MANAGERIAL

ECONOMICS
MODULE 1:
INTRODUCTION TO MANAGERIAL ECONOMICS
WHAT IS ECONOMICS?
•Deals with how to satisfy the unlimited wants
and needs of humans with the limited or
scarce resources we have.
•Dealing with scarcity and the wants and
needs.
ECONOMICS
•It comes from the Greek word,
“oikonomiya” meaning household
management.
•The concept originated in Greece, first
coined by Aristotle.
ECONOMICS
•It has two branches:
Microeconomics
Macroeconomics
WHAT IS MICROECONOMICS AND
MACROECONOMICS?
Microeconomics:
Is the study of individuals and business decisions.
Macroeconomics:
Looks at the decisions of countries and
governments.
WHAT IS MANAGERIAL ECONOMICS?
Helps managers recognize how economic
forces affect organizations and describes the
economic consequences of managerial behavior
It also links economic concepts, data and
quantitative methods to develop vital tools for
managerial decision making
MANAGERIAL ECONOMICS
Is a discipline that combines economic
theory with managerial practice
It tries to bridge the gap between the
problems of logic that intrigue economic
theorists and the problems of policy that
plague practical managers
MANAGERIAL ECONOMICS
Managerial economics helps managers arrive at
a set of operating rules that aid in the efficient
use of scarce human and capital resources.
It is as relevant to the management of
government agencies, cooperatives, schools,
hospitals, museums, and similar not-for-profit
institutions as it is to the management of profit-
oriented businesses.
NATURE OF MANAGERIAL ECONOMICS
MANAGEMENT
Guidance, leadership and control of the efforts of a
group of people towards some common objective.
Creation and maintenance of an internal Notes
environment in an enterprise where individuals,
working together in groups, can perform efficiently
and effectively towards the attainment of group
goals.(Koontz and O’ Donell)
NATURE OF MANAGERIAL ECONOMICS
MANAGEMENT IS:
Coordination
An activity or an ongoing process
A purposive process
An art of getting things done for other
people
NATURE OF MANAGERIAL ECONOMICS
ECONOMICS
Economists are primarily engaged in analyzing
and providing answers to manifestations of the
most fundamental problem, scarcity, Scarcity of
resources results from two fundamental facts of
life:
a. Human wants are virtually unlimited and
insatiable
b. Economic resources to satisfy these human
demands are limited.
THREE CHOICE PROBLEMS OF AN
ECONOMY/THREE BASIC QUESTIONS
What to produce and how to produce?
Demand theory guides the manager in the selection of
goods and services for production. It analyses consumer
behavior with regard to:
a. Type of goods and services they are likely to
purchase in the current period and in the future.
b. Factors influencing the consumption of a
particular good or service.
c. The effect of a change in these factors on the
demand of that particular good or service.
THREE CHOICE PROBLEMS OF AN
ECONOMY/THREE BASIC QUESTIONS
What to produce
Knowledge of demand elasticities helps
in setting up of prices in context of
revenue of a firm. Methods of demand
forecasting help in deciding the quantity
of a good or service to be produced.
THREE CHOICE PROBLEMS OF AN ECONOMY

How to produce the goods and services

 It involves selection of inputs and
techniques of production. Decisions are
made with regard to the purchase of
items ranging from raw materials to
capital equipment
THREE CHOICE PROBLEMS OF AN ECONOMY

For Whom it should be produced?

 An analysis of market structure explains
how price and output decisions are taken
under different market forms.
SCOPE OF MANAGERIAL ECONOMICS
Four Groups of problem in both decision
making and forward planning
1. Resource allocation
2. Inventory and queuing problem
3. Pricing problems
4. Investment problems
RESOURCE ALLOCATION
•Scarce resources have to be used with utmost
efficiency to get optimal results. These
include production programming, problem of
transportation, etc.
INVENTORY AND QUEUING PROBLEM
Inventory problems involve decisions about
holding of optimal levels of stocks of raw materials
and finished goods over a period.
These decisions are taken by considering demand
and supply conditions.
Queuing problems involve decisions about
installation of additional machines or hiring of
extra labor in order to balance the business lost by
not undertaking these activities
PRICING PROBLEMS

Fixing prices for the products of the firm is an

important part of the decision making process.
Pricing problems involve decisions regarding
various methods of pricing to be adopted
INVESTMENT PROBLEMS
Forward planning involves investment
problems. These are problems of
allocating scarce resources over time. For
example, investing in new plants, how
much to invest, sources of funds, etc.
THEORY OF THE FIRM
A business model where people are directly
involve which includes customers,
stockholder, management, employees, and
suppliers. Society is also involved because
businesses use scarce resources, pay taxes,
provide employment opportunities, and
produce much of society’s material and
services output.
Profit maximization is the traditional trend
THEORY OF THE FIRM

Today, the emphasis on profits has been

broadened to encompass uncertainty and the
time value of money. In this more complete
model, the primary goal of the firm is long-
term expected value maximization
The value of the firm is the present value of
the firm’s expected future net cash flows
CONSTRAINTS AND THEORY OF THE FIRM
Organizations frequently face limited availability of
essential inputs, such as skilled labor, raw materials,
energy, specialized machinery and warehouse space.
Decisions can also be constrained by contractual
requirements. For example, labor contracts limit
flexibility in worker scheduling and job assignments.
Legal restrictions, which affect both production and
marketing activities, can also play an important role in
managerial decisions.
LIMITATIONS OF THE THEORY OF THE FIRM
Research shows that vigorous competition
typically forces managers to seek value
maximization in their operating decisions.
Competition in the capital markets forces
managers to seek value maximization in their
financing decisions as well
LIMITATIONS OF THE THEORY OF THE
FIRM
•Managers who pursue their own interest
instead of stockholders’ interest run the risk of
losing their job.
•Unfriendly takeovers are especially hostile to
inefficient management that is replaced.
Moreover, recent studies show a strong
correlation between firm profits and
managerial compensation
LIMITATIONS OF THE THEORY OF THE
FIRM
It is unwise to seek the best technical solution
to a problem if the costs of finding such a
solution greatly exceed resulting benefits.
As a result, what often appears to be
satisfying on the part of management can be
interpreted as value-maximizing behavior
once the costs of information gathering and
analysis are considered.
LIMITATIONS OF THE THEORY OF THE
FIRM
Similarly, short-run growth maximization
strategies are often consistent with long-run
value maximization when the production,
distribution and promotional advantages of
large firm size are better understood.
PROFIT MEASUREMENT
PROFIT
Usually defined as the residual of sales revenue
minus the explicit costs of doing business
The economist also defines profit as the excess
of revenues over costs. However, inputs
provided by owners, including entrepreneurial
effort and capital, are resources that must be
compensated
PROFIT MEASUREMENT
PROFIT
Similarly, the opportunity cost of owner effort is
determined by the value that could be received in
alternative employment
ECONOMIC PROFIT – business profit minus
the implicit (non-cash) costs of capital and other
owner-provided inputs used by the firm.
WHY DO PROFITS VARY AMONG FIRMS

1. Disequilibrium Profit Theories

a. Frictional Profit Theory – It states that markets are
sometimes in disequilibrium because of unanticipated
changes in demand or cost conditions.
b. Monopoly Profit Theory – Some firms earn above-
normal profits because they are sheltered from
competition by high barriers to entry. Monopoly profits
can also arise because of luck (being in the right
industry at the right time) or from anticompetitive
behavior
WHY DO PROFITS VARY AMONG FIRMS
2. Compensatory Profit Theories
a. Innovation Profit Theory – describes above normal
profits that arise following successful invention or
modernization
b. Compensatory Profit Theory – describes above
normal rate of return that reward firms for
extraordinary success in meeting customer needs and
maintaining efficient operations. Compensatory profit
theory also recognizes economic profit as an
important reward to the entrepreneurial function of
owners and managers
ROLE OF PROFITS IN THE ECONOMY
Above-normal profits serve as a valuable signal
that firm or industry output should be increased
Expansion by established firms or entry by new
competitors occurs quickly during high profit
periods
Below-normal profits signal the need for
contraction and exit. Above-normal profits also
reward innovation and efficiency, just as below-
normal profits penalize stagnation and inefficiency
ROLE OF BUSINESS IN SOCIETY

Firms exist because they are useful. They

survive by public consent to serve social
needs
CENTRAL PROBLEMS OF ECONOMY
•Four distinctively macroeconomic problems
Recession
Unemployment
Inflation
Economic Growth or Stagnation
RECESSION
Defined as a period of two or more successive quarters of
decreasing production
In many recession periods, businesses that announced
they were hiring had long lines of people who wanted to
apply, with many more people than they could hire
Another possibility is that production might drop because
a war or disaster had destroyed factories and other capital
goods.
Ex. The Great Depression happened in the 1930’s
INFLATION
 Inflation is a rise in the general level of price of goods and services in an
economy over a period of time. A rising price level – inflation – has the
following disadvantages:
a. It creates uncertainty, in that people do not know what the money they
earn today will buy tomorrow
b. Uncertainty, in turn, discourage productive activity, saving and investing
c. Inflation reduces the competitiveness of the country in international
trade
d. Inflation is a hidden tax on “nominal balances.”
e. Predictable, people resort to other means to carry out their business,
means which use up resources and are inefficient.
UNEMPLOYMENT
• Unemployment occurs when a person is available to work
and currently seeking work, but the person is without
work
• A status in which individuals are without job and are
seeking a job
a. Reduction in the Output
b. Reduction in Tax Revenue
c. Rise in Government Expenditure
STAGNATION
• Period of many years of slow growth of gross domestic product,
in which the growth is, on the average, slower than the potential
growth in the economy
• Causes of Stagnation:
a. Population growth might be high
b. Fewer people might choose to work
c. The growth of labor productivity might slow
• Economic growth that, while positive, is less than the potential
growth of the economy.
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