BEC 30325: MANAGERIAL ECONOMICS

INTRODUCTION TO MANAGERIAL ECONOMICS

Session 01

Dr. Sumudu Perera

• Nature and scope of Managerial Economics

• Goals and Constraints of business

organizations

• The Theory of the firm

• The nature and importance of profit

• Economic Profit and Accounting Profit

• Quantitative techniques in Managerial

Economics

Session Outline

Managerial Economics

• Managerial Economics is the integration

of economic theory with decision

science tools, so as to make decision

making effective and efficient.

• The application of economic theory and

the tools of decision science to examine

how an organization can achieve its

aims or objectives most efficiently.

Managerial Economics deals with:

“How decisions should be made by

managers to achieve the firm’s

goals-in particular, how to maximize

profit”

Managerial Decision Problems

Economic theory

Microeconomics

Macroeconomics

Decision Sciences

Mathematical Economics

Econometrics

MANAGERIAL ECONOMICS

Application of economic theory

and decision science tools to solve

managerial decision problems

OPTIMAL SOLUTIONS TO

MANAGERIAL DECISION PROBLEMS

Managerial Decision Problems

• Product price and output

• Make or buy

• Production techniques

• Stock levels

• Advertising and media

• Labour hiring and training

• Investment and financing

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Decision Sciences :

Tools and Techniques for Analysis

• Numerical Analysis

• Statistical Estimation

• Forecasting

• Game Theory

• Optimization

• Simulation

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• Theory of consumer behaviour

• Theory of the firm

• Theory of market structures and pricing

8Economic Concepts:

Framework for Decisions

The goals of a firm :

Economic Goals; Maximizing or Satisficing?

• Profit

• Market share

• Revenue growth

• Return on investment

• Technology

• Customer satisfaction

• Shareholder value

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Non-economic goals and objectives

• A good place for our employees to work

• Provide high quality products/ services to the

customers

• Act as a good citizen in the society

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Optimal Decision

• Given the goals that the firm is pursuing, the

optimal decision in managerial economics is one

that bring the firm closest to this goal.

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Questions that managers must answer,

What are the economic conditions in a particular market?

• Market structure?

• Government regulations?

• Future conditions?

• International dimensions?

• Technology?

• Macroeconomic factors?

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It should be emphasized that practically in all managerial decisions

the task of the manager is the same. Namely, each goal involves

the optimization problem.

• The manager attempts either to maximize or minimize

some objective function, frequently subject to some

constraints.

• And for all goals that involve an optimization problem,

the basic general economic principles apply.

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Economics Vs. Managerial Economics

Economics

Study of economic theory

Belongs to positive

economics

Examine the human

behavior on using scarce

resources on unlimited

needs and wants

Limited Scope

Managerial Economics

Application of economic

theory

Belongs to normative

economics

Study the way of applying

economic theory for

decision making in firms

Wide scope

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Why is Managerial Economics Important?

• To estimate economic relationships

• To make decisions related to internal issues

• Effectively utilize resources (What/how

much/how/to whom, to produce)

• Pricing

• Face price and non-price competitions

• Maximizing sales, revenues, profits

• To identify the impact of external factors on

the firm

• To use theoretical concepts in economics to

actual behavior of firms

• A powerful “analytical engine”.

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Theory of the Firm

▪ Combines and organizes resources for the purpose of producing goods

and/or services for sale.

▪ Internalizes transactions, reducing transactions costs.

▪ Primary goal is to maximize the wealth or value of the firm.

Example -Theory of the Firm

Johns, an entrepreneur decides to set up a firm by recruiting people to

work for wages, by purchasing a property for the factory. Johns believes

that it is very much efficient and less costly to run a business through a firm,

rather than him doing everything alone.

He believes that a general contract agreed with laborers to perform a

number of tasks for specific wages and benefits is less costly than specific

contracts for each task undertaken.

He can also internalize many functions such as Finance, Marketing, IT,

Research and Development etc without giving those tasks to external

parties.

Value of the Firm

The present value of all expected future profits

1 2

1 21(1 ) (1 ) (1 ) (1 )

nn t

n tt

PVr r r r

1 1(1 ) (1 )

n nt t t

t tt t

TR TCValueof Firm

r r

Alternative Theories

▪ Sales maximization

Adequate rate of profit

▪Management utility maximization

Principle-agent problem

▪Satisficing behavior

Definitions of Profit

▪ Business / 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.

Example –Accounting vs Economic profit

Aniq is a final year student and he also works as a part-time gym instructor at the

College gymnasium. During his free hours he engages in training athletes, for which he

receives an allowance of Rs.10000 per month. He has to incur a cost of Rs.1200 per

month for his travelling and another Rs.600 on laundry on his sports clothes. Other than

that, on the days that he comes to the gym he has to spend on a protein drink which

would cost him Rs. 800 per month on average. If he was to be occupied elsewhere

during his free time, he could have worked at the college cafeteria and earned Rs.

5,500 per month.

Identify the explicit, implicit and economic costs of this scenario separately, and

compare the accounting and economic profits of engaging in as a gym instructor.

Function of Profit

▪ Profit is a signal that guides the allocation of society’s

resources.

▪ High profits in an industry are a signal that buyers want more

of what the industry produces.

▪ Low (or negative) profits in an industry are a signal that

buyers want less of what the industry produces.

The Changing Environment of

Managerial Economics

▪ Globalization of Economic Activity

Goods and Services

Capital

Technology

Skilled Labor

▪ Technological Change

Telecommunications Advances

The Internet and the World Wide Web

• Numerical analysis

• Statistical estimation

• Forecasting

• Game theory

• Optimization

• Simulation

Decision Science Tools

Department of Business Economics, FMSC, USJP

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Basic Training: Rules of Differentiation

Constant Function Rule: Y = f(X) =0

Power Function Rule:

Sum-and-Differences Rule

Product Rule

1bdYb aX

dX

dY dU dV

dX dX dX

dY dV dUU V

dX dX dX

Quotient Rule

Chain Rule

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dY dY dU

dX dU dX

2

dU dVV UdY dX dX

dX V