Managerial EconomicsManagerial Economics

Introduction: Fundamental Introduction: Fundamental Problems of An Economic System: Problems of An Economic System:

Scarcity and Efficiency Scarcity and Efficiency

The Three Problems of Economic OrganizationThe Three Problems of Economic OrganizationMarket command and mixed economiesMarket command and mixed economiesThe market mechanismThe market mechanismHow markets solve three economic problems?How markets solve three economic problems?The invisible hands and perfect competition The invisible hands and perfect competition The economic role of government The economic role of government General and partial equilibriumGeneral and partial equilibriumNature and scope of managerial economics Nature and scope of managerial economics

EconomicsEconomicsEconomics is the study of how economic agents Economics is the study of how economic agents or society choose to use scarce resources that or society choose to use scarce resources that have alternative uses to satisfy wants which are have alternative uses to satisfy wants which are unlimited and of varying degrees of importance unlimited and of varying degrees of importance Scarcity: the root of all economic problems Scarcity: the root of all economic problems Problem of choiceProblem of choiceSocial ScienceSocial ScienceDecision making by the manager Decision making by the manager Economics is Positive Sciences (what is ?)Economics is Positive Sciences (what is ?)Rational behaviorRational behaviorEconomic activity (consumption, productions Economic activity (consumption, productions and exchange) and exchange)

The central themes of The central themes of managerial economicsmanagerial economics

1.1. Identifying problems and Identifying problems and opportunitiesopportunities

2.2. Analyzing alternatives from which Analyzing alternatives from which choices can be madechoices can be made

3.3. Making choices that are best from Making choices that are best from the standpoint of the firm or the standpoint of the firm or organizationorganization

It is certainly It is certainly not true not true that all that all managers must be managerial managers must be managerial economists, any more than it is economists, any more than it is truetrue that all managers should have that all managers should have degree in management. However, degree in management. However, managers who understand the managers who understand the economic dimensions of business economic dimensions of business problems and apply economic problems and apply economic analysis to the specific problem they analysis to the specific problem they encounter often choose more wisely encounter often choose more wisely than those who do notthan those who do not

Rationality?Rationality?

Firm: maximize profit or sales Firm: maximize profit or sales revenue (Productive capacity and revenue (Productive capacity and size of the market)size of the market)

Consumer: Maximize profit (Size of Consumer: Maximize profit (Size of his budget)his budget)

Investor: maximize returns over Investor: maximize returns over investment (level of acceptable risk) investment (level of acceptable risk)

Rational decision making process Rational decision making process 1.1. Knowledge of all possible course of Knowledge of all possible course of

actionaction2.2. Separate the course of action into Separate the course of action into

feasible and infeasible feasible and infeasible 3.3. Consequences of alternative feasible Consequences of alternative feasible

courses of actioncourses of action4.4. Rank alternatives in terms of prioritiesRank alternatives in terms of priorities5.5. Choose the course of action that Choose the course of action that

occupies the highest position in the order occupies the highest position in the order of priority of priority

Three fundamental questionsThree fundamental questions

What goods and services to be What goods and services to be produced in what quantity?produced in what quantity?

How to produce those goods and How to produce those goods and services? How the scarce resources services? How the scarce resources and optimally allocated?and optimally allocated?

How the goods and services so How the goods and services so produced are distributed among the produced are distributed among the households?households?

Alternative economic systemsAlternative economic systems

Market economyMarket economy

Command economyCommand economy

Mixed economyMixed economy

Market EconomyMarket EconomyDemand decides the nature and quantity Demand decides the nature and quantity of goods and services to be produced of goods and services to be produced Consumers are assumed to act in a Consumers are assumed to act in a rational manner rational manner Given the demand, firms decide the Given the demand, firms decide the production methods to maximize their production methods to maximize their profitsprofitsOptimum allocation of scarce resourcesOptimum allocation of scarce resourcesFactor prices are determined by the Factor prices are determined by the marketmarketInvisible hands – Adam Smith Invisible hands – Adam Smith

Command Economy Command Economy Hierarchical organizational structureHierarchical organizational structure

Command decision making process Command decision making process

People carry out instruction given to themPeople carry out instruction given to them

Central planning authority to determine Central planning authority to determine resource allocation, production goal and resource allocation, production goal and pricesprices

State ownership of factors of productionState ownership of factors of production

Authoritarian methods to determine Authoritarian methods to determine resource use and prices resource use and prices

Mixed EconomyMixed EconomyUse of both market and command to co-Use of both market and command to co-ordinate economic activitiesordinate economic activitiesGovernment control many resources and Government control many resources and criteria other than personal gains and business criteria other than personal gains and business profit are used to decide how resources will be profit are used to decide how resources will be employedemployedGovernment as well as private business provide Government as well as private business provide goods and servicesgoods and servicesGovernment intervene in the market to control Government intervene in the market to control prices and correct the shortcomings of a prices and correct the shortcomings of a system in which prices and the pursuit of system in which prices and the pursuit of personal gains influence resource use and personal gains influence resource use and income income

Role of Government Role of Government Purchasing of labor services and other Purchasing of labor services and other

productive resourcesproductive resources Borrow funds from credit market Borrow funds from credit market Purchase output of business firmsPurchase output of business firms Contracts with business firmsContracts with business firms Tax on households and firms Tax on households and firms Provides national and social servicesProvides national and social services Free public goodsFree public goods Social security measuresSocial security measures Influence the market demand and prices Influence the market demand and prices Supply of goods and services Supply of goods and services

MARGINALISM MARGINALISM Marginal output of laborMarginal output of laborMarginal revenueMarginal revenueMarginal costMarginal costChange in independent variable by single Change in independent variable by single unitunitChunk changes rather than unit changes – Chunk changes rather than unit changes – Concept of instrumentalism (incremental Concept of instrumentalism (incremental output, cost, benefits) output, cost, benefits) All marginal concepts are incremental but All marginal concepts are incremental but all incremental concepts may not be all incremental concepts may not be confined to marginal concepts alone.confined to marginal concepts alone.

Opportunity Cost Opportunity Cost

The cost of particular alternative The cost of particular alternative chose is the cost of next best chose is the cost of next best alternative forgone alternative forgone

Opportunity cost is the highest Opportunity cost is the highest valued benefit that must be valued benefit that must be sacrificed as a result of choosing sacrificed as a result of choosing alternative alternative

Partial Equilibrium AnalysisPartial Equilibrium Analysis Determination of prices and quantity of a Determination of prices and quantity of a

commodity or a factor and working of its market commodity or a factor and working of its market viewed in isolation of what happens to other viewed in isolation of what happens to other commodities and factors is called partial commodities and factors is called partial equilibrium analysisequilibrium analysis

Partial equilibrium analysis do not take in to Partial equilibrium analysis do not take in to consideration the interrelationships or consideration the interrelationships or interdependence between the prices of goods and interdependence between the prices of goods and factors of production factors of production

Each product and factor market is considered as Each product and factor market is considered as independent and self-contained for proper independent and self-contained for proper explanation of the determination of price and explanation of the determination of price and quantity of a commodity or factor quantity of a commodity or factor

Not useful when commodities and factor markets Not useful when commodities and factor markets are interrelated and interdependent are interrelated and interdependent

General Equilibrium AnalysisGeneral Equilibrium Analysis

Used when markets for various Used when markets for various commodities and factors are commodities and factors are interrelated and interdependent interrelated and interdependent

General equilibrium analysis General equilibrium analysis considers simultaneous equilibrium considers simultaneous equilibrium of all the markets taking into account of all the markets taking into account all effects of changes in the price of all effects of changes in the price of one market over the othersone market over the others

Managerial Economics Managerial Economics

Managerial economics is an Managerial economics is an application of the principles of application of the principles of economic for the solution of business economic for the solution of business problems problems

Bridge between economics and Bridge between economics and business practicebusiness practice

What is Managerial Economics?Douglas - “Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization.”Pappas & Hirschey - “Managerial economics applies economic theory and methods to business and administrative decision-making.”Salvatore - “Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.”

Managerial EconomicsManagerial EconomicsManagerial economics is the science of directing scarce resources to manage cost effectively. Wherever resources are scarce, a manager can make more effective decisions by applying the discipline of managerial economics. These may be decisions with regard to customers, suppliers, competitors, or the internal workings of the organization.

How it differ from…..How it differ from…..Microeconomics is the study of individual economic

behavior where resources are costly. It addresses issues such as how consumers respond to changes in prices and income and how businesses decide on employment and sales. Microeconomics also extends to such issues as how voters choose between political parties and how governments should set taxes.

Managerial economics has a more limited scope – it is the application of microeconomics to managerial issues.

By contrast with microeconomics, the field of macroeconomics focuses on aggregate economic variables. Macroeconomics addresses such issues as how a cut in interest rates will affect the inflation rate and how a depreciation of the U.S. dollar will affect unemployment, exports, and imports. While it is certainly true that the whole economy is made up of individual consumers and businesses, the study of macroeconomics often considers economic aggregates directly rather than as the aggregation of individual consumers and businesses. This is the key distinction between the fields of macroeconomics and microeconomics.

Nature of Managerial Economics Nature of Managerial Economics

Is essentially microeconomic in Is essentially microeconomic in naturenature

Is pragmatic (practical)Is pragmatic (practical)

Belong to normative economics Belong to normative economics (what ought to be)(what ought to be)

Is conceptual in natureIs conceptual in nature

Utilize some theories of Utilize some theories of macroeconomicsmacroeconomics

Is problem solving in natureIs problem solving in nature

Scope of Managerial EconomicsScope of Managerial EconomicsEstimation of product demandEstimation of product demandAnalysis of product demandAnalysis of product demandPlanning of production schedulePlanning of production scheduleDeciding input combinationsDeciding input combinationsEstimation of cost of productionEstimation of cost of productionAnalysis of cost of productAnalysis of cost of productAchieving economies of scaleAchieving economies of scaleDetermination of price of productDetermination of price of productAnalysis of price of productAnalysis of price of productAnalysis of market structureAnalysis of market structureProfit estimation and planning Profit estimation and planning Planning and control of capital structurePlanning and control of capital structure

Managerial economics is applied Managerial economics is applied economics; it is the use of economics economics; it is the use of economics theory and methodology to solve practical theory and methodology to solve practical decision problems.decision problems.A primary emphasis of managerial A primary emphasis of managerial economics is the application of economic economics is the application of economic theory and methodology to the practice of theory and methodology to the practice of business decision making.business decision making. Secondary emphasis in managerial Secondary emphasis in managerial economics is the study of how managerial economics is the study of how managerial decisions are affected by the economic decisions are affected by the economic environment.environment.