer Choice Under Risk Study Material Notes

Latest from Managerial Economics study material