Managerial Economics

Dr. Hasnain Naqvi

Assistant Professor
Department of Management Sciences
COMSATS Institute of Information Technology
Islamabad Campus
Islamabad, 44000

Introduction, Basic Principles

and Methodology
The central themes of Managerial
Economics:
1. Identify problems and opportunities
2. Analyzing alternatives from which
choices can be made
3. Making choices that are best from
the standpoint of the firm or
organization

 Not true that all managers must

be managerial economists
But managers who understand the
economic dimensions of business
problems and apply economic
analysis to specific problems often
choose more wisely than those
who do not.

Some Economic Principles of

Managers
1. Role of manager is to make
decisions. Firms come in all sizes but
no firm has unlimited resources so
managers must decide how
resources are employed

2. Decisions are always among

alternatives.
3. Decision alternatives always have
costs and benefits
Opportunity cost = next best
alternative foregone.
Marginal or incremental approach
4. Anticipated objective of
management is to increase the
firms value

 Maximize shareholders wealth

Negative impact = principal-agent
problem
5. Firms value is measured by its
expected profits
Time value of money, discount
rates
6. The firm must minimize cost for
each level of production

7. The firms growth depends on

rational investment decisions
Capital budgeting decisions
8. Successful firms deal rationally
and ethically with laws and
regulations

Macroeconomics &
Microeconomics
Economists generally divide their
discipline into two main branches:
Macroeconomics is the study of the
aggregate economy.

National Income Analysis (GDP)

Unemployment
Inflation
Fiscal and Monetary policy
Trade and Financial relationships among
nations

 Microeconomics is the study of

individual consumers and producers in
specific markets.

Supply and demand

Pricing of output
Production processes
Cost structure
Distribution of income and output

Microeconomics is the basis of managerial

economics

 Methodology, data and application

Methodology- is a branch of
philosophy that deals with how
knowledge is obtained.
How can you know that you are
managing efficiently and
effectively?
You need some theory to do some
analysis.
Without theory, there can be no
good analysis

Microeconomics (probably more than

other disciplines) provides the
methodology for managerial
economics
Managerial Economics is about both
methodology and data
You need data to plug into some model
to do some analysis.
This gives you the information to
manage
Managerial Economics lends empirical
content to the study of effective

Review of Economic Terms

Resources are factors of production
or inputs.
Examples:

Land
Labor
Capital
Entrepreneurship

 Managerial Economics
The study of how to direct scarce
resources in the way that most
efficiently achieves a managerial
goal.

 Managerial economics is the use

of economic analysis to make
business decisions involving the best
use (allocation) of an organizations
scarce resources.

 Relationship to other business

disciplines
Marketing: Demand, Price Elasticity
Finance: Capital Budgeting, Break-Even
Analysis, Opportunity Cost, Economic Value
Added
Management Science: Linear
Programming, Regression Analysis,
Forecasting
Strategy: Types of Competition, StructureConduct-Performance Analysis
Managerial Accounting: Relevant Cost,
Break-Even Analysis, Incremental Cost
Analysis, Opportunity Cost

 Questions that managers must answer:

What are the economic conditions in a
particular market?

Market Structure?
Supply and Demand Conditions?
Technology?
Government Regulations?
International Dimensions?
Future Conditions?
Macroeconomic Factors?

 Questions that managers must

answer:
Should our firm be in this business?
If so, what price and output levels
achieve our goals?

 Questions that managers must answer:

How can we maintain a competitive
advantage over our competitors?

Cost-leader?
Product Differentiation?
Market Niche?
Outsourcing, alliances, mergers,
acquisitions?
International Dimensions?

 Questions that managers must

answer:
What are the risks involved?

Risk is the chance or possibility

that actual future outcomes will
differ from those expected today.

 Types of risk
Changes in demand and supply
conditions
Technological changes and the effect
of competition
Changes in interest rates and
inflation rates
Exchange rates for companies
engaged in international trade
Political risk for companies with
foreign operations

 Because of scarcity, an allocation

decision must be made. The allocation
decision is comprised of three separate
choices:
What and how many goods and services
should be produced?
How should these goods and services be
produced?
For whom should these goods and services
be produced?

 Economic Decisions for the Firm

What: The product decision begin
or stop providing goods and/or
services.
How: The hiring, staffing,
procurement, and capital budgeting
decisions.
For whom: The market
segmentation decision targeting the
customers most likely to purchase.

 Three processes to answer what,

how, and for whom
Market Process: use of supply,
demand, and material incentives
Command Process: use of
government or central authority,
usually indirect
Traditional Process: use of
customs and traditions

 Profits are a signal to resource

holders where resources are most
valued by society
So what factors impact
sustainability of industry
profitability?
Porters 5-forces framework
discusses 5 categories of forces
that impacts profitability

1. Entry
2. Power of input sellers
3. Power of buyers
4. Industry rivalry
5. Substitutes and Complements

Entry:
Heightens competition
Reduces margin of existing firms
Ability to sustain profits depends on
the barriers to entry: cost,
regulations, networking, etc.
Profits are higher where entry is low

Power of input suppliers:

Do input suppliers have power to
negotiate favorable input prices?
Less power if
a. inputs are standardized,
b. not highly concentrated
c. alternative inputs available
Profits are high when suppliers
power is low

Power of buyers:
High buyer power if
a. buyers can negotiate favorable
terms for the good/service
b. Buyer concentration is high
c. Cost of switching to other
products is low
d. perfect information leading to
less costly buyer search

Industry rivalry:
Rivalry tends to be less intense
a. in concentrated industries
b. high product differentiation
c. high consumer switching cost
Profits are low where industry rivalry
is intense

Substitutes and complements:

Profitability is eroded when there
are close substitutes
Government policies (restrictions
e.g. import restriction on drugs
from Canada to US) can affect the
availability of substitutes.

The Five Forces Framework

Entry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale

Entry

Power of
Input Suppliers

Power of
Buyers

Supplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints

Sustainabl
e Industry
Profits

Industry Rivalry
Concentration
Price, Quantity, Quality, or
Service Competition
Degree of Differentiation

Network Effects
Reputation
Switching Costs
Government Restraints

Switching Costs
Timing of Decisions
Information
Government Restraints

Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints

Substitutes & Complements

Price/Value of Surrogate Products
or Services
Price/Value of Complementary
Products or Services

Network Effects
Government
Restraints

Market Interactions
Consumer-Producer Rivalry
Consumers attempt to locate low
prices, while producers attempt to
charge high prices.

Consumer-Consumer Rivalry
Scarcity of goods reduces the
negotiating power of consumers as
they compete for the right to those
goods.

 Producer-Producer Rivalry
Scarcity of consumers causes
producers to compete with one
another for the right to service
customers.

The Role of Government

Disciplines the market process.

Overview of Lectures
Lecture 1: Demand
Lecture 2: Supply
Lecture 4: Quantitative Demand Analysis
Lecture 5: The Theory of Individual
Behavior
Lecture 6:Demand Estimation &
Forecasting
Lecture 7: Production
Lecture 8: Cost of Production

Lecture 9: Organizing Production

Lecture 10: Perfect Competition
Lecture 11:The Firms Decisions in Perfect
Competition
Lecture 12:Monopoly
Lecture 13:Price Discrimination
Lecture 14:Monopolistic Competition
Lecture 15: Oligopoly
Lecture 16: Oligopoly Games

Lecture 17: Labor and Capital Market

Lecture 18: Capital Market
Lecture 19: Economic Equations and Their
Solutions
Lecture 20: Economics Applications of
Derivatives
Lecture 21: ECONOMIC APPLICATION OF
DERIVATIVES A
Lecture 22: ECONOMIC APPLICATION OF
DERIVATIVES - A

Lecture 23: ECONOMIC APPLICATION OF

MAXIMA AND MINIMA-A
Lecture24: MAXIMIZATION OR
MINIMIZATION (OTIMIZATION) OF
MULTI-VARIABLE FUNCTIONS OR TWO
OR MORE VARIABLE
Lecture 25: CONSTRAINED OPTIMIZATION
Lecture 26: CONSTRAINT OPTIMIZATION
A
Lecture 27: Correlation & Regression

Lecture 28: Measuring a Nations Income

Lecture 29: Money
Lecture 30: Monetary Policy
Lecture 31: Fiscal Policy and NI Determination