Ch 1 INTRODUCTION

•Economics is concerned with the best possible use of

.
limited resources.
•But it is now considered that economics is much more
than merely a theory of value OR of resource
allocation.
•“Economics is the study of the factors affecting the
size, distribution and stability of a country’s National
Income.”
INTRODUCTION Cont….
o
Economics

Macroeconomics Microeconomics

Money, finance, banking “Sector” economics

Labour economics
Economics of IT and
EC
Managerial economics

Regional Economics
International Economics
Economic Development
DIFFERENCE
 How does managerial economics differ from
“regular” economics?

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

 Thedifference is in the way the economic

theory is applied.
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.
 applications of economic theory
 quantitative methods
 statistical methods
 computational methods
Relationship between Managerial
Economics and Related Disciplines
Economic Theory
 Microeconomics
 Study of the economic behavior of individual
decision-making units.
 Relevance to Managerial Economics
 Macroeconomics
 Study of the total or aggregate level of output,
income, employment, consumption, investment,
and prices for the economy viewed as a whole.
Decision Sciences

 Mathematical Economics
 Expresses and analyzes economic models using
the tools of mathematics.

 Econometrics
 Employs statistical methods to estimate and test
economic models using empirical data.
The Process of decision-
making
Nature & Characteristics M.E.
 M.E. is perspective rather than descriptive.
 M.E. belongs to Normative Economics rather
than Positive Economics.
 M.E. is pragmatic i.e. it avoids difficult
abstracts.
 M.E. is the combination of theory of firm &
theory of profits.
Scope Of M.E.
 Pricing Problems

 Resource Allocation

 Investment Problems

 Inventory & Queuing Problems

Role & Responsibility of
Managerial Economist

Optimal Decision:
Given the goal(s) that the firm is
pursuing, the optimal decision in
managerial economics is one
that brings the firm closest to
this goal.
Role & Responsibility of
Managerial Economist Cont….
Making decisions and processing
information are the two primary tasks of
managers.
Examples:
• Whether or not to close down a branch of the
firm?
• Whether or not a store or restaurant should
stay open more hours a day?
Role & Responsibility of
Managerial Economist Cont….

• How a government agency can be

reorganized to be more efficient?

• Whether to install an in-house computer rather

than pay for outside computing services?

• How a hospital can treat more patients without

a decrease in patient care?
Role & Responsibility of
Managerial Economist Cont….
All these, as well as many other managerial
decisions require the use of basic
economics.

Economic theory helps decision makers to

know what information is necessary in order
to make the decision and how to process
and use that information.
Questions that managers must
answer:
♦ Should our firm be in this business?
♦ If so, what price and output levels achieve our goals?
♦ How can we maintain a competitive advantage over
our competitors?
 Cost-leader?
 Product Differentiation?
 Market Niche?
 Outsourcing, alliances, mergers, acquisitions?
 International Dimensions?
Questions that managers must
answer:
♦ What are the economic conditions in a particular
market?

 Market Structure?
 Supply and Demand Conditions?
 Technology?
 Government Regulations?
 International Dimensions?
 Future Conditions?
 Macroeconomic Factors?
Role & Responsibility of
Managerial Economist Cont….
The manager attempts either to maximize
or minimize some objective function,
frequently subject to some constraint(s).

And, for all goals that involve an

optimization problem, the same general
economic principles apply!
Theory of the Firm

WHAT:
A firm is an organization that combines and
organizes resources for the purpose of
producing goods and services for sale. Firms
produce more than 70%of all goods and
services consumed in India. The remainder is
produced by Govt. & NGO.
Theory of the Firm Cont…
WHY?
Firms exists because it would be very
inefficient & costly for entrepreneurs to enter
into & enforce contracts with workers and
owners of capital, land and other resources
for each separate step of production and
distribution process. The firms exists in order
to save on such TRANSACTION COSTS.
Theory of the Firm Cont…
Firms Function Resulting in circular flow

The function of firms, therefore, is to purchase

resources or inputs of labor services, capital and
raw materials in order to transform them into goods
and services for sale. Resource owners then use
the income generated from the sale of their service
or other resources to firms to purchase the goods&
services produced by firms. The circular flow of
economic activity is thus complete.
Partners of Firm in Circular Flow
of Economic Activity
Theory of the Firm Cont…

Both Short term as well as Long term profits

are clearly important. The theory of the firm
now postulates that the primary goal or
objectives of the firm is to maximize the
wealth or VALUE OF THE FIRM.
Value of the Firm

π1 π2 πn n
πt
PV = + +L + =∑
(1 + r )
1
(1 + r ) 2
(1 + r ) n
t =1 (1 + r )t
PV=The present value of all expected future profits

= Expected Profits in each of the ‘n’ years

r = Appropriate discount rate
n
πt
TRt −TCt n
Value of Firm =∑ =∑
t =1 (1 +r ) (1 +r )t
t
t =1
Value of the Firm Cont…
Environment of the Firm
Theory of the Firm Cont…
 Combines and organizes resources for the
purpose of producing goods and/or services
for sale.
 Internalizes transactions, reducing
transactions costs.
 Economic theory assumes that the primary
goal of managers is to maximize the value of
the firm.
Constraints on the Operations
of Firm

 Legal Constraints
 Limited resourses
 Labour
 Capital
 Finance
 Raw materials
 Environment
Constraints on the Operations
of Firm Cont….

 Limited capacity of market

 Demand

 Societal Constraints

 Choice & Opportunity Cost

Economic Tools Applied Under
Managerial Economics

 Opportunity Cost
 Discounting Principle

 Equi-Marginal Principle

 Marginal Analysis

 Incremental Cost Principle