Managerial economics applies economic theory and decision science tools to help organizations achieve their objectives efficiently. It uses microeconomics, macroeconomics, mathematical economics, and econometrics to solve managerial problems and make optimal decisions. The goal is to maximize the value of the firm over time by finding the optimal solutions to managerial problems through the application of economic theory and analysis.

1. The Nature and Scope
of Managerial Economics

2. Managerial Economics Defined
The application of economic theory and the tools
of decision science to examine how an
organization can achieve its aims or objectives
most efficiently.
Example:
Economic theory says Q = f(P, Y, PC, PS, . . ):
By collecting data on above variables, we can estimate the
empirical (econometric) relationship. This estimated function
can be used for managerial decision making, forecasting etc.

3. Managerial Decision Problems
Economic theory Decision Sciences
Microeconomics Mathematical Economics
Macroeconomics Econometrics
MANAGERIAL ECONOMICS
Application of economic theory
and decision science tools to solve
managerial decision problems
OPTIMAL SOLUTION TO
MANAGERIAL DECISION PROBLEMS

4. Theory of the Firm
• Firm combines and organizes resources for the
purpose of producing goods and/or services for
sale.
• Internalizes transactions, reducing transactions
costs/time.
• Resource owners use the income generated
from the sale of their services/resources, to
purchase goods and services produced by
firms. Circular flow of economic activity is thus
completed.
• Primary goal is to maximize the wealth or value
of the firm.

5. Value of the Firm
• Managerial economics, begins by postulating a theory
of the firm, which is then used to analyse managerial
decision making. The theory of the firm is based on the
assumption that the goal of the firm is to maximise
profit. However, firms are observed to sacrifice short-
term profits for long term profits. Hence, its is
appropriate to postulate that the objective of the firm
is to maximise the wealth of value of the firm.
• The value of the firm is, present value of all expected
future profits:
π1 π2 πn n
πt
PV = + +L+ =∑
(1 + r ) (1 + r )
1 2
(1 + r ) n
t =1 (1 + r )
t
n
πt n
TRt − TCt
Valueof Firm = ∑ =∑
t =1 (1 + r ) t =1 (1 + r )t
t

6. Alternative Theories of the firm
• Sales maximization(William Baumol)
– Adequate rate of profit to satisfy share holders;
assuming this, maximise sales, even by sacrificing
some profits.
• Management utility maximization (Oliver
Williamson)
– Principle-agent problem: managers try to
maximise their benefits like salaries, fringe
benefits, stock options, staff size, lavish offices,
etc. This can be resolved by linking managers’
rewards to firm’s performance compared to similar
firms in the industry.
• Satisficing behavior( not maximising) with
reference sales, profits, growth, mkt.. Share etc.

7. Different Concepts of Profit
• Business Profit: Total revenue minus the
explicit or accounting costs of production.
• Economic Profit: Total revenue minus the
explicit and implicit costs of production.
• Opportunity Cost: Implicit value of a
resource in its best alternative use.

8. Theories of Profit
• Risk-Bearing Theories of Profit
• Frictional Theory of Profit
• Monopoly Theory of Profit
• Innovation Theory of Profit
• Managerial Efficiency Theory of
Profit

9. Function of Profit
• Profit is a signal that guides the
allocation of society’s resources.
• High profits in an industry are a signal
that buyers want more of what the
industry produces.
• Low (or negative) profits in an industry
are a signal that buyers want less of
what the industry produces.

10. The Changing Environment of
Managerial Economics
• Globalization of Economic Activity
– Goods and Services
– Capital
– Technology
– Skilled Labor
• Technological Change
– Telecommunications Advances
– The Internet and the World Wide Web