Managerial Economics

1. Managerial Economics
Jan Surya Sharma
SUPPLY DEMAND

2.  Greek words: OIKONOMIA “OIKOS NEMEIN”: HH Mgmt.
 Desires/Wants/Demands Unlimited
 Resources, G&S  Limited
 Problem: Scarcity & Choices
 To produce G&S  f(L, L, C, K, Entrepreneurship)
Introduction to Economics
Man’s Motivation  ‘Self-Satisfaction’ or ‘Value Creation’
Economics: a study of economic problems.
 Wants motive force of an economic activity.
 Wants  efforts.
 Efforts  satisfaction.
Economics Activities:
 Production
 Consumption
 Distribution
 Exchange

3. 1. Wealth Definition: ‘economics is the study of wealth’…
…Adam Smith (Wealth of Nations1776)
‘ economics deal with the phenomenon of wealth’… J. B. Say
2. Welfare Definition: ‘Political Economy or Economics is the study of man kind
in the ordinary business of life’…Alfred. Marshall 1890 (“Principles of Economic
Science)
-study of man & and human welfare.
3. Scarcity Definition. “Economic is the science which studies human behavior as a
relationship between ends & scarce means which have alternative uses.”…Lionel
Robbins (‘Nature & Significance of Economic Science1932)
4. Growth Definition. Paul Samuelson (Economics(1948):
Economics is the study of how people & society end up choosing with/without
money to employ scarce productive resources that could have alternative uses to
produce various commodities & distribute them for consumption. Economic
analyses the cost & benefits of improving patterns of resources use.
Scarcity: Unlimited wants ,scarcity of resources & alternative uses.
Dynamism: The importance of time is brought in the definition.
Economic growth: gave importance to economic growth
Wide scope: Economic choice exist not only in a monetary economy but also in
a barter economy.
Problem of choice: problem of choice in present & future in dynamic conditions.
Economics: Definitions

4. • No short definition of growing subject of Economics to serve the purpose
or we can agree with Prof. Viner that
“Economics is what economists do”
‘Economists do resource allocation or resource utilization. They study size,
distribution & stability of national income & economic growth•”
• Prof. Henry Smith: “Economics is the Study of how in a civilized society
one obtains the share of what other people have produced and of how
the total product of society changes and is determined”
Finally Conclude Economics
Economics:
‘A social/behavioral science that studies the problem of allocation of
scares resources for optimization of production, distribution,
consumption, & minimization of cost of goods & services’
Science that studies human behavior as a relationship between ends &
scares means which have alternate uses.

5. Fundamental Economic Problems
• What to produce? Quantity & range of goods/resources
– Choice on Limited Resources: trade-off between different
alternative collection of goods & services to be produced
• How to produce? Factors of production & Technologies to use
• For whom to produce? How the national products are
distributed, i.e., who should get & how much
• Are the resources economically used? Optimization of
resources, i.e., efficient use of limited resources
• Problem to full employment? How to achieve full-
employment & allocation of resources
• Problem of growth? Economy must expand or develop to
maintain conditions of stability

6. Introduction to
Managerial Economics
FOUNDATION/PREMISE OF UNDERSTANDING ECONOMICS
MAN’S MOTIVATION IS
SELF-SATISFACTION OR VALUE CREATION
GOAL & ROLE OF MANAGERIAL ECONOMICS
 TO REDUCE TRANSACTION COST
 make business decisions for the best use (optimizing
allocation) of an organization’s scarce resources

7. Managerial Economics & Theory
Manager: A person who directs
resources to achieve the stated goal.
Economics: science of making decisions in the
presence of limited resources
Microeconomics: deals with the decisions made by
individuals & groups, the factors that affect these
decisions, & how these decisions effect others".
Managerial economics: applies economics theory to business
problems,i.e., how to direct given resources through economic analysis
to make decisions in achieving the managerial goals efficiently.
Macroeconomics: deals with economics decisions
made at macro or aggregate level.

8. Economics
The social science that studies the problem of
allocation of scares resources for optimization of
production, distribution, consumption &
minimization of cost of goods & services.
“Science which studies human behavior as
a relationship between ends and scarce
means which have alternative uses.”
Alternative uses of available resources involves the study of
choices as they are affected by incentives and resources.
Micro Economics Macro Economics
-Positive Approach: (What is, what was or will be?)
-Normative Approach: (What ought to be?)

9. Micro-economics
Assumptions: “ceteris paribus”-other things remains unchanged, i.e.,
partial-equilibrium analysis.
General-equilibrium theory: allows for changes in different markets
& aggregates across all markets, including their
movements & interactions toward equilibrium.
Deals with the economic behavior & problems of
individual agents (firm, industry, consumer etc.) & their interactions
with markets, given scarcity, govt. regulations, product & service and
factors of production.
The Theory: considers aggregates of qty demand & qty supply at each
possible price per unit to describe the mkt. equilibrium on price &
quantity or respond to market changes over time. Broadly termed as
demand-& -supply/ market forces analysis.
Market structures, such as perfect competition & monopoly, are
examined for implications for behavior & economic efficiency.

10. Also considers factors affecting the long-term level & growth of
national income within a country & across countries.
Macro-Economics
Examines the economy as a whole to explain broad aggregates and their
interactions and effects.
Such aggregates include:
-national income & output,
-unemployment rate,
-price inflation &
Sub-aggregates like total consumption and investment spending and
their components.
Recently macroeconomics has further integrated micro-based
modeling of sectors, including rationality of players, efficient use of
market information, & imperfect competition.
It also studies effects of monetary policy and fiscal policy.

11. Managerial Economics
• Managerial economics applies economic theory to business
problems
How to use economic analysis to make decisions to achieve
firm’s goal of profit maximization and cost minimization?
Draws heavily from quantitative methods such as operations
research & programming and from statistical methods such as
regression analysis in the absence of certainty and perfect
knowledge.
A unifying theme & attempt to optimize business decisions,
including unit-cost minimization & profit maximization, given the
firm's objectives & constraints imposed & supported by
technology and market conditions.
Reliance: Upgrading technology to achieve EoS
Samsung, LG, Sony: Entry in India with P D
P&G and HUL : consumer preferences & segmentation

12. Managerial Economics :
more definitions
• It is the integration of Economic theory with business practice to
facilitating decision making & forward planning by management”
– W.W. Haynes
 “Economics decision making & forward planning”
– Spencer & Siegelman
 “ Use of economic modes of thought to analyze business situations”
– problems in business economics
– McNair & Meriam
 “The purpose of managerial economics is to show how economic
analysis can be used in formulating business policies”
– Joel Dean
 Branch of economics. including economic principles & concepts for
the analysis & solution of management problems of business
organizations & industries.

13. Nature & Scope of Managerial
Economics
Practical use of economic principles to solve the future
planning & problems of management.
Thus it is an ideal combination of art & science.
As a Science: Logical knowledge, where rules are made & the
truthfulness of the rules is examined. – it has rules &
principles for suitably predicting orderly knowledge.
Part of ideal Economics: absolute interpretation of causes
& consequences. “what” & “what should be”.
As an Art: The process of doing any work in the best way is art.
Thus, choice of those instruments from the limited means of
alternative use.

14. Nature and Scope of Managerial
Economics
How Is Managerial Economics Useful?
Theory of the Firm
Profit Measurement
Why Do Profits Vary among Firms?
Role of Business in Society

15. How Is Managerial
Economics Useful?
• Evaluating Choice Alternatives
– Identify ways to efficiently achieve goals.
– Specify pricing and production strategies.
– Provide production and marketing rules to
help maximize net profits.
• Making the Best Decision
– Managerial economics can be used to
efficiently meet management objectives.
– Managerial economics can be used to
understand logic of company, consumer, and
government decisions.

16. Scarcity & Basic
Choice Problem

17. Managerial
Economics
Tool for
Improving
Management
Decision Making

18. Theory of the Firm
• Expected Value Maximization
– Owner-managers maximize short-run profits.
– Primary goal is long-term expected value maximization.
• Constraints and the Theory of the Firm
– Resource constraints.
– Social constraints
• Limitations of the Theory of the Firm
– Alternative theory adds perspective.
– Competition forces efficiency.
– Hostile takeovers threaten inefficient managers.

19. The Corporation
- a Legal Device

20. Profit Measurement
Variability of Business Profits
–Business profits vary widely.
 Accounting Profits
 Total revenue (sales) minus cost of producing goods
or services.
 Reported on the firm’s income statement.
 Economic Profits
 Total revenue minus total opportunity cost.

21. Fundamental Concepts
• Incremental Reasoning
• Opportunity Cost
• Contribution
• Time Perspective
• Time Value of Money – Discounting
Principle &
• Equi-Marginal Principle

22. Incremental Reasoning
• Two basic concepts
– Incremental cost: the change in total cost as a
result of change in the level of output, investment,
etc
– Incremental revenue: the change in total revenue
resulting from change in level of output , price etc.
Use of Incremental Reasoning Principle
Almost all managerial decision are determined on
the basis of the criteria that the incremental
revenue should exceed incremental cost

23. Opportunity Cost
Generally people make decisions involving trade-offs.
Trade-offs: All alternates we give-up when we make decisions.
Opportunity Cost: the most desirable alternative that we give up.
or the second best alternative forgone after making a choice.
or the second best foregone alternative.
or the value of the next best alternative forgone (that is not
chosen).
Example: A person having Rs. 100000/- in cash has two alternatives to
increase cash.
Option 1: He gets a returns amount 10000/- by investing in bank.
Option 2: Investing in business, he gets a returns of amount 17000/-
Generally he chooses the option 2 because he will get more returns than
the option 1. Here the option 1 is the opportunity cost, that what we
have not chosen

24. Contribution
Contribution reflects the units of output to
overheads & profit contributions.
– Helps determine the best Product mix, counting or
Explicit Cost
– Unit contribution: the per unit difference of
incremental revenue from incremental cost.

25. Time Perspective
• Economists often make a distinction between short
run and long run.
– Short run: the period in which some of the inputs (called
fixed inputs) cannot be altered.
– Long run means that all the inputs can be changed.
Economists try to study the effect of policy decisions on
variables like prices, costs, revenue, etc, in the light of
these time distinctions.

26. Discounting Principle
• Based on the fundamental fact that a rupee now is worth
more than a rupee earned a year after.
• Unless these returns are discounted to find their present
worth, it is not possible to judge whether or not it is worth
undertaking the investment today.
– If Rs.100 is due after 1 year and the rate of interest is 10%.
– We can determine the sum to be invested now so as to produce
the return (R) of Rs.100 at the end of 1 year.
– The present value of the discounted value of Rs. 100 will then be:
• Vi = R/(1+i) = Rs. 100/1.10= Rs. 90.90
• For 2 years:
Rs 100/(1+i)2 = Rs 100/(1.10)2 = Rs 100/1.21 =82.64

27. Equi-Marginal Principle
• A utility maximizing consumer distributes his consumption expenditure
between various goods & services he/she consumes in such a way that
the marginal utility derived from each unit of expenditure on various
goods & service is the same. i.e., MUx = MUy = MUz = …= MUn
• This principle suggests that available resources (inputs) should be so
allocated between the alternative options that the marginal productivity
(MP) from the various activities are equalized.
. i.e., MPa = MPb = MPc = …= MPn
Units of
Expenditure (Rs.
10 million)
Marginal Productivity (MP)
Project A Project B Project
C
1st 50 40 35
2nd 45 30 30
3rd 35 20 20
4th 20 10 15
5th 10 0 12
 eg. Suppose a firm has a
total capital of Rs. 100
million which it has the
option of spending on
three projects, A,B, and C.
Each of these projects
requires a unit
expenditure of Rs. 10
million.

28. Why Do Profits Vary
Among Firms?
• Disequilibrium Profit Theories
– Rapid growth in revenues.
– Rapid decline in costs.
• Compensatory Profit Theories
– Better, faster, or cheaper than the competition is
profitable.

29. Role of Business in
Society
• Why Firms Exist
–Business is useful in satisfying consumer
wants.
–Business contributes to social welfare
• Social Responsibility of Business
–Serve customers.
–Provide employment opportunities.
–Obey laws and regulations.

30. Value Maximization: a Complex Process

31. The Economic Perspective
• How are resources allocated among competing
uses? (land, labor, capital & knowledge)
• in society
• in the firm
• How do individuals make decisions?
• the role of incentives
• incentive conflicts & opportunistic behavior

32. Economics & The Mgmt. Disciplines
• Marketing
• Finance
• Human resources
• Operations
• Accounting
“Business schools are basically
schools of applied economics”
- James March

33. Economics & Mgmt. Disciplines
• Relationship to other business disciplines
Marketing: demand, price elasticity
Finance: capital budgeting, breakeven analysis,
opportunity cost, value added
Management Science: linear programming,
regression analysis, forecasting
Strategy: types of competition, structure-
conduct-performance analysis
Managerial Accounting: relevant cost, breakeven
analysis, incremental cost analysis, opportunity
cost

34. Relevance of Economics In Business
• Economic analysis to make business decisions involving the best use
(optimizing allocation) of an organization’s scarce resources
• Evaluating Choice Alternatives
– Identify ways to efficiently achieve goals.
– Specify pricing & production strategies.
– Provide production & marketing rules to help maximize net profits.
• Making the Best Decision
– To efficiently meet management objectives.
– To understand logic of company, consumer, & government decisions
1. Demand Analysis & Forecasting 2. Cost & production Analysis.
3. Pricing Decisions, policies & practices. 4. Profit Management.
5. Capital Management. 6. Respond to incentives
7. Trading-off 8. For Electing 9. Global affairs 10. Society
• Government Decisions & Macroeconomic Policies
– Economic Growth& Development
– Full Employment opportunities Creation
– Economic Stability : Control over inflation & recession
– Modernization & Standard of Living

35. • Questions that managers must answer:
Mgrl. Eco. For Effective Mgmt.
(Basic Questions)
What are the economic conditions in our particular market?
 market structure?
 supply and demand?
 technology?
government regulations?
 international dimensions?
 future conditions?
 macroeconomic factors?

36. • Should our firm be in this business?
• if so, at what level/size?
• what should be the price? and
• at what output level?
Mgrl. Eco. For Effective Mgmt.
(Basic Questions to be Answered )
 How can we maintain a competitive advantage over other firms?
 cost-leader?
 product differentiation?
 market niche?
 outsourcing, alliances, mergers?
 international perspective?

37. • What are the risks involved?
• shifts in demand/supply conditions?
• technological changes?
• the effect of competition?
• changing interest rates and inflation rates?
• exchange rates (for companies in international trade)?
• political risk (for firms with foreign operations)?
Mgrl. Eco. For Effective Mgmt.
(Basic Questions to be Answered )
Risk: The uncertainty or chance of actual future outcomes
that differ from those expected.

38. Identify Goals and Constraints
• Sound decision making involves having well-
defined goals.
– Leads to making the “right” decisions.
• In striking to achieve a goal, we often face
constraints.
– Constraints are an artifact of scarcity.

39. Understanding Firms’ Incentives
• Incentives play an important role within the firm.
• Incentives determine:
– How resources are utilized.
– How hard individuals work.
• Managers must understand the role incentives play in
the organization.
• Constructing proper incentives will enhance
productivity and profitability.

40. Market Interactions
• Consumer-Producer Rivalry
– Consumers attempt to locate low prices, while
producers attempt to charge high prices.
• Consumer-Consumer Rivalry
– Scarcity of goods reduces the negotiating power of
consumers as they compete for the right to those
goods.
• Producer-Producer Rivalry
– Scarcity of consumers causes producers to compete
with one another for the right to service customers.
• The Role of Government
– Disciplines the market process.

41. Firm Valuation and Profit Maximization
• The value of a firm equals the present value of current
and future profits (cash flows).
• A common assumption among economist is that it is the
firm’s goal to maximization profits.
– This means the present value of current and future profits, so
the firm is maximizing its value.

42. • Control Variable Examples:
– Output
– Price
– Product Quality
– Advertising
– R&D
• Basic Managerial Question: How much of the
control variable should be used to maximize net
benefits?
Marginal (Incremental) Analysis

43. Net Benefits
• Net Benefits = Total Benefits - Total Costs
• Profits = Revenue - Costs
Marginal Benefit (MB)
Change in total benefits arising from a change in the
control variable.
Slope (calculus derivative) of the total benefit curve.
Marginal Cost (MC)
 Change in total costs arising from a change in the control
variable, Q.
 Slope (calculus derivative) of the total cost curve

44. Marginal Principle
• To maximize net benefits, the managerial
control variable should be increased up to the
point where MB = MC.
• MB > MC means the last unit of the control
variable increased benefits more than it
increased costs.
• MB < MC means the last unit of the control
variable increased costs more than it
increased benefits.

45. The Geometry of Optimization: Total
Benefit and Cost
Q
Total Benefits
& Total Costs
Benefits
Costs
Q*
B
C
Slope = MC
Slope =MB

46. The Geometry of Optimization: Net
Benefits
Q
Net Benefits
Maximum net benefits
Q*
Slope = MNB

47. The Gap Between Theory & Practice & The
role of Managerial Economics
• Gap exists between theory & practice in all walks of life
• Economic world is extremely complex because of
interdependency of various factors on each other & economic
theories are simplistic
• “ceteris paribus” assumption itself is more unrealistic.
• Managerial economics bridges gap between economic theory &
business practice using economic logic & analysis of tools
through
a) identifying the problems/objectives
b) collecting the relevant facts & related info.
c) processing & analyzing the facts & info.
d) drawing the relevant conclusions
e) determining & evaluating the alternative means
f) taking a decision that is viable & feasible for optimizing goals.

48. Conclusion
Managerial Economics: A discipline about application of
economic theory & methods to managerial decision making &
practices by enriching the analytical skills through developing the
logical structuring of problems & providing adequate solutions.
Business: Transactions between 2 or more parties.
Decision Making: Steps: Identifying of strategies, evaluation of
strategies & determining of criteria for choosing strategies.
Core elements of economic theory: The theory of firm, consumer
& demand theory, production & cost theory, price theory &
competition theory etc.,
Economics: a discipline that proceeds by making assumptions in
order to build simple models & as the situations being analyzed
become more complex, more sophisticated & advanced methods
of analysis become necessary to relax these assumptions.

49. Thanks !