Managerial Economics
Module 2
Obj ecti ves
Explore the relationship of economic concepts and analysis to
business decision-making and strategies
1 Explain the roles of Microeconomics and Industrial
Organization to Managerial Economics
Engage ourselves to individual segments of economy and
analyze how they are affected by recent crisis
Understand the principal-agent problem and why it occurs
Manageri al Economi cs
▸ Microeconomics ▸ Industrial Organization
▸ To create a systematic and logical way of analyzing
business practices and tactics designed to get the most profit,
as well as formulating strategies for sustaining or protecting
these profits in the long-run
Economic theory 6
simplifies complexity.
Microeconomics
▪ the study and analysis of the behavior
of individual segments of the economy
Indi vi dual segments of economy:
Individual consumers
Workers and owners of resources
Individual firms
Industries
Markets for goods and services
Deci si ons i nvol ved:
Choosing the profit- maximizing production level
Cost minimization
How much to spend in advertising
Allocating production between 2 or more manufacturing plants
Setting the profit- maximizing price for the goods the firm sells
Business Practice or Tactics
routine business decisions managers must make to
earn the greatest profit under the prevailing market
conditions facing the firm
Microeconomics serves
as the “Swiss army knife” 11
for explaining most
business practices.
Industrial Organization
▪ branch of economics focusing on the behavior and structure
of firms and industries
▪ an additional complementary tool for business analysis
▪ supplies considerable insight into the nature, motivation, and
consequences of strategic actions firms may wish to undertake
Strategic Decisions
business actions taken to alter market conditions and
behavior of rivals in ways that increase and/or protect the
strategic firm’s profit
Strategic decisions differ from routine business
practices and tactics because strategic decisions do not
accept the existing conditions of competition as fixed, but
rather attempt to shape or alter the circumstances under
which a firm competes with its rival.
Opportunity Cost
▪ what a firm’s owners give up to use resources to produce goods
or services
2 Kinds of Inputs
Market-supplied resources Owner-supplied resources
▪ owned by others and hired, ▪ owned and used by a firm
rented or leased in
resource markets Examples: Money provided to
the business by its owners,
Examples: Labor, raw time and labor provided by the
materials purchased from owners, land, building and
commercial suppliers and capital equipment owned and
capital equipment rented or used by the firm
leased
Total economic cost
sum of opportunity costs of market supplied resources
opportunity costs of owner-supplied resources
Explicit Costs Implicit costs
the monetary the non monetary
payments made for opportunity costs of
market-supplied using a firm’s own
inputs resources
3 important types of implicit costs:
▪ Equity capital - opportunity cost of cash provided to a firm by its owners
▪ Opportunity cost of using land or capital owned by the firm
▪ Opportunity cost of the owner’s time spent in managing the firm
Principle:
The opportunity cost of using resources is the amount the firm
gives up by using these resources. Opportunity costs can be
either explicit costs or implicit costs. Explicit costs are the costs
of using market-supplied resources, which are monetary payments
to hire, rent or lease resources owned by others. Implicit costs are
the costs of using owner-supplied resources, which are the greatest
earnings foregone from using resources owned by the firm in the
firm’s own production process. Total economic cost is the sum of
explicit and implicit costs.
Explicit Costs
of
Market-Supplied Resources
The monetary payments to resource
owners
Implicit Costs
of
Owner-Supplied Resources
The returns forgone by not taking the
owners’ resources to market
Total Economic Cost
The total opportunity costs of both
kinds of resources
Economic Profit vs Accounting Profit
Economic Profit Total Revenue Total Economic Cost
Total Revenue Explicit Costs Implicit Costs
Accounting Profit Total Revenue Explicit Costs
Since the owners of firms must cover the costs of all resources used
by the firm, maximizing economic profit, rather than accounting
profit, is the objective of the firm’s owners.
Maximizing the Value of the Firm
Value of a firm
▪ the price for which the firm can be sold, which equals the present
value of future profits
Risk Premium
▪ an increase in the discount rate to compensate investors for
uncertainty about the future
Principle:
The value of a firm is the price for which it can be sold, and the
price is equal to the present value of the expected future profits
of the firm. The larger (smaller) the risk associated with future
profits, the higher (lower) the risk adjusted discount rate used to
compute the value of the firm, and the lower (higher) will be the
value of the firm.
Principle:
If cost and revenue conditions in any period are independent of
decisions made in other time periods, a manager will maximize the
value of a firm (the present value of the firm) by making decisions
that maximize profit in every single time period.
Some common mistakes managers make:
▪ Never increase output simply to reduce average costs
▪ Pursuit of market share usually reduces profit
▪ Focusing on profit margin won't maximize total profit
▪ Maximizing total revenues reduces profit
▪ Cost-plus pricing formulas don’t produce profit maximizing prices
Separation of Ownership
and Control of the Firm
The Principal-Agent Problem
▪ a manager takes an action or makes a decision that advances
the interests of the manager but reduces the value of the firm
A principle-agent problem arises between a firm’s
owner and manager when two conditions are met:
▪ the objectives of the owner and manager are not aligned
▪ the owner finds it either too costly or impossible in the case of moral hazard to
perfectly monitor the manage to block all management decisions that might be
harmful to the owner of the business
Principal-Agent Relationship
▪ relationship formed when a business owner (the principal)
enters an agreement with an executive manager (the agent)
whose job is to formulate and implement tactical and strategic
business decisions that will further the objectives of the
business owner (the principal)
Complete contract
▪ an employment contract that protects owners from every possible
deviation by managers from value maximizing decisions
Hidden actions
▪ actions or decisions taken by managers that cannot be observed by
owners for any feasible amount of monitoring
Moral hazard
▪ a situation in which managers take hidden actions that harm the
owners of the firm but further the interests of the managers
Project #1
Make a research or documentation on the topic:
“The Impact of COVID 19 to the Economy of Indigenous People”
▸ How are they able to manage during the quarantine period?
Please submit on or before August 21, 2020 via LMS.
R eference
Thomas, C. R., & Maurice, S. (2015). Managerial Economics: Foundations
of Business Analysis and Strategy. New York, NY: McGraw-Hill Education.
