MANAGERIAL ECONOMICS

Laurice M. Capila
 Table of Contents

Module 1: Introduction to Economics 1

Introduction 1
Learning Objectives 1
Lesson 1. Scarcity and Efficiency 2
Lesson 2. Microeconomics and Macroeconomics 2
Lesson 3. The Three Economic Questions 3
Lesson 4. Factors of Production 5
Lesson 5. Meaning and Definition of Managerial Economics 7
Assessment 8
Summary 8
References 9

Module 2: Concept of Economics in Decision Making 10

Introduction 10
Learning Objectives 10
Lesson 1. What do you mean by Decision Making? 11
Lesson 2. Rewards and Sacrifices: The Trade-off 11
Lesson 3. Types of Decision Makers 13
Lesson 4. Models of Decision Making 14
Assessment 17
Summary 17
References 17

Module 3: Nature and Scope of Managerial Economics 18

Introduction 18
Learning Objectives 18
Lesson 1. Nature of Managerial Economics 19
Lesson 2. Scope of Managerial Economics 20
Lesson 3. Managerial Economics Relationship with Other Disciplines 24
Assessment 26
Summary 26
References 26
Module 4: Demand Analysis 27
Introduction 27
Learning Objectives 27
Lesson 1. Introduction and Meaning of Demand 28
Lesson 2. Law of Demand 28
Lesson 3. Exceptions to the Law of Demand 30
Lesson 4. Factors Affecting the Demand 31
Assessment 33
Summary 35
References 35
Course Code : Econ 1

Course Description: This course concentrates on the application of the

tools of economic analysis in business management decision-making. It
focuses on three areas: theory of the firm, market structure and pricing and
role of government in the business economy.
The first part will focus on the concept of profit and wealth
maximization as well as alternative objectives of the firm.
The second part will deal on price determination and characteristics of
the different markets, e.g., pure competition, monopoly, monopolistic,
oligopoly, and will discuss various pricing practices.
Finally, the third part will introduce government intervention and
regulation in the market economy. Cases and problem exercises will be used
to complement lectures to enable students to apply the concepts and tools of
economics.

Course Intended Learning Outcomes:

At the end of the course, the students should be able to:

1. Analyze the roles of managers in firms;
2. Evaluate the effects of internal and external decisions to be made by
managers;
3. Illustrate the demand and supply conditions and assess the position of
a company;
4. Identify the competition strategies, including costing, pricing, product
differentiation, and market environment according to the natures of
products and the structures of the markets;
5. Develop optimal business decisions by integrating the concepts of
economics, mathematics and statistics.

Course Requirements:
 Assessment Tasks - 60%
 Major Exams - 40%
Periodic Grade 100%

PRELIM GRADE : 60% (Activity 1-4) + 40% (Prelim exam)

MIDTERM GRADE : 30% (Prelim Grade) + 70 % [60% (Activity 5-7)
+ 40% (Midterm exam)]
FINAL GRADE : 30% (Midterm Grade) + 70 % [60% (Activity 8-10)
+ 40% (Final exam)]
 MODULE 1
INTRODUCTION TO ECONOMICS

Introduction

The basic purpose of studying of economics is the efficient utilization of scarce

resources. We always have to make choices amongst various alternatives available for
efficient utilization of our scarce resources.
Economics is the study how to efficiently use and allocate scarce resources to meet
the unending needs and maximum satisfaction of man. It is a social science concerned with
the efficient use of limited resources to achieve maximum satisfaction of economic wants.

Learning Outcomes

At the end of this module, students should be able to:

1. Analyze the concept of economics-scarcity and efficiency;

2. Discuss the two main branches of economics-microeconomics and macroeconomics;
3. Elaborate the three economic questions;
4. Distinguish the four factors of production; and
5. Interpret the meaning and definition of managerial economics.

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Lesson 1. Scarcity and Efficiency (Samuelson & Nordhaus, 2010)

Economics is the study of how societies use scarce resources to produce valuable
commodities and distribute them among different people. Behind this definition are two key
ideas in economics: those goods are scarce and that society must use its resources efficiently.
Indeed, economics is an important subject because of the fact of scarcity and the desire for
efficiency. There are two key ideas in economics:
 Scarcity of goods
 Efficient use of resources

Scarcity of goods
Scarcity is the condition in which our wants are greater than our limited resources. It
is the central problem of every society.

If there been no scarcities managerial problem won’t exists. It is only because of this
scarcity a manager has to think an optimum allocation of scarce resources.

Efficiency use of Resources

An economy makes best use of its limited resources that takes the critical notion of
efficiency. Efficiency denotes most effective use of a society’s resources in satisfying people’s
wants and needs.

Lesson 2. Microeconomics and Macroeconomics

(www.investopedia.com, 2020)

Despite having made thousands of economic choices, you probably rarely think about
your economic behavior. For example, why are you reading this module right now rather than
doing something else? Economics is divided into two different categories: microeconomics
and macroeconomics. Microeconomics is the study of individuals and business decisions,
while macroeconomics looks at the decisions of countries and governments.

While these two branches of economics appear to be different, they are actually
interdependent and complement one another. Many overlapping issues exist between the two
fields.

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Microeconomics
Microeconomics focuses on your economic actions and other individuals and
companies ' economic activities that make decisions about what to buy and what to sell, how
much to work and how much to play, how much to spend and how much to invest.
Microeconomics explores the factors affecting individual economic decisions and how
markets organize specific decision-makers' decisions.

For example, microeconomics describes how prices and production are calculated on
an individual market, such as the bath soap market, sports gear or unskilled labor market.
You've probably thought little about what affects your own economic choices.

You have probably given even less thought to how your choices connect with those
made in the Philippine economy by hundreds of millions of others to determine measures such
as total output, employment and economic growth.

Macroeconomics
Macroeconomics, on the other hand, studies the behavior of a country and how its
policies affect the economy as a whole. It analyzes entire industries and economies, rather
than individuals or specific companies, which is why it's a top-down approach. It tries to
answer questions like "What should the rate of inflation be?" or "What stimulates economic
growth?" It focuses on the economic output as a whole, especially the national economy. And
microeconomics looks at the single pieces of the economic puzzle. To look at the larger
picture, macroeconomics brings all the pieces together.

Lesson 3. The Three Economic Questions (Pettinger, 2019)

If resources were unlimited, we could all have whatever we want. But as the scarcity-
forces-tradeoff principle reminds us, resources are limited. Just as scarcity forces individuals
to make choices about what to have and what to give up, it also forces societies to make
choices. The larger and more advanced a society is the more numerous and complex these
choices may be. In the end, however, these choices boil down to three basic questions.

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 Because of scarcity, all economic choices can be potted into three big questions about
the goods and services a society must produce. In order to meet the needs of its people, every
society must answer three basic economic questions. These questions are:

1. What goods and services will be produced?

2. How will they be produced?
3. For whom will they be produced?

What Goods and Services Will Be Produced? (Pettinger, 2019)

A society determines the kind and quantity of products it will produce depending on
what the consumers want to buy or are willing to pay for. Most people take for granted the
many choices that go into deciding what gets produced – everything from which new kitchen
appliances are introduced and which novelists get published, to which roads are built.

Different methods can be used to allocate goods and services. People acting
individually or collectively must choose which methods to use to allocate different kinds of
goods and services. Although different economies resolve these ad millions of other questions
using different decision-making rules and mechanisms, all economies must somehow decide
what to produce.

How Will Goods and Services Be Produced? (Pettinger, 2019)

A society decides who will produce goods and what process of production will be used.
The economic system must determine how output is to be produced. Which resources should
be used, and how should they be combined to make each product? How much labor should
be used and at what skill levels? What kinds of machines should be used? What type of
fertilizer grows the best strawberries? Should the office complex be built in the city or closer
to the national highway? Millions of individual decisions determine which resources are
employed and how these resources are combined.

For Whom Will Goods And Services Be Produced? (Pettinger, 2019)

The question revolves around the issue of who will benefit from the goods and services
produced. Who will consume the goods and services produced? The economic system must

4
determine how to distribute the fruits of production among the population. Should equal
amounts be provided to everyone? Should it be first come, first served, so those willing to wait
in line the longest get more? Should goods be allocated according to height, weight, religion,
age, gender and race? The question, “For whom will goods and services be produced?” often
is referred to as the distribution question.

Although every society answers the three basic economic questions differently, in
doing so, each confronts the same fundamental problems: resource allocation and scarcity.

Lesson 4. Factors of Production (Hayes, 2020)

What Are Factors of Production?

Factors of production are the inputs needed for the creation of a good or service. The
factors of production include land, labor, entrepreneurship, and capital. It refers to the
economic resources used to produce goods and services in a society, economists divide these
resources into the four categories described below.

The Basics of Factors of Production

The modern definition of factors of production is primarily derived from a neoclassical
view of economics. It amalgamates past approaches to economic theory, such as the concept
of labor as a factor of production from socialism, into a single definition. Land, labor, capital
and entrepreneurship as factors of production were originally identified by the early
political economists such as Adam Smith, David Ricardo, and Karl Marx.

Land
The first factor of production is land, but this includes any natural resource used to
produce goods and services. This includes not just land, but anything that comes from the
land. Some common land or natural resources are water, oil, copper, natural gas, coal, and
forests. Land resources are the raw materials in the production process. These resources can
be renewable, such as forests, or nonrenewable such as oil or natural gas. The income that
resource owners earn in return for land resources is called rent.
Labor
The second factor of production is labor. Labor is the effort that people contribute to
the production of goods and services. Labor resources include the work done by the waiter

5
who brings your food at a local restaurant as well as the engineer who designed the bus that
transports you to school. It includes an artist's creation of a painting as well as the work of the
pilot flying the airplane overhead. If you have ever been paid for a job, you have contributed
labor resources to the production of goods or services. The income earned by labor resources
is called wages and is the largest source of income for most people.

Capital
The third factor of production is capital. Think of capital as the machinery, tools and
buildings humans use to produce goods and services. Some common examples of capital
include hammers, forklifts, conveyer belts, computers, and delivery vans. Capital differs based
on the worker and the type of work being done. For example, a doctor may use a stethoscope
and an examination room to provide medical services. Your teacher may use textbooks,
desks, and a whiteboard to produce education services. The income earned by owners of
capital resources is interest.

Entrepreneurship
The fourth factor of production is entrepreneurship. An entrepreneur is a person who
combines the other factors of production - land, labor, and capital - to earn a profit. The most
successful entrepreneurs are innovators who find new ways produce goods and services or
who develop new goods and services to bring to market. Without the entrepreneur combining
land, labor, and capital in new ways, many of the innovations we see around us would not
exist. Think of the entrepreneurship of Henry Ford or Bill Gates. Entrepreneurs are a vital
engine of economic growth helping to build some of the largest firms in the world as well as
some of the small businesses in your neighborhood. Entrepreneurs thrive in economies where
they have the freedom to start businesses and buy resources freely. The payment to
entrepreneurship is profit.

Lesson 5. Meaning and Definition of Managerial Economics

Meaning of Managerial Economics (Prachi, 2018)

Sometimes it is interchangeably used with business economics. It has been referring
to as an economics applied to decision making. It is described as application of economic

6
theory and methodology to decision making process by the management of the business
firms. In it, economic theories and concepts are used to solve practical business problem. It
falls on the borderline of economic and management. It helps in decision making under
uncertainty and develops effectiveness of the organization. The basic purpose of managerial
economic is to express how economic analysis can be used in formulating business plans.

Definitions of Managerial Economics (Prachi, 2018)

Managerial economics is used synonymously with business economics. It is a branch
of economics that deals with the application of microeconomic analysis to decision-making
techniques of businesses and management units. It acts as the via media between economic
theory and pragmatic economics. Managerial economics bridges the gap between "theory
and practice". Managerial economics can be defines as:

According to Spencer and Siegelman (n.d):

“Managerial economics is the integration of economic theory with business practice for the
purpose of facilitating decision-making and forward planning by management”.

According to McGutgan and Moyer (n.d):

“Managerial economics is the application of economic theory and methodology to decision-

making problems faced by both public and private institutions”.

Managerial economics studies the application of the principles, techniques and

concepts of economics to managerial problems of business and industrial enterprises. The
term is used interchangeably with micro economics, macroeconomics, and monetary
economics.

Management
Management is necessary in every organization to be well managed to enable it to
achieve its desired goals. Management includes a number of functions: planning, organizing,
staffing, directing, and controlling.

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Economics
Economics deals with the combination of economic theory with business practices for
the purpose of facilitating decision making and forward planning by management. In other
words it is concerned with using of logic of economics, mathematics, and statistics to offer
effective ways of thinking about business decision.

Managerial Economics = Management + Economics

Assessment Task 1

In not less than 1,000 words, write an essay on how do you think
COVID-19 pandemic would affect the entire economy of the
Philippines?

Summary
Economics is the study how to efficiently use and allocate scarce resources to meet
the unending needs and maximum satisfaction of man. It has two key ideas- scarcity of goods
and efficiency use of resources. The two main branches of economics are microeconomics
and macroeconomics. And because of scarcity, all economic choices can be potted into three
big questions about the goods and services a society must produce. These questions are:
what to produce, how to produce and for whom to produce. In able to produce goods and
services in a society, economists divide resources into the four categories; land, labor, capital
and entrepreneurship. Managerial economics is the combination of management and
economics.

8
References
Hayes, A. (2020, August 17). “Factors of Production”. Retrieved from
https://www.investopedia.com/terms/f/factors-production.asp

Investopedia Staff. (2020, Jan 13). “Microeconomics vs. Macroeconomics: What’s

the Difference?” Retrieved from
https://www.investopedia.com/ask/answers/difference- between-
microeconomics-and-macroeconomics/

Pettinger, T. (2019, July 29). “Basic Questions of Economics”. Retrieved from

https://www.economicshelp.org/blog/21651/economics/basic-questions-of-
economics/

Prachi, M. (2018, October 27). “Managerial Economics”. Retrieved from

https://theinvestorsbook.com/managerial-economics.html

Samuelson, P.A. & Nordhaus, W. D. (2010). “Economics”. McGraw-Hill Companies,

Inc. Retrieved from http://pombo.free.fr/samunord19.pdf

9
 MODULE 2
CONCEPT OF ECONOMICS IN
DECISION MAKING

Introduction

Where do you continue your decision making thinking? Whatever the type of
organization or business operation, often even survival in the business world depends on
making wise economic decisions. The awareness of the decision-making process itself is a
crucial component.

Since economic decision-making relies heavily on accounting information, it is

important for economic decision-makers to be of benefit to that information. Life is an endless
series of choices, some of them very complex and some fairly simple. We are trying to reduce
ambiguity about any decision by gathering as much information as possible, because we
cannot foresee the future.

Learning Outcomes

At the end of this module, students should be able to:

1. Recognize the meaning of decision making;
2. Determine why decision making is related to managerial economics;
3. Explain the concepts of extrinsic and intrinsic rewards, sacrifices, and opportunity
costs as they pertain to decision situations;
4. Describe the two types of economic decision makers;
5. Analyze and interpret the three decision making models.

10
Lesson 1. What do you mean by Decision Making?

“Whatever a manager does he does through making decisions” (Ducker, 2016).

Decision-making is Managerial Economics' main goal. Decision-making can be defined as
selecting the appropriate action from among several alternative courses of action. So we
may assume that decision-making issue occurs when scarcity of resources arises.

Decision-making is the method of determining possible courses of action in a given

decision situation and choosing an appropriate possible. This description has two essential
parts to it (Economic Decision Making, n. d., p.33):

1. Identifying alternative courses of action means that the best solution may not exist or might
not be identifiable.
2. Selecting an appropriate alternative implies that a variety of suitable alternatives may exist,
and unacceptable alternatives must be evaluated and rejected. Thus, judgment is the key to
decision-making.

Choice is implied in our definition of decision making. We may not like the alternatives
available to us, but we are rarely left without choices.

Lesson 2. Rewards and Sacrifices: The Trade-off

(Economic Decision Making, n. d., p.33)

In general, all actions are aimed at achieving some form of compensation, either
economic or personal. It takes sacrifice for reward. For example, when you made the decision
to attend college or university, you wanted a reward for sure. Which sacrifice was that?

Think of some things you cannot do because you are attending college. Some
sacrifices cannot be measured in peso (such as loss of sleep, lack of home-cooked meals,
and loss of leisure time). Some, however, can be measured. Suppose that instead of attending
college you could work full time and earn P15,000 a month. Attending college, therefore, costs
you that P15,000, in addition to what you pay for tuition and books. We call the P15,000 an
opportunity cost of making the decision to attend college.

Opportunity Cost

11
 It is the advantages overlooked by not preferring one specific alternative. Within a
decision scenario, if an alternative is chosen, the advantages of all rejected alternatives are
part of the opportunity cost of the selected alternative.

Cost/Benefit Analysis
Examining the relationship between rewards and sacrifices is known as cost/benefit
analysis. This deals with the trade-off between the benefits of choosing a specific choice and
the sacrifices required to achieve those benefits. In a condition of absolute certainty, in which
the outcome of a decision is known without doubt, cost/benefit analysis provides a certain
outcome. Unfortunately, absolute certainty rarely, if ever, exists.

For example accountants use to describe the trade-off between rewards and
sacrifices; money is usually a form of reward.

Money is an extrinsic reward, meaning that it comes from outside ourselves and is a
tangible object we can acquire.

An intrinsic reward is one that comes from inside us. When you accomplish a difficult task, the
intrinsic reward comes from the sense of satisfaction you feel. When you accomplish a difficult
task, the intrinsic reward comes from the sense of satisfaction you feel. An old adage says,
“The best things in life are free.” Not so! Anything worth having requires sacrifice.

Figure 1. Cost versus benefit

Decision makers want the reward or benefit from a decision to be greater than the
sacrifice or cost required to attain it.

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Lesson 3. Types of Decision Makers (Economic Decision Making, n. d., p.35)

The Cambridge English Dictionary defines a decision maker as a “person who decides
things, especially at a high level in an organization.” A decision maker might be responsible
for strategic decisions like acquisitions, business expansion or capital investment. Economic
decision making, in this module, refers to the process of making business decisions involving
money. All economic decisions of any consequence require the use of some sort of accounting
information, often in the form of financial reports. Anyone using accounting information to
make economic decisions must understand the business and economic environment in which
accounting information is generated, and they must also be willing to devote the necessary
time and energy to make sense of the accounting reports. Economic decision makers are
either internal or external.

Internal Decision Makers

They are individuals within a company who make decisions on behalf of the company.
Internal decision makers decide whether the company should sell a particular product,
whether it should enter a certain market, and whether it should hire or fire employees. Note
that in all these matters, the responsible internal decision maker makes the decision not for
himself or herself, but rather for the company. Depending on their position within the company,
internal decision makers may have access to much, or even all, of the company’s financial
information. They do not have complete information, however, because all decisions relate to
the future and always involve unknowns.

External Decision Makers

They are individuals or organizations outside a company who make decisions that
affect the company. External decision makers make decisions about a company. External
decision makers decide whether to invest in the company, whether to sell to or buy from the
company, and whether to lend money to the company. Unlike internal decision makers,
external decision makers have limited financial information on which to base their decisions
about the company. In fact, they have only the information the company gives them—which
in most cases is not all the information the company possesses.

13
 Figure 2. External vs.
Internal Decision Makers

The figure above illustrates some decisions made by internal and external decision
makers.

Lesson 4. Models of Decision Making (Chand, n. d.)

The decision-making process though a logical one is a difficult task. All decisions can
be categorized into the following three basic models.

(1) The Rational/Classical Model.

(2) The Administrative or Bounded Rationality Model.
(3) The Retrospective Decision-Making Model.

All models are beneficial for understanding the nature of decision-making processes
in enterprises or organizations. All models are based on certain assumptions on which the
decisions are taken.

1. The Rational/Classical Model

The rational model is the first attempt to know the decision-making-process. It is
considered by some as the classical approach to understand the decision-making process.

14
The classical model gave various steps in decision-making process which have been
discussed earlier.

Features of Classical Model

1. Problems are clear.
2. Objectives are clear.
3. People agree on criteria and weights.
4. All alternatives are known.
5. All consequences can be anticipated.
6. Decision makes are rational.

2. Bounded Rationality Model or Administrative Man Model

Decision-making involve the achievement of a goal. Rationality demands that the
decision-maker should properly understand the alternative courses of action for reaching the
goals. He should also have full information and the ability to analyze properly various
alternative courses of action in the light of goals sought. There should also be a desire to
select the best solutions by selecting the alternative which will satisfy the goal achievement.

Herbert A. Simon defines rationality in terms of objective and intelligent action. It is

characterized by behavioral nexus between ends and means. If appropriate means are
chosen to reach desired ends the decision is rational.

Bounded Rationality model is based on the concept developed by Herbert Simon. This
model does not assume individual rationality in the decision process. Instead, it assumes that
people, while they may seek the best solution, normally settle for much less, because the
decisions they confront typically demand greater information, time, processing capabilities
than they possess. They settle for “bounded rationality or limited rationality in decisions. This
model is based on certain basic concepts.

a. Sequential Attention to alternative solution

Normally it is the tendency for people to examine possible solution one at a time
instead of identifying all possible solutions and stop searching once an acceptable (though
not necessarily the best) solution is found.

15
b. Heuristic
These are the assumptions that guide the search for alternatives into areas that have
a high probability for yielding success.

c. Satisficing
Herbert Simon called this “satisficing” that is picking a course of action that is
satisfactory or “good enough” under the circumstances. It is the tendency for decision makers
to accept the first alternative that meets their minimally acceptable requirements rather than
pushing them further for an alternative that produces the best results. Satisficing is preferred
for decisions of small significance when time is the major constraint or where most of the
alternatives are essentially similar. Thus, while the rational or classic model indicates how
decisions should be made (i.e. it works as a prescriptive model), it falls somewhat short
concerning how decisions are actually made (i.e. as a descriptive model).

3. Retrospective decision model (implicit favorite model)

This decision-making model focuses on how decision-makers attempt to rationalize
their choices after they have been made and try to justify their decisions. This model has been
developed by Per Soelberg. He made an observation regarding the job choice processes of
graduating business students and noted that, in many cases, the students identified implicit
favorites (i.e. the alternative they wanted) very early in the recruiting and choice process.
However, students continued their search for additional alternatives and quickly selected the
best alternative.

The total process is designed to justify, through the guise of scientific rigor, a decision
that has already been made intuitively. By this means, the individual becomes convinced that
he or she is acting rationally and taking a logical, reasoned decision on an important topic.

16
 Assessment Task 2

In this new normal situation, write an essay about what rewards do you hope
to obtain and what sacrifices are you personally making by attending college
or university this Academic Year 2020-2021?

Summary

Decision-making is Managerial Economics' main goal. Decision-making can be

defined as selecting the appropriate action from among several alternative courses of
action. In order to achieve certain compensation, it takes sacrifice for reward which describes
the trade-off. Economic decision makers are either internal or external. There are four different
decision-making models; rational, bounded rationality, intuitive, and creative.

References
Chand, S. (n d). “Models of Decision Making”. Retrieved from
http://www.pearsoned.ca/highered/divisions/virtual_tours/jones-
fa/jones_finac_ce_ch02.pdf

Ducker, P. F. (2016, April 14). “Decision Making: Meaning & Definition”. Retrieved
from https://www.gktoday.in/gk/decision-making-meaning-and-definition

Economic Decision Making. (n d). Retrieved from

http://www.pearsoned.ca/highered/divisions/virtual_tours/jones-
fa/jones_finac_ce_ch02.pdf

17
 MODULE 3
NATURE AND SCOPE OF MANAGERIAL
ECONOMICS

Introduction

Imagine for a moment that you have finished your studies and entered a manufacturing
company as an engineer. How are you doing there? You are planning to manufacture a
maximum quantity of products of a specified quality at a fair rate. At the other hand, if you are
a sales manager, you will sell a maximum quantity of products for minimal advertisement
costs. In other words, you want to reduce your costs and optimize your profits, and by doing
so, you follow managerial economic concepts.

Managers are often faced with many issues in their day-to-day operations, such as
how much quantity should be supplied; at what price; should the commodity be manufactured
internally; or should it be imported from outside; how much quantity should be generated to
make a specified amount of profit, and so on. Managerial economics offers us a clear insight
into the quest for solutions to management problems.

Learning Outcomes

At the end of this module, students should be able to:

1. Analyze the nature and other features related to managerial economics;

2. Interpret the scope of managerial economics;
3. Recognize the five types of resource decisions taken by business organizations;
4. Identify the two areas of decision making;
5. Describe the relationship of managerial economics with other disciplines.

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Lesson 1. Nature of Managerial Economics
(Introduction to Managerial Economics, 2018)

The Nature of Managerial Economics analyses towards solving business problems,

constitutes the subject-matter of Managerial Economics. It helps in decision making and
forward planning. The problem of choice arises because resources are limited and the firm
has to make the most profitable use of these resources. The other features of managerial
economics are explained as below:

Close to microeconomics
Managerial economics is concerned with finding solutions to a single firm's numerous
management problems. So it is similar to microeconomics.

Operates against the backdrop of macroeconomics

The global macroeconomics conditions are often seen as restricting factors for the
business to operate. In other words, the managerial economist must be mindful of the limits
set by conditions of macroeconomics, such as government industrial policy, inflation, etc.

Normative statements
Typically a normative statement contains or suggests the words ought’ or ‘should’.
They represent the moral attitudes of individuals, and are manifestations of what a team of
people should do. These claims are based on assumptions of importance and reflect opinions
of what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’. One problem with normative statement is that they
are difficult to validate by looking at the evidence, because they are all about the future.

Prescriptive actions
Goal focused is the prescriptive action. Given a question and the company's priorities,
it recommends the course of action for optimal solution from the available alternatives. If the
concept is not merely stated, it also describes whether the concept may be applied on not in
a given context.

Applied in nature

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 'Models' are designed to represent the dynamic business conditions of real life and
these models are of enormous benefit to decision-making managers. The numerous areas of
intensive use of templates include inventory control, optimization, project management etc.
We often use case-study methods in managerial economics to conceptualize the issue, define
the alternative and identify the best course of action.

Offers scope to evaluate each alternative

Managerial economics offers an opportunity to measure the expense and revenue of
each alternative. The managerial economist will determine which alternative is better for
optimizing the company's profits.

Interdisciplinary
The contents, tools and techniques of managerial economics are drawn from a variety
of subjects such as economics, management, mathematics, statistics, accounting,
psychology, organizational behavior, sociology and so on.

Assumptions and limitations

Each managerial economic concept and theory is based on some assumptions, and
as such their validity is not universal. Where assumptions shift, the theory may not hold good
at all.

Lesson 2. Scope of Managerial Economics

(Introduction to Managerial Economics, 2018)

Scope of managerial economics refers to its area of study. Managerial economics

refers to its area of study. Managerial economics provides managers with a strategic analysis
method that can be used to provide a clear picture of how the business world functions and
what can be done to preserve productivity in a growing climate. Managerial economics is
mainly concerned with applying economic concepts and theories to five types of resource
decisions taken by business organizations of all sizes.

 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

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  Promotional strategy and activities.
 The selection of the location from which to produce and sell goods or service to
consumer.

The production department, marketing and sales department and the finance
department usually handle these five types of decisions.

The scope of managerial economics covers two areas of decision making

a) Operational or Internal issues
b) Environmental or External issues

a) Operational issues:
Operational issues refer to those, which wise 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

Demand Analyses and Forecasting:

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. Demand analysis should be a basic activity of the firm because many of the other
activities of the firms depend upon the outcome of the demand forecast. Demand analysis
provides:

1. The basis for analyzing market influences on the firms; products and thus helps in the
adaptation to those influences.

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 2. 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.

Pricing and competitive strategy

Pricing decisions have been always within the preview of managerial economics.
Pricing policies are merely a subset of broader class of managerial economic problems. 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.

Production and cost analysis

Production analysis is in physical terms. While the cost analysis is in monetary terms
cost concepts and classifications, cost-out-put relationships, economies and diseconomies of
scale and production functions are some of the points constituting cost and production
analysis.

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.

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

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and management of profit, in calculating the pure return on capital, besides future profit
planning.

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:

1. The choice of investment project

2. Evaluation of the efficiency of capital
3. 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.

Strategic planning
Strategic planning provides management with a framework on which long-term
decisions can be made which has an impact on the behavior of the firm. The firm sets certain
long-term goals and objectives and selects the strategies to achieve the same. Strategic
planning is now a new addition to the scope of managerial economics with the emergence of
multinational corporations. The perspective of strategic planning is global. It is in contrast to
project planning which focuses on a specific project or activity. In fact the integration of
managerial economics and strategic planning has given rise to be new area of study called
corporate economics.

b) Environmental or External Issues:

An environmental issue in managerial economics refers to the general business
environment in which the firm operates. They refer to general economic, social and political
atmosphere within which the firm operates. A study of economic environment should include:

 The type of economic system in the country.

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  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.

Lesson 3. Managerial Economics Relationship with Other Disciplines

(Introduction to Managerial Economics, 2018)

Many new subjects have evolved in recent years due to the interaction among basic
disciplines. While there are many such new subjects in natural and social sciences,
managerial economics can be taken as the best example of such a phenomenon among social
sciences. Hence it is necessary to trace its roots and relationship with other disciplines.

Economics
Managerial economics has an applied bias and its wider scope lies in applying
economic theory to solve real life problems of enterprises. Both managerial economics and
economics deal with problems of scarcity and resource allocation.

Accounting
Managerial economics has been influenced by the developments in management
theory and accounting techniques. Accounting refers to the recording of pecuniary
transactions of the firm in certain books. A proper knowledge of accounting techniques is very
essential for the success of the firm because profit maximization is the major objective of the
firm.

Mathematics
The use of mathematics is significant for managerial economics in view of its profit
maximization goal long with optional use of resources. The major problem of the firm is how
to minimize cost, how to maximize profit or how to optimize sales. Mathematical concepts and
techniques are widely used in economic logic to solve these problems. Also mathematical

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methods help to estimate and predict the economic factors for decision making and forward
planning.

Statistics
Managerial Economics needs the tools of statistics in more than one way. A successful
businessman must correctly estimate the demand for his product. He should be able to
analyses the impact of variations in tastes. Fashion and changes in income on demand only
then he can adjust his output. Statistical methods provide and sure base for decision-making.
Thus statistical tools are used in collecting data and analyzing them to help in the decision
making process.

Operations Research
Taking effectives decisions is the major concern of both managerial economics and
operations research. The development of techniques and concepts such as linear
programming, inventory models and game theory is due to the development of this new
subject of operations research in the postwar years. Operations research is concerned with
the complex problems arising out of the management of men, machines, materials and
money.

The Theory of Decision- making

As such this new branch of knowledge is useful to business firms, which have to take
quick decision in the case of multiple goals. Viewed this way the theory of decision making is
more practical and application oriented than the economic theories.

Computer Science
Computers have changes the way of the world functions and economic or business
activity is no exception. Computers are used in data and accounts maintenance, inventory
and stock controls and supply and demand predictions. What used to take days and months
is done in a few minutes or hours by the computers. In fact computerization of business
activities on a large scale has reduced the workload of managerial personnel. In most
countries a basic knowledge of computer science, is a compulsory program for managerial
trainees.

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 Assessment Task 3

Write an essay about how you can apply Managerial Economics to the course
you’re taking right now in college?

Summary

The nature of managerial economics analyses towards solving business problems

constitutes the subject-matter of Managerial Economics. The other features of managerial
economics are close to microeconomics, operates against the backdrop of macroeconomics,
normative statements, prescriptive actions, applied actions, applied in nature, offers scope to
evaluate each alternative, interdisciplinary, and assumptions and limitations. The scope of
managerial economics covers two areas of decision making operational or internal issues and
environmental or external issues. Managerial economics is also related with others disciplines;
Economics, Accounting, Mathematics, Statistics. Operations Research, Decision Making and
Computer Science.

Reference
“Introduction to Managerial Economics”. (2018). Retrieved from https://aits-
tpt.edu.in/wp-content/uploads/2018/08/Introduction-to-Managerial-
Economics.pdf

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 MODULE 4
DEMAND ANALYSIS

Introduction

The success of any company depends primarily on sales, and sales rely on the
conduct of consumer demand. Analysis of customer demand is one of the key conditions for
any company undertaking’s life. The management needs to assess the demand for the
product in order to take decisions about production, cost allocation, product pricing,
advertisement, inventory holdings, etc. How much the company will aim to produce is largely
based on the market for its product. When demand falls short of supply, the two must be
balanced by creating new demand through more and better ads. Unless the commodity is not
in demand, its manufacture is unwarranted. The further inventories the business will keep, the
more likely the potential demand for the commodity will be greater. When the market for the
commodity is increasing, it can charge a higher price, with all items staying the same.

Learning Outcomes

At the end of this module, students should be able to:

1. Interpret and analyze the meaning and application of demand;

2. Examine the concept of law of demand;

3. Illustrate the law of demand with the help of demand schedule and demand curve;

4. Enumerate the assumptions and exceptions to the law of demand; and

5. Name and identify the factors affecting the demand.

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Lesson 1. Introduction and Meaning of Demand
(Introduction to Managerial Economics, 2018)

Commonly speaking, demand means the desire for an object. But there is more to
explore in economics than that. According to Stonier and Hague, "Economic demand means
demand backed by ample money to pay for the requested goods." This implies that the market
only becomes successful if, in addition to this, the buying power reflects the desire to purchase
a product.

Thus, economic demand means a desire backed by a willingness to buy a commodity

and a purchasing power to pay. In the words of Benham, “The demand for anything at a given
price is the amount of it which will be bought per unit of time at that price”. (Thus demand is
always at the price of a certain quantity at the specified time.) Thus demand has three basic
elements - price, quantity demanded and time. Despite such, demand needs to make
economies meaningful.

Lesson 2. Law of Demand (Introduction to Managerial Economics, 2018)

Law of demand shows the relation between price and quantity demanded of a
commodity in the market. In the words of Marshall, “the amount demand increases with a fall
in price and diminishes with a rise in price”.

The Law of Demand may be explained with the help of the following demand schedule.

Demand Schedule

Table 1. Demand Schedule for Apple

When the price falls from Rs. 10 to 8

quantity demand increases from 1 to 2. In the

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same way as price falls, quantity demand increases on the basis of the demand schedule we
can draw the demand curve.

Figure 3: Demand Curve for Apple

The demand curve DD shows the inverse relation between price and quantity demand
of apple. It is downward sloping.

Assumptions:
Law is demand is based on certain assumptions
1. This is no change in consumers taste and preferences.
2. Income should remain constant.
3. There should be no substitute for the commodity
4. The commodity should not confer at any distinction
5. The demand for the commodity should be continuous
6. People should not expect any change in the price of the commodity

Lesson 3. Exceptions to the Law of Demand

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 (Introduction to Managerial Economics, 2018)

The following are the exceptions to the Law of Demand:

1. Giffen paradox
The Giffen good or inferior good is an exception to the law of demand. When the price
of an inferior good falls, the poor will buy less and vice versa. For example, when the price of
maize falls, the poor are willing to spend more on superior goods than on maize if the price of
maize increases, he has to increase the quantity of money spent on it.

2. Veblen or Demonstration effect

‘Veblen’ has explained the exceptional demand curve through his doctrine of
conspicuous consumption. Rich people buy certain good because it gives social distinction or
prestige for example diamonds are bought by the richer class for the prestige

3. Ignorance
Sometimes, the quality of the commodity is Judge by its price. Consumers think that
the product is superior if the price is high. As such they buy more at a higher price.

4. Speculative effect
If the price of the commodity is increasing the consumers will buy more of it because
of the fear that it increase still further, Thus, an increase in price may not be accomplished by
a decrease in demand.

5. Fear of shortage
During the times of emergency of war People may expect shortage of a commodity.
At that time, they may buy more at a higher price to keep stocks for the future.

6. Necessaries
In the case of necessaries like rice, vegetables etc. people buy more even at a higher
price.

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Lesson 4. Factors Affecting the Demand
(Introduction to Managerial Economics, 2018)

The following are the factors affecting the demand:

1. Price of the Commodity

The relation between price and demand is called the Law of Demand. It is not only the
existing price but also the expected changes in price, which affect demand.

2. Income of the Consumer

The second most important factor influencing demand is consumer income. The
demand for a normal commodity goes up when income rises and falls down when income
falls. But in case of Giffen goods the relationship is the opposite.

3. Prices of related goods

The demand for a commodity is also affected by the changes in prices of the related
goods also. Related goods can be of two types:

(i). Substitutes which can replace each other in use; for example, tea and coffee are
substitutes. The change in price of a substitute has effect on a commodity’s demand in the
same direction in which price changes. The rise in price of coffee shall raise the demand for
tea;

(ii).Complementary goods are those which are jointly demanded, such as pen and ink. If the
price of pens goes up, their demand is less as a result of which the demand for ink is also
less. The price and demand go in opposite direction. The effect of changes in price of a
commodity on amounts demanded of related commodities is called Cross Demand.

4. Tastes of the Consumers

The amount demanded also depends on consumer’s taste. Tastes include fashion,
habit, customs, etc. A consumer’s taste is also affected by advertisement. If the taste for a
commodity goes up, its amount demanded is more even at the same price. This is called
increase in demand. The opposite is called decrease in demand.

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5. Population
Increase in population increases demand for necessaries of life. A change in
composition of population has an effect on the nature of demand for different commodities.

6. Government Policy
Government policy affects the demands for commodities through taxation. Taxing a
commodity increases its price and the demand goes down. Similarly, financial help from the
government increases the demand for a commodity while lowering its price.

7. Expectations Price in the Future

If consumers expect changes in price of commodity in future, they will change the
demand at present even when the present price remains the same. Similarly, if consumers
expect their incomes to rise in the near future they may increase the demand for a commodity
just now.

8. Climate and weather

The climate of an area and the weather prevailing there has a decisive effect on
consumer’s demand. In cold areas woolen cloth is demanded. During hot summer days, ice
is very much in demand. On a rainy day, ice cream is not so much demanded.

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 Assessment Task 4

Name that Demand Factor

A. Match the demand factor with the correct definition
Terms:
1. Income
2. Consumer Preference
3. Number of Buyers
4. Prices of Related Goods
5. Expectations of the Future
Definitions
a. What buyers would rather purchase; or goods and services that
consumers would choose over the alternatives
b. What consumers anticipate will happen
c. Quantity of consumers demanding a good or service
d. Money earned from working (like salary or wage), investing, or
selling goods and services
e. Prices of goods associated with a particular product, like the price
of a substitute or complement

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B. Each choice below describes a change in demand associated with a particular factor.
Place each one into the correct column.

Income Consumer Number of Prices of Future

Preference Buyers Related Goods Expectations

Choices:

1. Demand for American cars increased, because American car companies began
selling their products to consumers in more countries.
2. Present demand for goods and services decreased, because consumers expect
lower salaries in the future.
3. Demand for tea rose increased, because the price of coffee increased.

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Summary

Economic demand means demand backed by ample money to pay for the requested
goods. This implies that the market only becomes successful if, in addition to this, the buying
power reflects the desire to purchase a product. Law of demand shows the relation between
price and quantity demanded of a commodity in the market and it may be explained by using
the demand schedule and the demand curve that maybe affected by the assumptions,
exceptions and factors to the demand.

Reference
“Introduction to Managerial Economics”. (2018). Retrieved from https://aits-
tpt.edu.in/wp-content/uploads/2018/08/Introduction-to-Managerial-
Economics.pdf

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