What is managerial economics?

 Analysis of risks and uncertainties

- Application of economic theory  Optimization
and methods to business decision  Discounting and time value of
making money technique
- The term “business” should be
applied in a broader context Managerial Economics and the
covering decisions that require Business Functions
evaluation in terms of total - Managerial decisions involve
benefits and costs of a quantitative
transaction(both monetary and analysis:
non-monetary benefits and o Marketing (pricing and
costs). advertising expense
o Covers decisions made by: o Human Resources (hiring
 Profit oriented and Compensation
enterprises package)
 Government o Finance and accounting
institutions (does finances allow
 International expand operations or new
organizations product line
 Non-profit o Productions and operations
organizations (NGOs) (schedule and level of
output)
How is Managerial Economics related
to other disciplines?
- Microeconomic Theory is closely
related to Managerial Economics
o Theory of the firm
o Theory of consumer
behavior
o Market structure and
competition theory
o Production and cost theory

Approach:
 Neoclassical framework
 Individuals are rational agents
that maximize utilities subject to
constraints Economic Theories and Econometrics
 Firms are rational agents that - A scientific theory describes the
maximize profits subjects to relationship between important
constraints variables affecting the
organization
- Theories or hypotheses are
testable, verified or refuted.
- The validation of the theory or
hypothesis can be done through:
o experimental method
(controlled set up)
o observation method (it is
Managerial Economics in relation to difficult to control the other
Decision Sciences o variables affecting the
 Numerical and algebraic analysis relationship between a
 Statistical information and particular set of variables.
forecasting To isolate the effect of X
 variable on the Y variable, other factors constant
we do econometrics (I will - Sellers will sell more if the price
not ask you to run improves, ceteris paribus, thus,
regressions, but you must price and quantity of a good has a
know how to interpret positive relationship
results.
MAIN POINTS
1. Managerial economics is the
Characteristics of a good theory application of economic principles
 It makes accurate forecast to analyze business and
 Explains or describes the existing government decisions.
observations 2. In the manager has to use the
 It can be applied to many following to make decisions
situations, not only to a limited consistent with the goals of the
number of scenarios or cases company: experience,
 Variables involved are judgement , common sense,
measurable intuition, rules of thumb and very
 It has minimum assumptions important: sound analysis
3. The primary objective of many
Steps involved in a decision making organizations, preferably the
1. Problem perception private firms is to maximize the
2. Identification of constraints value of the firm by maximizing
3. Predicting the consequences profits. However, there are other
of the decision management goals such as
4. Definiton of objectives making decisions in the interest
5. Identification of alternatives of other stakeholders such as
and strategies addressing the welfare of the
6. Decision and Sensitivity workers, consumers and the
analysis society at large.

The role of the manager is to The primary objective of public

verify which is the true cause of managers and government
the problem. regulators is to maximize social
welfare. Government projects should
Basic Economic Tools: A Review only be undertaken if the total
benefits exceed the total costs.
Demand
- shows the behavior of the
consumers The Economics of Production,
- refers to the quantity demanded Cost and Profit Maximization of
by the consumers given the the Firm: Part 1
prices holding other factors
constant “Government and business leaders
- Consumers buy more at lower should pursue the path to new
prices, ceteris paribus, thus, price programs and policies the way a
and quantity of a good has a climber ascends a formidable
negative relationship mountain or the way a soldier makes
his way through a mine field with
Supply small and careful steps”
- shows the behavior of the
companies or the sellers Profits as a signal for optimal
- Refers to the quantity supplied by resource allocation
the sellers given the prices  In an economy that is driven by
holding market forces, the profit serves as
 a mechanism in achieving an  Accounting Profit = Total Revenue
optimal allocation of the scarce - Explicit Cost
or limited resources  Economic Profit = Total Revenue -
 Resources will move towards Explicit Cost - Implicit Cost
profitable uses.  Explicit Cost = involves cash
 Resources will move away from payment
uses which are incurring losses.  Implicit Cost = costs incurred for
 The allocation of the resources is using your own resources, no
optimal if the economy is cash payment is made
maximizing profits and/or  Accounting profit is greater than
minimizing losses. economic profit

What about the organizations which A Simple Model of the Firm

are not profit oriented?  single good or service for a single
 The tools of economics can also market
be applied to non-profit  find combination of output and
organizations. It may not be profit price that maximize profits.
maximization. You may call it  revenues and costs are assumed
attaining efficient use of predictable (We discuss risks and
resources. uncertainty later)
 Non-profit organizations also  If revenues and costs of one
consider the opportunity cost of product does not affect the
their valuable resources. revenues and costs of other
 Non-profit organizations also use products, the firm can maximize
marginal analysis. the total profits by maximizing
the profits per product. Multi-
The Five Theories of Profits product companies like Procter
1. Frictional theory of profit – profits and Gamble assign product
or losses are the result of managers to specific consumer
disequilibrium conditions or products
shocks or adjustments.
2. Monopoly theory of profit – profits Total Revenue, Total Costs and Profits
are the result of the monopoly  Total Revenue = (Price)(Quantity)
power of the firm to charge higher  Total Costs = (Per unit cost)
prices than under competitive (Quantity)
conditions.  Profits = Total Revenue – Total
3. Innovation theory of profit – Costs
profits are a reward for successful  The law of demand influences the
innovation. Innovations that Total Revenue. Other things
reduce the cost of production, or equal, the higher the price, the
those that increase the demand fewer is the quantity demanded
for the product(new product line, by the consumers, thus the lower
new designs, new markets. the quantity sold by the firm.
4. Risk and uncertainty bearing  The pricing strategy of other firms
theory of profit –profits are a will have an impact on the
reward for the entrepreneur for quantity of a product that you can
assuming risks and uncertainties sell.
5. Managerial efficiency theory of
profits – entrepreneurs who are Simple Analysis
more efficient in the use of  If firm A reduces the price of its
resources will get more profits good, the law of demand says
that firm A will be able to sell a
Accounting Profit versus Economic higher quantity of the product.
Profit
 There are three sources of
additional quantity sold by firm A
1. Existing consumers of firm A who
decide to buy more
2. Consumers from competitors of
firm A, say firms B, and C who
now decide to buy from A
(depends on market structure).
3. New consumers of the product. Why do we invert the demand?
1. In math, the independent variable
Why is the demand curve important? (X) is written on the horizontal
 Helps the firm predict the axis, the dependent variable (Y) is
consequences of its output and written on the vertical axis.
pricing decisions. Offering a 2. If we do this, we should see the
discount or reducing the price is price on the horizontal axis
not always advantageous to the (independent variable,
producer (consider the market consumers do not control the
structure or the number of price) and put the quantity
competitors in the market). demanded on the vertical axis
 Examples of how the knowledge (consumers can decide on
about the demand curve is used: how many units they would
a. Predict the impact on profit of like to buy).
offering selective fare discount 3. In all economics books, the price
by airlines. is on the vertical axis, quantity
b. Predict the impact of demanded is on the horizontal
government day care axis.
subsidies on working mothers. 4. Price and Quantity demanded are
c. Predict the impact of reducing reversed because they are based
the price of necessities on on the inverse demand curve.
profits 5. This helps us add various demand
curve horizontally.
Sample Demand Equation: Q = 8.5 -
0.05P
 8.5 lot is the intercept which
states that if the price is 0, the
consumers would want to have
8.5 lot of a product (1 lot =100
microchips). The intercept
captures the effects of other
factors not considered in the
equation.
 0.05 is the slope of the demand
curve which states that as price
increases by 1 unit (1 unit =
$1,000), the quantity demanded
decreases by 0.05 unit or lot.
 Take note of the unit of the price
and quantity when you interpret
the equation.
The Economics of Production, if the marginal revenue after
Cost and Profit Maximization of advertising exceeds marginal cost
the Firm: Part 2 (printed ppt) after advertising
o Teaser: Will you consider
PART 3 your previous investment
in a relationship (financial,
emotional, time) in
Incremental versus Marginal deciding whether to keep
Analysis your marital relationship or
 Marginal analysis is better than part ways with your
incremental analysis because it partner? What are the
looks at the change in the profits possible marginal benefits
given a small change in the and the marginal costs of
decision variable. your decision?
 Marginal profit is the change in
the profit as the firm changes the Sensitivity Analysis
output by a small amount in this
case by 0.1. 1) If there is a change in the Fixed
 MR > MC, profits can still be Cost, the Marginal Cost is not
increased by increasing output affected, thus the optimal output
 MR < MC, not maximizing profits, does not change
reduce output to increase profits 2) If the material cost for production
 MR=MC, profit is maximized. Do increases, this changes the variable
not change the level of output cost, which changes the marginal
 Using marginal analysis, optimal cost, thus, it reduces the optimal
output is 3.4 lots. Profits = 117.8 level of output?
3) If the demand shifts to the right, it
Applications of marginal analysis improves the marginal revenue, so
1. make or buy decisions- compare the optimal output increases
the supplier price versus the cost
that you will incur if you will
produce the good yourself
2. capital expenditure decisions –
undertaking an investment
involves the comparison of the
return on investment (marginal
benefit) and the interest rate or
opportunity cost of your funds
(marginal cost).
3. output expansion and contraction
decision – amidst the Covid 19
pandemic, will the cost of the
store affect your decisions to
operate or not? No. Your decision
is now based on marginal revenue
versus marginal cost if you decide
to continue operating.
4. product line decision- a firm will
keep on adding a product line
provided the marginal revenue
generated by the product exceeds
the marginal cost of producing it.
5. optimal advertising decision- firm
will increase advertising expense