Managerial economics*

MBA-641

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 Chapter I
CONCEPT OF ECONOMICS
Unlimited want Vs limited resources
There are two fundamental facts that laid
foundation for the discipline called
economics
 Unlimited Wants

 Limited resources

Unlimited wants: Society's wants for

material goods and services are
unlimited:
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 Introduction (Cont…)

Limited resources: Economic resources like,

Land, labor, capital, and entrepreneurial skill
are limited to produce all goods & services:
Wants are: multiplicative, endless and
recurrent

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 Introduction (Cont…)
Limited resource means
 It is not possible to produce all goods
and services needed by the society.
Limited resource + Unlimited wants =
Scarcity
Scarcity: refers to a physical condition
where the quantity desired of a
particular resource exceeds the quantity
available
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 Introduction (Cont…)
Because of scarcity, economic resources must
be allocated efficiently.
The need to balance unlimited wants
with limited resources has raised the
question of efficient utilization of
scarce resources.
To allocate economic resources efficiently the
discipline called economics has emerged.

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 Introduction (Cont…)
Therefore, what is economics after
all?
Economics: is the study of efficient
allocation of resources in order to attain
the maximum fulfillment of unlimited
human wants or needs.
Economics: is a branch of social science
which deals with efficient utilization of
scarce or limited resources to fulfill the
unlimited human wants
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 Introduction (Cont…)
It is about,
 the efficient use of the scarce resources
. How?
 by minimizing loss so as to get the
maximum possible satisfaction.
Central aim / goal of economics
Economic Growth
Full employment
Price stability
Equitable distribution of income
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 Major Economic Problems
There are three basic economic problems, and
these economic problems are universal
These are,
 what,
 how and
 for whom to produce?
What to produce?
What product in what quantity?,
It refers to the problem of allocation of
scarce resource between their alternative
uses. 8
 Economic Problems (cont…)
How to produce?
It refers to the methods of production.
It is about the choice of technology.
It is about combination of factors and the
particular technique to use in producing a good
or service.
For whom to produce?
It is about the distribution of output (income)
among the society.
Once the product is produced who will get it?
Shall we have society in which few are rich and
majority are poor? 9
 Economic System

These basic Economics problems are solved

differently in different Economic Systems
Economic System: The set of Organizations
and Institutions that are established to
solve the economic problems (What, How
and for whom?)

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 Economic System (Cont…)
Historically four forms of economic systems
are observed (Assignment I, Which part
of the world applied what economic
system? Why? Discuss in details Pros
and cons of all ES)
Traditional Economy
Command Economy
Free market economy system
Mixed Economic System
1. Traditional Economy:
Production and distribution are coordinated by custom rule
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 Economic System (Cont…)
Technological change and innovation is
constrained by tradition
Economic activities are considered
secondary to religion and cultural values
2. Command Economy system:
Resources are owned by the state
Economic activities are led by the central
government
Social welfare is a guiding factor for
economic activity 12
 Economic System (Cont…)
The role of Market and competition are
eliminated by law
Freedom of choice is curbed by what the
society afford for all.
Innovation, Quality of product are
problems of this system
3. Free market economy system
Resources are privately owned
The economic activities are led by
invisible hand 13
 Economic System (Cont…)
Self interest is the motivating factor /
guiding force to carry out economic
activities
Competition is the regulating factor of self
interest
Freedom of choice
Government plays limited role.
The market economy is beloved to lead to
 innovation and
 quality of products
Public Goods, Externality, Market power are
some of the problem of this system 14
 Economic System (Cont…)
4. Mixed Economy System: It is the hybrid
of the Free and command economy system
It supposed to combine the good elements
of both economy system

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 Microeconomics Vs Macroeconomics
Economics is categorized into two broad categories
as, macroeconomics and microeconomics
(Part of Assignment I, Discuss in details the two
broad categories of Economics. NB: Hand-writing is
more preferred, and add your own creativity to
deserve more).
Macroeconomics: is a branch of economics which
studies the economy as a whole
It is the study of the behavior of the economy as
a whole.
Microeconomics: It is a branch of economics which
deals with the decision making behavior of
individual economic agents such as households,
business firms,
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 Microeconomics (Cont …)
It studies the flow of goods and services
from producers to the consumers and how
these good and services are priced in the
flow.
It also studies the flow of economic
resources and how they are priced in the
flow
The flow of goods and services and the
flow of resources are presented by a
simple flow diagram
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 Cont’d

More over it deals about :-

A. Theory of demand: which explains the consumers
behaviors and answers the following questions:
How consumers decide whether or not to buy a
commodity?

How do consumers behave when price of a

commodity, their income, and tastes & fashion
changes?

Thus, Knowledge of demand theory is therefore,

helpful in the choice of commodities for
production.
 Cont’d…….
B. Theory of production
Explains the relationship between inputs
and outputs
Explains under what conditions costs
increase or decrease
How total output increases when units of
one factor or input increases keeping
other factors constant
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 Pricing theory
Explains how prices are determined under
different market conditions, when price
determination is desirable, feasible, and
profitable.
Explains to what extent advertising can be
helpful in expanding sales in a competitive
market
Generally, pricing theory help to determine
the pricing policy of the firm. 20
 Macro economics
Macro-economics is the study of entire
economies and economic systems, like;-
 Economic growth,
 national income,
 employment,
 unemployment, inflation, and international
trade.
 Fiscal and monetary policy
 The whole economic development issue
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What is Managerial Economics?

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 Concept of managerial economics

Douglas - “Managerial economics is .. the

application of economic principles and
methodologies to the decision-making
process
Pappas & Hirschey - “Managerial economics
applies economic theory and methods to
business and administrative decision-making.”

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 MEs
Managerial economics, meaning the application
of economic methods in the managerial decision-
making process, is a fundamental part of any
business or management course. All the main
aspects of managerial economics:
 The theory of the firm; demand theory and
estimation; production and cost theory and
estimation; market structure and pricing; game
theory; investment analysis and government
policy. 24
 Cont’d…..
 Managerial economics studies the problems
of individual business firm.
 Managerial economics studies the real
business problems like demand
determination, demand forecasting, pricing
of a product and type of competition.

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 Main concern of ME
The following aspects (areas) are concern of
managerial economics.
 Demand Analysis and demand forecasting
 Cost and production analysis
 Pricing decisions, policies and practices
 Profit management and Capital management

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 An overview of Economic Agents and
Flows of the Economics Activities
Who are Economic Agents (Decision making
units)?
Major Participants are,
1. Households
2. Business Firms
3. Government
Households : are consumers of goods and
services
• Most of them own labor
• many own capital and
• some natural resources that are rented, or
sold.
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 Flows of the Economics (Cont…)
 The objective of the households is
to maximize their utility
Household play a dual role in
economic activity.
They consume goods and services
(demanders)
They supply economic resources
(suppliers)
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 Flows of the Economics (Cont…)
Business Firms
• These are producing unit of the economy
 They will employee economic resources
and pay for their use to household

 They will produce good and services

needed by household
Firms can come up in different size.
Regardless of their size they share common
objective of profit maximization 29
 Flows of the Economics (Cont…)

Business Firms play a dual role

 They purchase (employ) economic
resources (demanders)
 They supply final goods and services
(suppliers)
Government
 Government assumed to play limited role
in market economy system.
 It only provide legal frame-work for
proper functioning of the market system
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The interdependence of goods and
factors markets

FIRMS
•suppliers of goods and services,
•demanders of factor services
HOUSEHOLDS
•Demanders of goods and services,
•Suppliers of factor services)

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 The Circular flow of economic activities
Birr Birr

Factor Goods
services
(3) (2)
P P Products
Factors S
market S
market
PF2
P2
P F1 P1
D2 D2
D1 D1
O QF1QF2 Q O Q1 Q2 Q

Factor
services Goods
(4)
(1)
Factor
Birr Birr Consumer
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supply
demand 32
 3. Firms as economic agents

Objectives of firms(producer)
 Profit maximization
 Sale maximization
 Cost minimization
1. Profit as objective of Business firms
 ‘profit’ is the difference between total revenue(TR) and
total cost(TC)
Π = TR - TC
 To an accountant, ‘profit means the excess of revenue over
all paid- out for productive cost ( it is the difference
between total revenue and explicit cost)
Π =TR - TC( explicit cost)
 Economic profit’ is includes the implicit(opportunity) cost
as cost of production.
 D/C B/N
• Explicit costs: are out-of-pocket costs—
payments that are actually made. Wages that a
firm pays its employees or rent that a firm pays
for its office are explicit costs.
• Implicit Costs: Often for small businesses, they
are resources contributed by the owners—for
example, working in the business while not
getting a formal salary or using the ground floor
of a home as a retail store.

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 consumer preference and
demand/Consumer Behaviors

Recall the definition of

 demand and
 the law of demand
Demand : Is the quantity that a consumer
is willing to buy at a particular price
(Ceteris paribus)
Law of Demand : State that there is an
inverse relationship between price of a
commodity and the quantity demanded.

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 Consumers Behavior (Cont…)
Assumptions
A consumer is a rational being
Consumer has a full knowledge of
 all the available commodity,
 their price and
 his income.
The goal of the consumer is to maximize his
utility
What is utility?
the term utility describe the satisfaction
derived from the consumption of a good or
service.
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 Consumers Behavior (Cont…)
Utility is the level of satisfaction that is
obtained by consuming a commodity.
Properties of utility
‘Utility’ and ‘Usefulness” are not synonymous.
Utility is subjective: The utility of a product
will vary from person to person.
 For example, non-smokers do not derive any
utility from cigarettes.
The utility of a product can be different at
different places and time.

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 Consumers Behavior (Cont…)
Is utility measurable?
Economists are divided on the issue of
measurability of utility
For some utility can be quantitatively
measured
For others utility can not be
quantitatively measured rather it is
ordinal in nature
Accordingly, we have two approaches
 Cardinal utility approach
 Ordinal Utility approach
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 2.1. Cardinal Utility Approach
This school postulate that the utility can be
measured
What is the measurement unit?
 Monetary unit
 By a subjective unit called util
Assumptions
Rationality
Cardinal Utility: The utility of each commodity
is measurable and the most convenient
measurement is money.
Constant Marginal Utility of Money.
 The essential feature of a standard unit of
measurement is that it is consistent. 39
 Cardinal Utility (cont…)
Consumer Income is constant and all is
spent on the same product.
 That is, saving gives no positive utility to
the consumer.
Diminishing Marginal Utility (DMU).
 The utility derived from each successive
units of a commodity diminishes. .
Consumer is price taker: He cannot
influence the market price of goods and
services.
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 Cardinal Utility (cont…)
Utility is independent on the quantity of
the individual commodity.
 If there are n commodities in the bundle
with quantities X1, X2, X3 …… Xn the total
utility is then
 U = f (X1, X2, X3 ……. Xn).

 Utility is also additive, i.e., U (X1) + U (X2)

+U (X3) ……… +U ( Xn ) = Total Utility (TU)

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 Cardinal Utility (cont…)
Total and Marginal Utility
Total Utility: refers to the total amount of
satisfaction a consumer gets from consuming or
possessing some specific quantities of a
commodity at a particular time.
if a consumer consumes 4 units of a commodity
and derives U1, U2, U3 and U4 from the
successive units consumed,
then TU = U1+U2+U3+U4.
In case the number of commodities consumed is
greater than one, then
TU= TUx TUy + TUz + ……… TUn
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Graphical representation of total utility

TU

11
8
TU
6
4
2

O 1 2 3 4 5 Quantity 43
 Cardinal Utility (cont…)
Marginal Utility (MU) It can be defined as,
total utility derived from, the last unit of
a commodity consumed.
It is the change in the total utility
resulting from unit change in commodity
consumed
It is the slope of total utility,
MU = TU/ Q
 TU = Change in Total Utility
 Q = Change in quantity consumed 44
 Marginal Utility (cont…)

Utility

Marginal utility

Quantity
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 Part of Assignment I,
 Why managerial Economics is so
popular in todays global business?
 Discuss in details and write on Pros
and cons of both Cardinal and
Ordinal Utility.
 NB: Final Submission Date for
Assignment I : before final exam
 End of Chapter I.
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