Managerial

Economics
MBS First Semester
Tribhuvan University
2021 MBS First Semester
Managerial Economics
Tribhuvan University
Course Contents:
1. Introduction to Managerial Economics and Theories of Firm
2. Demand analysis and forecasting
3. Production and cost analysis
4. Pricing theory and practice
5. Risk Analysis
6. Market efficiency and role of the government

Unit 1:
Introduction to Managerial Economics and Theories of firm
Concept of Managerial Economics.
 The concept of managerial economics was initiated after 1950’s by Prof. Dean Joel and
Practicability of managerial economics in real practice was proved by Warren E. Buffet.
  Managerial economics in its simplest form may be defined as the application of economic theory
to the problems of management.
 Managerial economics is that part of economic theory which deals with the application of
economic tools and concepts to the solution of business problems or the problems of resource
allocation among the competing ends.
 Managerial economics is the discipline which deals with the application of economic theory to
business management.
 Managerial economics refers to the application of economic theory and decision science tools to
find the optimal solution to business decision problems.
 Managerial economics prescribes rules for improving managerial decision
 It tells managers how action should be undertaken to achieve organizational goals efficiently.
 Managerial economics also helps managers recognize how economic forces affect organizations
and describes the economic consequences of management behavior.
 Managerial Economics can be defined as amalgamation of economic theory with business
practices so as to ease decision-making and future planning by management.

Main Concern of Managerial Economics:(O3)

O - Opening of firms/ Industries
O - Operation of firms/ Industries
O - Out (exit) of firms/Industries from the market.
Managerial economics believes that successful managers make good decisions and the most useful tool of
managerial decision making is the methodology of managerial economics.

How Economics contributes to Managerial Decisions

According to Baumol, a Nobel laureate in economics, economic theory contributes to business decision
making in three important ways:

 By providing framework for building analytical models:

Which can help recognize the structure of managerial problem, determine the important factors to
be managed and eliminate the minor factors that might obstruct decision making.

 By providing a set of analytical methods:

Which may not be directly applicable to analyses specific business problems but they do widen
the scope of business analysis and enhance the analytical capability of business analyst in
understanding the nature of the business problems.

 Various economic terms are used in common parlance:

Which are not applicable to business analysis and decision making. Economic theory offers
clarity to various economic concepts used in business analysis, which enables the managers to
avoid conceptual pitfalls (traps).
Characteristics or features of Managerial Economics
1. Microeconomic in Character/Nature
2. Pragmatic
3. Normative
4. Conceptual and Quantitative
5. Theory of Firm
6. Goal-oriented
7. Coordination between Theory and Practice
8. Wise Choices
9. Multidisciplinary
10. Help of Macroeconomics
11. Aims at helping the management

Scope of Managerial Economics:

A. Internal/Operational Issues (Decision making issues):
 (Microeconomics theories and analytical tools are applied)
◦ Demand Analysis and Forecasting
◦ Production and Cost Analysis
◦ Pricing Theory and Practices
◦ Profit Analysis and Profit Management
◦ Capital and Investment Decisions
◦ Inventory Management

Some of basic internal management issues:

 What to produce: choice of the business

 How much to produce: determining the size of the firm
 How to produce: choice of efficient and affordable technology
 How to price the product: determining the price of the product  How to promote sale of the
product
 How to face price competition from the competing firms
 How to enlarge the scale of production: planning new investment
 How to manage profit and capital.

A. External/Environmental Issues:
(macroeconomic theories and tools are applied)
 What is the nature and trend of domestic business environment?
 What is the nature and trend of international business environment?
 What is the nature and impact of social costs and government policy measures?
 Trend in the Economy
 International Economic Conditions

Relation of Managerial Economics with Traditional Economics:

Relationship with microeconomics
Pricing, output determination, cost analysis, what to produce? how to produce? How much to invest? etc.
Relationship with macroeconomics

 Environmental issues
 Prediction of aggregate economic variables
 Policy issues
Note: Managerial economics differs with traditional economic issues in various aspects such as
practicability, character, scope, assumptions, hypothesis etc.
 What is the Difference between Traditional Economics and Managerial
Economics?

The upcoming discussion will help you to differentiate between traditional and managerial
economics.

The difference in Traditional Economics:

 Traditional Economics has both Micro and Macro aspects.

 This is both positive (existing certain) and Normative Science.
 This deals with Theoretical aspects only.
 Here, problems are analyzing both from a Micro and Macro point of view.
 It studies human behavior based on certain assumptions, but these assumptions do not hold good
in Managerial Economics.
 Here, we study only the economic aspects of the problems.
 Here, we study principles underlying rent, wages, interest, and profits.
 Traditional Economics scope is wide and it covers various areas.

The difference in Managerial Economics:

 It is essentially Micro in character.
 This is essentially Normative (setting standard) in nature.
 While it deals with Practical aspects.
 It studies the activities of an individual firm or unit.
 Managerial economics deals mainly with Practical problems.
 Here, both economic and non-economic aspects of the problems are studying.
 Here, we study mainly the principles of profit only.
 While the scope of Managerial Economics is limited and its scope is not so wide as that of
Traditional Economics.
 Here, the most important task is to study how to improve the efficiency of the firm.
Role of Managerial Economist:
Making decisions - organizing - processing information.
Specific Decisions
(i) Producing scheduling,
(ii) Demand forecasting,
(iii) Market research,
(iv) Economic analysis of the industry,
(v) Investment appraisal,
(vi) Security management analysis,
(vii) Advice on foreign exchange management,
(viii) Advice on trade
(ix) Pricing and the related decisions, and
(x) Analyzing and forecasting environmental factors.

General Tasks:
1. Organizing the resources and uses.

2. Processing the information.

Uses of Managerial economics in business decision making:

Determination of price and output
Demand forecasting
Allocation of resources
Determination of profit margin
Investment decision making
Maintenance of Inventories
Environment analysis etc.

Nature and Functions of Profit:

Meaning of Profit:
 Profit means different things to different people like; businessmen, accountants,
economists, tax collectors, workers etc.
  The role and excess of profit differs in different economies as well.
 Generally, Profit is the excess of income over expenditure.
 Profit includes various economic concepts like opportunity cost, Fixed and Variable costs,
and revenues
Profit is a financial benefit that is realized when the amount of revenue gained from a business
activity exceeds the expenses, costs, and taxes needed to sustain the activity

Accounting Profit Vs. Economic Profit:

Business Profit/Accounting Profit
= TR – Explicit Cost
Or, Accounting Profit= TR-(W+R+I+M)
Where; TR=total revenue, W=wages and salaries, R=rent, I= interest and M= cost of materials.
Explicit cost is the cost paid for external factors of production.
Economic Profit/Pure Profit
= TR- (Explicit + Implicit Cost)
=Accounting Profit- (opportunity cost + unauthorized payments e.g. bribes)
*Implicit Cost refers to the cost incurred for self-owned factors of production along with normal
Profit. It is also known as opportunity cost.

Accounting Profit Vs. Economic Profit

Economic Profit Accounting Profit

A theoretical financial figure based on Actual profit (net income) is determined
assumptions
Isn't part of financial statements or reported Calculated according to GAAP and
reported to IRS
Used for internal analysis Used by investors to analyze a potential
investment
Illuminates for management the wisdom of Provides insight into how well
various business options management is running company
Can reveal how efficiently a company uses Is used to calculate investors' earnings
its resources per share
Example of Accounting
Profit:
Let us suppose, the total
revenue of ABC firm from
the sale of goods in 2020 is
$120,000. Its costs on the
purchase of raw material,
payment of wages and
other
utilities i.e., explicit costs
are $50,000. The firms
accounting profit will be.....
 Total sales revenue =
$120,000
Purchase of raw
materials, Wages to labour
and other utilities = $50000
Accounting profit =
Total Revenue - Explicit
Cost
=$120,000 -
($50,000)
=$70,000
Functions of Profit:
Measurement of performance.
Incentive for expansion.
Incentive for new inventions and innovations.
Ensures future capital.  Attracts new investor.
Increases risk bearing capacity.
Incentive for Research and Development.
Main Heart of market economy.
Indicator of success and achievement etc.

Features of value maximization model:

(1) This model creates direct relationship between profit and managers remuneration
(2) This model is more useful in competitive markets
(3) It provides simple explanation and easy to make managerial decision
(4) It deals with both cost and benefit of the firm in long-run
(5) It also deals with social contribution and benefits.
Superiority of Value maximization model:
Value maximization model is superior than profit maximization model in following respects:
 Profit maximization model deals with short-term profit maximizing business projects.
Value maximization model deals with long-run profit maximizing business projects and
this model incorporates all these activities including risk analysis.
 Profit maximization model is static model. It is because this model deals the objective of
a firm on the basis of single time period. But, value maximization model is dynamic
model. It is because this model explains the objective of a firm with future risk and
uncertainty on the basis of multi-period.
 Profit maximization model is focused on sole-trading business at which welfare
maximization of single owner is preferred. Value maximization model is focused on
corporate business at which welfare maximization of many shareholders is preferred.

Constrained Optimisation
i. Legal constrained
ii. ii. Inputs constrained
iii. iii. Financial constrained