INTRODUCTION TO MANAGERIAL ECONOMICSINTRODUCTION TO ECONOMICS + Economics is the social science that studies how people interact with value; in particular, the production, distribution, and consumption of goods and services. (Paul Krugman) * The term economics is derived from economic science, and the word economic is perhaps shortened from economical or derived from the French word économique or directly from the Latin word ceconomicus "of domestic economy". This in tum comes from the Ancient Greek oikonomikos, "practiced in the management of a household or family" and therefore "frugal, thrifty", which in turn comes from cikonomia "household management" which in turn comes from oikos "house" and nomos, "custom" or "law." + It was only during the eighteenth century that Adam Smith, the Father of Economics, defined economics as the study of nature and uses of national wealth’.MICROECONOMICS The study of an individual consumer or a firm is called microeconomics. * Microeconomics deals with behavior and problems of single individual and of micro organization. = Itis concerned with the application of the concepts such as price theory, Law of Demand and theories of market structure and so on.MACROECONOMICS + The study of aggregate or total level of economic activity in a country is called macroeconomics. + It studies the flow of economics resources or factors of production (such as land, labor, capital, organization and technology) from the resource owner to the business firms and then from the business firms to the households. * Itis concerned with the level of employment in the economy. + It discusses aggregate consumption, aggregate investment, price level, and payment, theories of employment, and so on.MANAGERIAL ECONOMICS = Managerial Economics refers to the firm's decision making process. It could be also interpreted as “Economics of Management” or “ Industrial economics “ or “Business economics”.NATURE OF MANAGERIAL ECONOMICS: + Close to microeconomics - Managerial economics is concerned with finding the solutions for different managerial problems of a particular firm. Thus, it is more close to microeconomics. + Operates against the backdrop of macroeconomics - The macroeconomics conditions of the economy are also seen as limiting factors for the firm to operate. In other words, the managerial economist has to be aware of the limits set by the macroeconomics conditions such as government industrial policy, inflation and so on. + Normative statements - A normative statement usually includes or implies the words ‘ought’ or ‘should’. They reflect people's moral attitudes and are expressions of what a team of people ought to dos . Such statement are based on value judgments and express views of what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’.NATURE OF MANAGERIAL ECONOMICS: « Prescriptive actions + Prescriptive action is goal oriented. * Given a problem and the objectives of the firm, it suggests the course of action from the available alternatives for optimal solution. * Italso explains whether the concept can be applied in a given context on not, For instance, the fact that variable costs are marginal costs can be used to judge the feasibility of an export order. + Applied in nature « ‘Models’ are built to reflect the real life complex business situations and these models are of immense help to managers for decision-making. * The different areas where models are extensively used include inventory control, optimization, project management etc. + In managerial economics, we also employ case study methods to conceptualize the problem, identify that alternative and determine the best course of action.NATURE OF MANAGERIAL ECONOMICS: + Offers scope to evaluate each alternative + Managerial economics provides an opportunity to evaluate each alternative in terms of its costs and revenue. * The managerial economist can decide which is the better alternative to maximize the Profits for the firm. * Interdisciplinary: * The contents, tools and techniques of managerial economics are drawn from different subjects such as economics, management, mathematics, statistics, accountancy, psychology, organizational behavior, sociology and etc.SCOPE OF MANAGERIAL ECONOMICS + Managerial economics refers to its area of study. Managerial economics, provides management with a strategic planning tool that can be used to get a clear perspective of the way the business world works and what can be done to maintain profitability in an ever-changing environment. + Managerial economics is primarily concerned with the application of economic principles and theories to five types of resource decisions made by all types of business organizations. * The selection of product or service to be produced. + The choice of production methods and resource combinations. + The determination of the best price and quantity combination « Promotional strategy and activities. * The selection of the location from which to produce and sell goods or service to. consumerSCOPE OF MANAGERIAL ECONOMICS « The scope of managerial economics covers two areas of decision making * Operational or Internal issues + Environmental or External issuesOPERATIONAL ISSUES Operational issues refer to those, which are within the business organization and they are under the control of the management. Those are: * Theory of demand and Demand Forecasting * Pricing and Competitive strategy * Production cost analysis * Resource allocation + Profit analysis + Capital or Investment analysis + Strategic planningOPERATIONAL ISSUES Demand Analyses and Forecasting + Demand analysis also highlights for factors, which influence the demand for a product. + This helps to manipulate demand. Thus demand analysis studies not only the price elasticity but also income elasticity, cross elasticity as well as the influence of advertising expenditure with the advent of computers. + Demand forecasting has become an increasingly important function of managerial economics. A firm can survive only if it is able to the demand for its product at the right time, within the right quantity. Understanding the basic concepts of demand is essential for demand forecastingOPERATIONAL ISSUES Pricing and competitive strategy * Pricing decisions have been always within the preview of managerial economics. Price theory helps to explain how prices are determined under different types of market conditions. * Competitions analysis includes the anticipation of the response of competitions the firm's pricing, advertising and marketing strategies. Product line pricing and price forecasting occupy an important place here.OPERATIONAL ISSUES Production and cost analysis + Production analysis is in physical terms. * While the cost analysis is in monetary terms cost concepts and classifications, cost- output relationships, economies and diseconomies of scale and production functions are some of the points constituting cost and production analysis.OPERATIONAL ISSUES Resource Allocation + Managerial Economics is the traditional economic theory that is concerned with the problem of optimum allocation of scarce resources. + Marginal analysis is applied to the problem of determining the level of output, which maximizes profit. + In this respect linear programming techniques has been used to solve optimization problems. In fact lines programming is one of the most practical and powerful managerial decision making tools currently available.OPERATIONAL ISSUES Profit analysis * Profit making is the major goal of firms. There are several constraints here an account of competition from other products, changing input prices and changing business environment hence in spite of careful planning, there is always certain risk involved. * Managerial economics deals with techniques of averting of minimizing risks. Profit theory guides in the measurement and management of profit, in calculating the pure return on capital, besides future profit planning.OPERATIONAL ISSUES Capital or investment analyses * Capital is the foundation of business. Lack of capital may result in small size of operations. Availability of capital from various sources like equity capital, institutional finance etc. may help to undertake large-scale operations. + Hence efficient allocation and management of capital is one of the most important tasks of the managers. = The major issues related to capital analysis are: * The choice of investment project « Evaluation of the efficiency of capital + Most efficient allocation of capital + Knowledge of capital theory can help very much in taking investment decisions. This involves, capital budgeting, feasibility studies, analysis of cost of capital etc.OPERATIONAL ISSUES Strategic planning * Strategic planning provides a long-term goals and objectives and selects the strategies to achieve the same. + The perspective of strategic planning is globalENVIRONMENTAL OR EXTERNAL ISSUES They refer to general economic, social and political atmosphere within which the firm operates. Asstudy of economic environment should include: a.The Type of Economic System in the Country + The general trends in production, employment, income, prices, saving and investment. + Trends in the working of financial institutions like banks, financial corporations, insurance companies + Magnitude and trends in foreign trade; + Trends in labor and capital markets; + Government's economic policies viz. industrial policy monetary policy, fiscal policy, price policy etc.ENVIRONMENTAL OR EXTERNAL ISSUES b. The Social Environment refers to social structure as well as social organization like trade unions, consumer's co-operative etc. c.The Political Environment refers to the nature of state activity, chiefly states’ attitude towards private business, political stability etc. d. The Environmental Issues highlight the social objective of a firm i.e.; the firm owes a responsibility to the society. Private gains of the firm alone cannot be the goal.ECONOMIC PRINCIPLES RELEVANT TO MANAGERIAL ECONOMICSSCARCITY Scarcity — the Basic Economic Problem « The problem that Economics, a social science, attempts to overcome is that of Scarcity. * Scarcity arises when something is both limited in quantity yet desired = Some facts about scarcity: + Not all goods are scarce, but most are + Some goods that humans consume are infinite, such as air + Organize the following words under the correct category: Scarce or Not ScarcePARADOX OF VALUE + What makes something scarce? + Nobody needs diamonds, yet they are considered extremely valuable « Everybody needs water, yet they are considered extremely cheap + This is known as the “diamond / water paradox”. The answer lies in the fact that economic value is derived from scarcity = The more scarce an item, the more valuable it is * The less scarce, the less value it has in society!MICROECONOMICS Microeconomics: Studies the behaviors of INDIVIDUALS within an economy: Consumers and producers in particular markets. Examples of microeconomic topics: « The Automobile market in Switzerland, + the market for movie tickets in Zurich, + the market for airline tickets between the US and Europe, + the market for vacations to Spain, + the market for international school teachers.MACROECONOMICS Macroeconomics: Studies the total effect on a nation's people of alll the economic activity within that nation. The four main concerns of macroeconomics are: = total output of a nation, + the average price level of a nation, + the level of employment (or unemployment) in the nation and + distribution of income in the nation Examples of macroeconomic topics: + Unemployment in Canada, inflation in Zimbabwe, economic growth in China, the gap between the rich and the poor in AmericaMICROECONOMICS VS. MACROECONOMICS eee eee + Individual markets + National markets + the behavior of firms (companies) and + Total output and income of nations consumers + Total supply and demand of the _ nation + the allocation of land, labor and capital + Taxes and government spending resources + Interest rates and central banks + Supply and demand + Unemployment and inflation + The efficiency of markets + Income distribution + Product markets + Economics growth and development + Supply and Demand + International trade + Profit maximization + Utility maximization Competition Resource markets + Market failureOTHER FUNDAMENTAL PRINCIPLES Scarcity: + Economics is about the allocation of scarce resources among society's various needs and wants. Resources: + Economics is about the allocation of resources among society's various needs and wants. Tradeoffs: + Individuals and society as whole are constantly making choices involving tradeoff between alternatives. Whether its what goods to consume, whaf goods fo produce, how fo produce them, Opportunity Cost: + Opportunity cost is the forgone benefit that would have been derived by an option not chosen. * Inother words, every economic decision involves giving up something. + NOTHING IS FREE!FACTORS OF PRODUCTION * The production of all of the good we desire requires scarce resources. It is the allocation of these resources between humans’ competing wants that Economics focuses on. | ana | Labor rn Entrepreneurship This refers to the Capital refers to the fools and innovation and creativity technologies that are used to applied in the produce the goods and production of goods and services we desize.Since more Services. The physical Land resources are _Labor refers to the those things that are human resources used “gifts of nature”.The __in the production of. sollinwhich we goodsandservices. “sna peter tools enhance the | Scamsty of land, labor grow food, wood, Laboristhehuman sin ofall types of goods and capital does not P types of minerals such as work, both physical and Ronan copper and tin and intellectual, that peo nen ticeay oa caine ‘which itself: = t computers to education to ingenuity, which it isa resources such as contributes to the resource that goes into ae cea haircuts, yet the amount of t goal, gas and production of goods ritalin the world is limited, the production of out uranium are scarce and services capital is a scarce resource. economic output.BASIC ECONOMIC PROBLEM Ina world of finite resources, the wants of man are virtually infinite. The basic Economic Problem is how to allocate those limited, scarce resources between the unlimited wants of man. This problem gives rise to three cuiestions that any and all economic systems must address. The Three Basic Economics Questions are : = What should be produced? Given the resources with which society is endowed, what combination of dilferent goods and services should be produced? * How should things be produced? Should production use lots of labor, or should lots of capital and technology be used? + Who should things be produced for? How should the output that society produces be distributed? Should everyone keep what he or she makes, or should trade take place? Should everyone be given equal amounts of the output, or should it be every man for ‘imself? = These are the three guiding questions of any economic system.FREE TRADE « The market system allocates society's scarce resources through the free, voluntary exchanges of individuals households and firms in the free market. These exchanges are broadly known as “trade”. Trade ban exist between individuals, or between entire nations. Trade between countries is called International Trade. Voluntary exchanges between individuals and firms in resource and product markets involving the exchange of goods, services, land, labor and capital is a type of trade. International trade involves the exchange of resources, goods, services, assets (both real and financial) across national boundaries. Trade makes everyone better off, and leads to a more efficient allocation of society's scarce resources.MODEL BUILDING IN ECONOMICS K model of the solar system: Allows astronomers to illustrate in a simplified model the relationships between solar bodies. A Circular Flow Model: Allows economists to illustrate in a simplified model the relationships between households and firms in a market economy. Coteris Paribus: Like in other scientists, when using economic models we must assume “all else equal”. This allows us to observe how one variable in an economy will affect another, without considering all the other factors that may affect the variable in question.POSITIVE AND NORMATIVE ECONOMICS Economists explore the world of facts and data, but also often draw conclusions or prescribe policies based more on interpretation or even their own opinions. It is important to distinguish at all times whether the focus of our studies is in the realm of positive or normative Economics + Positive economic statements: Each of the following statements above are statements of fact, and each can be supported by evidence based on quantifiable ‘observations of the world. + Unemployment rose by 0.8 percent last quarter as 250,000 Americans lost their jobs in both the public and private sectors. + Rising pork prices have led to a surge in demand for chicken across China. + Increased use of public transportation reduces congestion on city streets and lowers traffic fatality rates.POSITIVE AND NORMATIVE ECONOMICS + Normative economic statements: Each of the statements above are based on observable, quantifiable variables, but each includes an element of opinion + Unemployment rates are higher among less educated workers, therefore government should include education and job training programs as a component of benefits for the nation's unemployed. + Rising pork prices harm low income households whose incomes go primarily towards food, therefore, to slow the rise in food prices, the Chinese government should enforce a maximum price scheme on the nation's pork industry. + It is the government's obligation to provide public transportation options to the nation's people to relieve the negative environmental and health effects of traffic congestion.OPPORTUNITY COST + Opportunity cost is what must be given up in order to undertake any activity or economic exchange. + Opportunity costs are not necessarily monetary, rather when you buy something, the opportunity cost is what you could have done with the money you spent on that thing. + Even non-monetary exchanges involve opportunity costs, as you may have done something different with the time you chose to spend undertaking any activity in your ie. + Examples of opportunity costs * The opportunity cost of watching TV on a weeknight is the benefit you could have gotten from studying. + The opportunity cost of going to college is the income you could have earned by getting a job out of high school + The opportunity cost of starting your own business in the wages you give up by working for another company + The opportunity cost of using forest resources to build houses is the enjoyment people get from having pristine forests.ECONOMIC GROWTH VS. ECONOMIC DEVELOPMENT Economic Growth: This refers to the increase in the total output of goods and services by a nation over time. + It is also sometimes defined as an increase in household income over time. + Itis purely a monetary measure of the increases in the material well being of a nation. + Ona PPC growth can be shown as an outward shift of the curve. Economic Development: This refers to the improvement in peoples’ standard of living over time. + Measured by improvements in health, education, equality, life expectancy and soon + Incorporate income as well, but is a much broader measure than growth + Ona PPC development can be shown by a movement towards the production of goods that improve peoples’ livesPRODUCT AND RESOURCE MARKETS In the market system, there exists an interdependence between all individuals. + Households depend on the goods and services produced by business firms, and the incomes they provide us, for our survival + Business firms depend on households for the workers, the capital, the land resources they need to produce the goods they hope to sell us and make profits on. + These exchanges all take place in one of two categories of market present in all market economies SSC LOT RY Cary pC UNS} Where households buy the goods and Where business firms buy the productive services we desire from firms.Examples: resources they need to make their products: + ‘The market for private schools + The market for teachers + ‘The market for dental services + The market for dentists + ‘The market for airline travel + The market for pilots + The market for football merchandise + The market for football playersPRODUCT AND RESOURCE MARKETS =Product Markets: Consumers buy goods and services from firms Households use their money incomes earned in the resource market to buy goods and services Expenditures by households become revenues for firms Firms seek to maximize their profits Households seek to maximize their utility (happiness)PRODUCT AND RESOURCE MARKETS In Resource Markets: + Households supply productive resources (land, labor, capital) + Firms buy productive resources from households. In exchange for their productive resource, firms pay households: + Wages: payment for labor + Rent: payment for land = Interest: payment for capital « Profit: payment for entrepreneurship « Firms seek to minimize their costs in the resource market + Firms employ productive resources to make products, which they sell back to households in the product marketCIRCULAR FLOW MODEL The Circular Flow Market economies are characterized by a circular flow of money, resources, and products between households, and firms in resource and The Circular Flow of product markets. Notice: Money, Resources and + Money earned by Goods and Services households in the resource market is spent on goods and services in the product market + Money earned by firms in the product market is spent on resources from households in the resource ‘The incentives of Households: Maximize Utility market. The incentive of Firms: Maximize Profits!RESOURCE PAYMENTS (INCOMES FOR HOUSEHOLDS) = In exchange for their land, labor, capital and entrepreneurship, households receive payments. The payments for the four productive resources: Firms pay households RENT: Landowners have the option to use their land for their own use For Land: Rent or fo ent it to firms for their use. If the landowner uses his land for his own use, the ‘opportunity cost of doing to is the rent she could have earned by providing ito a firm. Firms pay households WAGES. To employ workers, firms must pay workers money wages. Ifa For Labor: Wages worker is self employed, the opportunity cost of seliemployment isthe wages he could have ‘earned working for anther fim. Firms pay households INTEREST. Most firms wil ak out loans to acquire capital equipment. ‘The money they borrow comes mostly from households savings. Households put their money For Capital: Interest __inbanks because they earn interest on it. Banks pay interest on loans, which becomes the payment to households. Ifa household chooses to spend its extra income rather than save it, ‘the opportunity cost of doing £0 is the interest it could earn in a bank. Households earn PROFIT for their entrepreneurial skills. An entrepreneur who takes a risk by puting his creative skills to the test in the market expects to earn a normal profit for his efforts.IMPORTANT FACTORS TO CONSIDER + The role of government in the economy: In every unit of this course we will ‘examine the appropriate role of government in the market economy. There are some who argument government should never interfere with the free functioning of markets; on the other hand, when market failures arise, the government may be needed to improve the allocation of resources. - Threats to sustainability of current economic trends: What threat do global warming, environmental degradation, population growth and urbanization play to the ability of our economic systems to endure?IMPORTANT FACTORS TO CONSIDER + The conflict between the pursuits of efficiency and equity: Sometimes the pursuit of wealth and economic growth leaves some individuals behind. To what ‘extent should economic policy be concerned with income and wealth inequality? Is there a mechanism available for reducing inequality while at the same time encouraging efficiency? + The distinction between economic growth and economic development: The emerging market economies of the world have achieve amazing economic growth for decades; but at what cost? Is increasing income and output the only thing the market system is good for? Does getting richer assure we will be happier, live longer and healthier lives, and live in a just society?