MANAGERIAL

ECONOMICS
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INTRODUCTION
Economics is a study of human activity both at
individual and national level. Any activity involved
in efforts aimed at earning money and spending this
money to satisfy our wants such as food, Clothing,
shelter, and others are called “Economic activities”.

Adam Smith, the Father of Economics, defined

economics as the study of nature and uses of national
wealth’.
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INTRODUCTION
“Economics is a study of man’s actions in the ordinary business of life: it
enquires how he gets his income and how he uses it”. ( Dr. Alfred
Marshall)

Economics as “the science, which studies human behavior as a

relationship between ends and scarce means which have alternative uses”.
( Prof. Lionel Robbins)

Economics is the science that deals with the management of scarce

resources in demand; it studies problems on using available economic
resources as efficiently as possible so as to attain the maximum fulfillment
of society’s unlimited demand for goods and services
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MICROECONOMICS
➢ The study of an individual consumer or a firm is called
microeconomics.

➢ Micro means ‘one millionth’.

➢ Microeconomics deals with behavior and problems of

single individual and of micro organization.

➢ It is concerned with the application of the concepts such as

price theory, Law of Demand and theories of market structure
and so on.
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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.

➢ It is 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.
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BASIC TERMS IN THE STUDY

OF MANAGERIAL ECONOMICS
Efficiency- refers to productivity and proper allocation of
economic resources

Effectiveness- attainment of goals and objectives

Opportunity Costs- refers to the foregone value of the next best

alternative; it is the value of what is given up when one makes a
choice
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BASIC TERMS IN THE STUDY

OF MANAGERIAL ECONOMICS
Production- an economic activity that combines its factors from
land, labor, capital and entrepreneurs

Land- refers to all natural resources, which are given by, found in
nature and not manmade

Labor- any form of human effort exerted in the production of

goods and services

Capital- refers to man made goods used in the production of

other goods and services
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BASIC TERMS IN THE STUDY

OF MANAGERIAL ECONOMICS
Entrepreneurship- pertains to the skills, talent and risk-taking
behaviour needed in building, operating and expanding a
business; an economic resource that is remunerated in the form of
profit
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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”.

-Utilization of managerial skills in the business by applying

economic theories and concepts to maintain efficiency in costing
and production and its effectiveness on every decision making by
the firms to fully maximize their profits
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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”.

-Utilization of managerial skills in the business by applying

economic theories and concepts to maintain efficiency in costing
and production and its effectiveness on every decision making by
the firms to fully maximize their profits (Economic theories and
concepts are microeconomic and macroeconomic elements that
will help the entrepreneurs come up with productive decisions)
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MANAGERIAL ECONOMICS
- Efficiency in costing and production

- Effectiveness in decision making

- As the pull out component from microeconomic theory,

concepts and techniques that helps every manager select
strategic direction, to allocate efficiently the resources available
and respond effectively to tactical issues (Mcguigan, Moyer
and Harris)
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MANAGERIAL ECONOMICS
- The study of how to direct scarce resources in the way that
most efficiently achieves a managerial goal (Baye)

- Deals with the nature of the firm, how and why it is organized
the way it is, in order to make a better, more efficient and more
highly rewarded executive (McCormick)

- The application of economic theory and the tools of analysis of

decision science to examine how an organization can achieve
its aims or objectives most efficiently (Salvatore)
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MANAGERIAL ECONOMICS
- The branch of economics which deals with the application of
the theories, tools and findings of economic analysis to
managerial decision making in all types of organizations,
including government agencies, educational centers, not for
profit foundations and business enterprises (Villegas)
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NATURE OF MANAGERIAL ECONOMICS

1. 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.

2. 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.
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NATURE OF MANAGERIAL ECONOMICS

3. 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 do

• Such statement are based on value judgments and express views of

what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’.

• One problem with normative statements is that they cannot to verify by

looking at the facts, because they mostly deal with the future.
Disagreements about such statements are usually settled by voting on
them
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NATURE OF MANAGERIAL ECONOMICS

4. 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.

• It also 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.
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NATURE OF MANAGERIAL ECONOMICS

5. 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.
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NATURE OF MANAGERIAL ECONOMICS

6. 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.

7. 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
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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.

a. The selection of product or service to be produced.

b. The choice of production methods and resource combinations.

c. The determination of the best price and quantity combination

d. Promotional strategy and activities.

e. The selection of the location from which to produce and sell goods or service to
consumer
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SCOPE OF MANAGERIAL ECONOMICS

The scope of managerial economics covers two areas of decision making

• Operational or Internal issues

• Environmental or External issues

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SCOPE OF MANAGERIAL ECONOMICS

A. OPERATIONAL ISSUES: Operational issues refer to those, which are within the
business organization and they are under the control of the management. Those are:

1. Theory of demand and Demand Forecasting

2. Pricing and Competitive strategy

3. Production cost analysis

4. Resource allocation

5. Profit analysis

6. Capital or Investment analysis

7. Strategic planning
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SCOPE OF MANAGERIAL ECONOMICS

B. Environmental or External Issues: .

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.

a. The general trends in production, employment, income, prices, saving and investment.

b. Trends in the working of financial institutions like banks, financial corporations, insurance
companies

c. Magnitude and trends in foreign trade;

d. Trends in labour and capital markets;

e. Government’s economic policies viz. industrial policy monetary policy, fiscal policy, price
policy etc.
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THEORY OF THE FIRM

Earning profit

Profit

- as the difference that arises when a firm’s total revenue is greater than its total cost

- The difference between the income an entrepreneur receives from the sale of his goods and
services and the expenses he incurs to produce them

- Maximize wealth or value of the firm

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INCREASING ITS OWN VALUE AS AN
ECONOMIC ACTIVITY
- Growth- measured in terms of increase in assets that appreciate in
value, greater production capacity accompanied by increase in sales
volume and increase in owner’s equity

- Stability- refers to the firms ability to weather the ups and downs in
the economy or the ability to continue operations despite anticipated
risks in a business

- Owners equity- difference between total assets and total liabilities of a

business entity (Net Assets / Net Asset Value or Net Working Capital)
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IMPROVING THE QUALITY OF LIFE IN THE COMMUNITY

Corporate Social Responsibility

- The company gets involved in civic activities

- The firm has a chance of improving the life of people

- Support other entities that are directly or indirectly affected by its

business transactions
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THE DECISION MAKING MODELS

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THE ROLE OF PROFIT

Economic Profit- the difference between total revenue and total

economic cost

Economic cost- the cost of the alternative opportunity that is

foregone

Opportunity cost- the cost of explicit and implicit resources that

is considered as foregone given the choices
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THE ROLE OF PROFIT

Risk Bearing Theory of Profit- based on the assumption that the

investment risk experienced by the owners of the organization
should be compensated by economic profits above a competitive
rate of return

Temporary Disequilibrium Theory of Profit- when the firm

earned a long run equilibrium normal rate of profit that should
be adjusted to risk

Monopoly Theory of Profit- assumes one firm which dominates

the industry has the possibility to earn above normal rates of
return for a long period of time because of zero competition
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THE ROLE OF PROFIT

Innovation Theory of Profit- assumes that due to innovation success,

an organization is rewarded by above normal profit; creativity or
successful innovation fuels economic profits

Managerial Efficiency Theory of Profit- assumes that exceptional

managerial skills of well managed enterprise meet the above normal
profit (compensatory theory of profit)

*The higher the efficiency level of the firm, the higher the
compensatory factor will be that goes above normal returns

*Profit is he reward representation of greater efficiency

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PROFIT MAXIMIZATION
• The Shareholder Wealth- Maximization Model of the Firm

• Goals in Public Sector and Non Profitable Enterprises

• Non- Profitable Objectives

• Understanding the Markets

• Consumer- Producer Rivalry

• Consumer- Consumer Rivalry

• Producer- Producer Rivalry

• Government and the Market

ELEMENTS OF
DEMAND
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LAW OF DEMAND
- States that the quantity of goods bought is inversely related to
the goods’ price, while all others are constant

CONCEPT OF DEMAND

In Economics, demand refers to effective demand which implies:

• Desire
• Means to purchase
• Willingness to use those means for that purchase

Demand for a commodity refers to the desire to buy a commodity

backed with sufficient purchasing power and the willingness to
spend
Horizontal Demand Curve- price is constant regardless of Qd
Vertical Demand Curve- Qd is constant regardless of price

In terms of Elasticity or Price Responsiveness

Horizontal Demand Curve- perfectly elastic/ extreme price sensitivity in a
perfect competition

*Perfect Competition/ Pure Competition- characterized by having infinite

number of buyers and sellers, none of whom can influence or dictate the
price, homogenous products and services, freedom of entry or exit

Vertical Demand Curve- perfectly inelastic, Qd is fixed regardless of the

willingness of the buyer to pay
 PRICE ELASTICITY OF DEMAND

- The degree of responsiveness of quantity demanded to a

change in price

2 Measures:

1. Arc Elasticity- the coefficient of the price elasticity of

demand between two points along the demand curve
2. Point Elasticity- the measurement is more exact ;
measures only one point on the demand curve
INCOME ELASTICITY OF DEMAND

- Measures a product’s percentage change in demand as a

ratio of the percentage change in income which caused the
shift in the demand curve

As income increases, a coefficient of:

>1 means demand is elastic and the good is superior

<1 means demand is inelastic and the good is inferior
=1 means demand is unitary and the good is normal
CROSS ELASTICITY OF DEMAND

- Measures percentage change in demand of Good X which is

a shift of the demand curve in response to a percentage
change in the price of Good Y
- May have a coefficient of greater than 1, less than 1 or
equal to 1, indicating demand sensitivity

If the coefficient ec:

+ commodities X and Y are substitutes
- Commodities X and Y are complements
THE THEORY OF
INDIVIDUAL
BEHAVIOR
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APPROACHES IN UNDERSTANDING
CONSUMER BEHAVIOUR

• Utility Approach

• Indifference Curve Approach

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UTILITY
- Refers to the satisfaction or pleasure that an individual or consumer
gets from the consumption of a good or service that one purchases

- It is measured by how much a consumer is willing to pay for a good or

service
Total Utility of Cup of Ice Cream

Quantity of Ice Cream (in cups) Total Utility

0 0

1 10

2 18

3 24

4 28

5 30

6 30

7 28

8 25
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ASSUMPTIONS ABOUT CONSUMER

PREFERENCES
- Preferences are complete

- More is better because the more goods consumed, the higher the utility

- Preferences are transitive

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MARGINAL UTILITY
- The rate at which total utility changes as the level of consumption rises

- Change in total utility for a change in the quantity of goods consumed

- The additional satisfaction that an individual derives from consuming

an extra unit to, or taking away one unit from, some economic variable
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MARGINAL UTILITY
- The rate at which total utility changes as the level of consumption rises

- Change in total utility for a change in the quantity of goods consumed

- The additional satisfaction that an individual derives from consuming

an extra unit to, or taking away one unit from, some economic variable
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LAW OF DIMINISHING MARGINAL UTILITY

- After some point, as consumption of goods increase, the marginal
utility of the goods begin to fall

- The more of something a person consume, the less additional

satisfaction a person gets from additional consumption
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INDIFFERENCE CURVE APPROACH

ASSUMPTIONS

- Consumer is given a choice of basket of goods with only 2 desirable

products/ goods

- The two goods are preferred by the consumer. The two goods are
choice baskets reflecting the combination of goods available for the
consumer.

- The goods are not perfect substitutes for one another

- The goods are given up at the expense of another: if you want to

increase the consumption of the number of units of goods, you have to
combine it with other goods at lesser number of units
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ESSENTIAL PROPERTIES OF INDIFFERENCE CURVE

o Higher indifference curves are better

o Indifference curves do not intersect

o Indifference curves are downward sloping to the right

o Indifference curves are convex to the point of origin

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BUDGET CONSTRAINTS
ASSUMPTIONS

1. There are 2 goods: Goods X and Goods Y

2. The prices of the goods are represented by the following notations:

Px= price of goods X Py= price of goods Y

3. Consumer’s income (I) is fixed in the short run.

4. The expenditure of the consumer is equal to the income. Therefore, there is no

savings

5. The utility of the consumer is based on the expenditure for goods x and y which is
equal to the sun of the price of each good multiplied by the quantity bought.
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UTILITY MAXIMIZATION: THE CONSUMER EQUILBRIUM

POINT
- Answers the question “To attain maximum utility or satisfaction, how
many units of goods X and Y should a consumer buy given the income
and the prices of goods?”
PRODUCTION
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PRODUCTION
- Process of converting input into output

- Refers to any economic activity, which combines the four factors of

production to form an output that will give direct satisfaction to
consumers

- In this production process, the manager is concerned with efficiency in

the use of the inputs (technical vs. economical efficiency)
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FACTORS OF PRODUCTION
Land- natural resources that represents the gift of nature to our
productive processes

Labor- the mental and physical ability used in the production of goods
and services

Capital- goods that are used in the production of other goods and services

Entrepreneurial Ability
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CONCEPT OF EFFICIENCY
Economic efficiency:

- occurs when the cost of producing a given output is as low as possible

Technological efficiency:

- occurs when it is not possible to increase output without increasing

inputs
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TECHNOLOGY
- The body of knowledge applied to how goods are produced

- The production process employed by firms in creating goods and

services

CATEGORIES:

Labor Intensive- employed by economies where labor resources are

abundant and cheap

Capital Intensive- utilizes more capital resources than labor resources in

the production process; employed by industrialized economies since
capital resources in these economies are cheaper than labor
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TYPES OF PRODUCTION INPUTS

Fixed Input- any resource the quantity of which cannot readily be
changed when market conditions indicate that a change in output is
desirable

Variable Input- any economic resource the quantity of which can be easily
changed in reaction to changes in output level
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SHORT RUN VS LONG RUN

Short Run

- a period of time so short that there is at least one fixed input therefore
changes in the output level must be accomplished exclusively by
changes in the use of variable inputs

- Treats one of the inputs as fixed or meaning the amount or level of

capital tends to be fixed

Long Run- is a period of time so long that all inputs are considered
variable (planning horizon); can freely expand its production facilities as
well as its labor requirements
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You will see that basic production theory is simply an

application of constrained optimization:
• The firm attempts either to minimize the cost of producing a given
level of output or

• To maximize the output attainable with a given level of cost.

• Both optimization problems lead to same rule for the allocation of

inputs and choice of technology
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Production Function
• A production function is purely technical relation which connects
factor inputs & outputs. It describes the transformation of factor
inputs into outputs at any particular time period.

• Expresses the amount of output that can be produced given certain

amounts of input

• Functional relationship between quantities of inputs used in

production and outputs to be produced

• Q = f (L,K)

• Where: Q is the level of output L is the no.of units of labor K is the

no.of units of capital
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Production Concepts
Total Product- refers to the total output produced after utilizing the fixed
and variable inputs in the production process

Fixed Inputs- components of production which do not change

Variable Inputs- are the changeable resources in the production

Marginal Product- the extra output produced by 1 additional uni of that

input while other inputs are held constant

Average Product- total product over total units of inputs used

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THE THEORY OF COST

Cost-refers to all expenses acquired during the economic activity or the
production of goods and services

Profit= Sales- Costs or Profit= Total Revenue- Total Costs

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COST CONCEPTS
Explicit Costs- are payments to non-owners of a firm for their resources

Implicit Costs- are the opportunity costs of using resources owned by the firm

Fixed Costs/Overhead/ Supplementary- expenses which are spent for the use of
fixed factors of production (sunk cost-obligated to pay)

Variable Costs/Prime/Operating-expenses which change as a consequence of a

change in quantity of output produced
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CATEGORIES OF COSTS
Total Fixed Costs- consist of costs that do not vary as output varies and that must
be even paid even if output is zero

Total Variable Costs- consist of costs that are zero when output is zero and vary
as output increases/decreases

TC= TFC+TVC

Average Fixed Costs- total fixed costs over the quantity of output produce

AFC= FC/Q
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CATEGORIES OF COSTS
Average Variable Cost= VC/Q

Average Total Costs- total cost divided by the quantity of output produced

ATC= TC/Q or AFC+AVC

Marginal Costs- the cost of producing one additional unit of output; the change
in total cost when one additional unit of output is produced

MC= change in TVC/ change in Q