Managerial Economics &
Business Strategy
Chapter 1
The Fundamentals of
Managerial Economics
McGraw-Hill/Irwin
Michael R. Baye, Managerial Economics and
Business Strategy
Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
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Managerial Economics
Manager
A person who directs resources to achieve a
stated goal.
Economics
The science of making decisions in the
presence of scare resources.
Managerial Economics
The study of how to direct scarce resources
in the way that most efficiently achieves a
managerial goal.
Economic vs. Accounting
Profits
Accounting Profits
Total revenue (sales) minus dollar cost of
producing goods or services.
Reported on the firms income statement.
Economic Profits
Total revenue minus total opportunity cost.
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Opportunity Cost
Accounting Costs
The explicit costs of the resources needed to
produce produce goods or services.
Reported on the firms income statement.
Opportunity Cost
The cost of the explicit and implicit resources
that are foregone when a decision is made.
Economic Profits
Total revenue minus total opportunity cost.
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Profits as a Signal
Profits signal to resource holders
where resources are most highly
valued by society.
Resources will flow into industries that
are most highly valued by society.
Marginal (Incremental)
Analysis
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Control Variable Examples:
Output
Price
Product Quality
Advertising
R&D
Basic Managerial Question: How
much of the control variable should
be used to maximize net benefits?
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Net Benefits
Net Benefits = Total Benefits - Total
Costs
Profits = Revenue - Costs
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Marginal Benefit (MB)
Change in total benefits arising from
a change in the control variable, Q:
B
MB
Q
Slope (calculus derivative) of the
total benefit curve.
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Marginal Cost (MC)
Change in total costs arising from a
change in the control variable, Q:
C
MC
Q
Slope (calculus derivative) of the
total cost curve
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Marginal Principle
To maximize net benefits, the
managerial control variable should be
increased up to the point where MB =
MC.
MB > MC means the last unit of the
control variable increased benefits
more than it increased costs.
MB < MC means the last unit of the
control variable increased costs more
than it increased benefits.
The Geometry of Optimization:
Total Benefit and Cost
Total Benefits
& Total Costs
Costs
Benefits
Slope =MB
B
Slope = MC
C
Q*
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The Geometry of Optimization:
Net Benefits
Net Benefits
Maximum net benefits
Slope = MNB
Q*
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