Economics and Managerial Decision Making

Economics is “the study of the behavior of human beings in producing, distributing and consuming material goods and services in a world of scarce resources.”

Economics and Managerial Decision Making

Management is the discipline of organizing and allocating a firm’s scarce resources to achieve its desired objectives. Involves the ability to organize and administer various tasks in pursuit of certain objectives.

INTRODUCTION TO MEINTRODUCTION TO ME

How does managerial economics How does managerial economics differ from “regular” economics?differ from “regular” economics?

There is no difference in There is no difference in the theory; theory; standard economic theory provides standard economic theory provides the basis for managerial the basis for managerial economics.economics.

The difference is in the way the The difference is in the way the economiceconomic theory is applied.theory is applied.

Definitions of Managerial Economics Integration of economic theory with

business practice for the purpose of facilitating decision making and forward planning by management. – Prof. Spencer Sigelman.

The purpose of Managerial economics is to show how economic analysis can be used in formulating business policies – Prof. Joel Dean

Economics and Managerial Decision Making

Managerial economics is the use of economic analysis to make business decisions involving the best use (allocation) of an organization’s scarce resources.

Managerial economics is (mostly) Managerial economics is (mostly) applied applied micromicroeconomics.economics.

Managerial economics deals Managerial economics deals withwith

““How decisions How decisions shouldshould be made by be made by managers to achieve the firm’s managers to achieve the firm’s goalsgoals - in particular, how to - in particular, how to maximize profit.”maximize profit.”

(Also government agencies and (Also government agencies and nonprofit institutions benefit from nonprofit institutions benefit from knowledge of economics, i.e. knowledge of economics, i.e. efficient recourse allocation is efficient recourse allocation is important for them too...)important for them too...)

Micro and Macroeconomics 2 major branches of

economics Micro – derived for Greek

word micros meaning small Macro – derived form Greek

word macros means aggregative – whole – large

Microeconomics

Branch of economics which is concerned with analysis of behaviour of the individual economic units or variables such as an individual consumer or a producer or the price of a particular product.

Basically deals with individual decision making and the problem of resource allocation.

Examines in particular as to how individual consumers and producers behave and how their behaviors interact

Importance and uses of microeconomics

Explains price determination and allocation of resources

Direct relevance in business decision making Serves as a guide for business/ production

planning Serves as a basis for prediction Useful in determination of economic policies

of the government Serves as the basis for welfare economics Explain the phenomena of international trade

Macroeconomics

Branch of economics which deals with the aggregate behaviour of the economy as a whole

Macroeconomics is essentially aggregate economics

Study of economic system in general Study of very large, economy – wide

aggregate variables like national income, total savings, total consumption, total investment, money supply, unemployment, price levels, economic growth rate etc.

Importance of macroeconomics Explains the working of the

economy as a whole Knowledge is indispensable for

policy makers Useful for the planner for preparing

economic plans for the country’s development

Helpful in international comparison

Distinction between micro and macroeconomics

MICRO- Study of individual Individualistic

approach Variables – indl

dd,ss, price etc.

MACRO - Study of

aggregate Aggregate

approach Variables – agg

dd, agg ss, price level etc

Review of Economic Terms Microeconomics is the study of

individual consumers and producers in specific markets.– Supply and demand– Pricing of output– Production processes– Cost structure– Distribution of income and output

Review of Economic Terms Macroeconomics is the study of the

aggregate economy.– National Income Analysis (GDP)– Unemployment– Inflation– Fiscal and Monetary policy– Trade and Financial relationships among

nations

Review of Economic Terms Scarcity is the condition in which

resources are not available to satisfy all the needs and wants of a specified group of people.

Review of Economic Terms Resources are factors of

production or inputs.– Examples:

Land Labor Capital Entrepreneurship

Review of Economic Terms Opportunity cost is the amount

or value that must be sacrificed in choosing one activity over the next best alternative.

Economics and Managerial Decision Making

Relationship to other business disciplines– Marketing: Demand, Price Elasticity– Finance: Capital Budgeting, Break-Even

Analysis, Opportunity Cost, Economic Value Added

– Management Science: Linear Programming, Regression Analysis, Forecasting

– Strategy: Types of Competition, Structure-Conduct-Performance Analysis

– Managerial Accounting: Relevant Cost, Break-Even Analysis, Incremental Cost Analysis, Opportunity Cost

Economics and Managerial Decision Making

Questions that managers must answer:– How can we maintain a competitive

advantage over our competitors?Cost-leader?Product Differentiation?Market Niche?Outsourcing, alliances, mergers, acquisitions?

Economics and Managerial Decision Making

Questions that managers must answer:– What are the risks involved?

Risk is the chance or possibility that actual future outcomes will differ from those expected today.

Economics and Managerial Decision Making

Types of risk– Changes in demand and supply conditions– Technological changes and the effect of

competition– Changes in interest rates and inflation

rates– Exchange rates for companies engaged in

international trade– Political risk for companies with foreign

operations

Nature of Managerial Economics Managerial economics aims at

providing decision making to firms. It draws heavily on the prepositions of micro economic theory that studies the phenomenon at individual level i.e behaviour of individual consumers, households and firms.

Nature of Managerial Economics The concepts of economics which

ME frequently uses are : Elasticity of demand. Marginal cost. Marginal revenue. Market structures and their

significance in pricing policies.

Nature of Managerial Economics ME makes use of both Micro &

Macro economics. Micro economics assists the firm in forecasting & macro economics studies the aggregate levels. Macro economics indicates the relationship between, for example, level of consumption and national income, level of national income and employment etc.

Nature of Managerial Economics This helps the management in knowing

the level of demand at a future period of time, based on the relationship between the national income and the demand for a particular product.

Eg : Demand for cars, televisions, refrigerators etc can have a impact of changes in the level of national income.

Nature of Managerial Economics ME is prescriptive in nature. It

recommends how a thing should be done in alternative conditions.

Eg: It may be derived from economic analysis the it is more profitable to produce 100 units of a particular product by using 5 machines and 15 workers than using 2 machines and 25 workers.

Nature of Managerial Economics ME uses a scientific approach. In

practice some firms may use simple rules based on past experience. However, the quality of decisions made can be improved by using a systematic approach. This is achieved by the study of ME.

Scope of ME

The scope of ME is so wide that it touches almost all areas of the manager’s decision making. It deals with demand analysis, forecasting, production function, cost analysis, inventory management, resource allocation, capital budgeting. A brief introduction to these areas will give an idea of the scope of ME.

Scope of ME

Demand Analysis and forecasting : A correct analysis of the future demand for

a companies product enables a manager to take decisions related to the production scheduling & inventory management.

For this he has to consider things such as income elasticity and cross elasticity.

This process of accessing the future demand is called as demand forecasting.

Scope of ME

Production function : We know that resources are scarce and

have alternative uses. Inputs play a imp. role in the economics of production.

The factors of production should be combined in a particular way to maximize output.

Alternatively, when the prices of some inputs shoots up, a manager has to work out a change in the use of inputs so as to bring the total costs of production as low as possible.

Thus, production function helps ME.

Scope of ME

Cost analysis : Cost analysis talks of

determinants of costs, relationship between costs and output, forecast of cost and profit etc. which is essential for managerial decision making.

Scope of ME

Inventory management : Large capital of companies is

blocked in inventory. If this capital can be save, it can be used for alternative production priorities.

Tools like ABC analysis etc. help the managers in deciding the levels of inventory.

Scope of ME

Pricing : The price of the product often

determines how much of what product will be purchased.

Merely knowing the cost of production is not enough to set the price. Various other aspects such as the market conditions, conditions of competition, various options available for pricing also have to be considered.

Subject matter and scope of microeconomicsMicroeconomics

Pricing (Theory of value)

Distribution (Factor Pricing)

Welfare (Welfare economics)

Theory of demand

Theory of Production

Theory of pricing

General Theory of Distribution

Theories of

Rent Wages Interest Profits