MANAGERIAL

ECONOMICS
Introduction
Economics

• The study of how people use their scare resources to

satisfy their unlimited wants

• Deals with economic choice

• Why a choice?
 Wants, desires: unlimited
 Resources: scarce
 If Resources are scare, Goods and Services are
Scare
Resources
• Inputs or Factors of Production

1. Labor
2. Capital
3. Natural Resources
4. Entrepreneurial ability
Resources
 Labor – human effort
 Physical effort
 Mental effort
 Time
 Payment: Wage
 Capital – human creations
 Physical capital
 Human capital
 Payment: Interest
Goods and Services
 Good: see, feel, touch
 Service: intangible
 Scarce good/service
 The amount people desire exceeds the amount
available at zero price
 Choice
 Give up some goods and services
Goods and Services
 Bads
 We want none of them; not even at a zero price

 Free goods and services

 “There is no such thing as a free lunch”

 Involve a cost to someone
Economic Decision Makers
 Households
 Consumers
 Demand goods and services
 Resource owners
 Supply resources
 Firms, Governments, Rest of the World
 Demand resources
 Produce goods and services
Simple Circular Flow Model
Markets

 Bring together buyers and sellers

 Determine price and quantity

 Product markets
 Goods and services

 Resource markets
 Resources
Rational Self-Interest

 Individuals are rational

 Make the best choice
 Given the available information
 Maximize expected benefit
 With a given cost
 Minimize expected cost
 For a given benefit

 The lower the personal cost of helping others, the more

help we offer
Choice – Time and Information

 Time and information – scarce; valuable

 Rational decision makers

 Willing to pay for information
 Improve choices
 Acquire information
 Additional benefit expected exceeds the additional
cost
Economic Analysis is Marginal Analysis

 Expected marginal benefit

 Expected marginal cost

 Marginal
 Incremental, additional, extra

 Rational decision maker:

 Change the status quo if expected marginal benefit
exceeds expected marginal cost
The Scientific Method for Economic Analysis
Managerial Economics
Managerial Economics Defined

• The application of economic theory and the tools of

decision science to examine how an organization can
achieve its aims or objectives most efficiently.

• applications of economic theory

• quantitative methods
• statistical methods
• computational methods
Economic Theory
• Microeconomics
• Study of the economic behavior of individual decision-making units.
• Relevance to Managerial Economics
• Macroeconomics
• Study of the total or aggregate level of output, income,
employment, consumption, investment, and prices for the economy
viewed as a whole.
Decision Sciences
• Mathematical Economics
• Expresses and analyzes economic models using the tools of
mathematics.

• Econometrics
• Employs statistical methods to estimate and test economic models
using empirical data.
Economic Methodology
• Economic Models
• Abstract from details
• Focus on most important determinants of economic behavior –
cause and effect

• Evaluating Economic Models

• A model is accepted if it predicts accurately and if the predictions
follow logically from the assumptions.
Theory of the Firm
• Combines and organizes resources for the purpose of
producing goods and/or services for sale.

• Internalizes transactions, reducing transactions costs.

• Economic theory assumes that the primary goal of

managers is to maximize the value of the firm.
Value of the Firm

The present value of all expected future profits

Definitions of Profit

• Business or Accounting Profit: Total revenue minus the

explicit or accounting costs of production.

• Economic Profit: Total revenue minus the explicit and

implicit costs of production.

• Opportunity Cost: Implicit value of a resource in its best

alternative use.
Theories of Profit
• Risk-Bearing Theories of Profit

• Frictional Theory of Profit

• Monopoly Theory of Profit

• Innovation Theory of Profit

• Managerial Efficiency Theory of Profit

Alternative Theories

• Sales maximization
• Adequate rate of profit

• Management utility maximization

• Principal-agent problem
Production Possibility Curve
• Is also called as Substitute curve, production indifference
curve, transformation curve and production frontier.

• Shows all the alternative combinations of two

commodities that a nation can produce by fully utilizing all
its factor of production
 PPC
A The Economy’s
Consumer goods (millions of units per year)

50
48 B
C Production
43
U Possibilities
34 D Unattainable Frontier
30
Inefficient PPF (AF): Economy uses all
resources and technology
I E
20 efficiently

10 Inefficient: inside PPF

F Unattainable: outside PPF

0 10 20 30 40 50

Capital goods (millions of units per year)

Opportunity Cost
• The Next Best use of a resource

• The benefits foregone by not putting it to the next best use

is the cost of putting the resource to the present use.

• This cost of putting the resource to the present use is

nothing but what is foregone and so, what is foregone is
called the ‘opportunity cost’ of this resource being put
to the present use.
Choice and Opportunity Cost
 Scarcity
 Make a choice
 Pass up another
opportunity
 Opportunity cost
 The value of the best
alternative forgone
 Opportunity lost
 Monetary aspect
 Non-monetary aspect
Opportunity Cost
 Opportunity cost is subjective
 ‘the road not taken’
 Calculating opportunity cost
 Requires time and information
 Time: the ultimate constraint
 Opportunity cost varies with
circumstance
 Depends on the alternative
General and Partial Equilibrium
• Partial Equilibrium, studies equilibrium of individual
firm, consumer, seller and industry. It studies one
variable in isolation keeping all the other variables
constant.

• General Equilibrium, studies a number of economic

variable, their inter relation and inter dependencies for
understanding the economic system.
• Economic System, is the set of mechanisms and
institutions that resolve the what, how and for whom
questions.
Q&A
Next Lecture – Unit II – Demand and Supply
Analyses