Module 1

Introduction to Managerial Economics

INTRODUCTION
How does managerial economics differ from regular economics? There is no difference in the theory; standard economic theory provides the basis for managerial economics. The difference is in the way the economic theory is applied.

What is managerial economics?

Managerial economics is the use of economic analysis to make business decisions involving the best use (allocation) of an organizations scarce resources
Managerial economics is (mostly) applied microeconomics (normative microeconomics)

Managerial economics deals with

How decisions should be made by

managers to achieve the firms goals in particular, how to maximize profit. (Also government agencies and nonprofit institutions benefit from knowledge of economics, i.e. efficient recourse allocation is important for them too...)

Relationship between Managerial Economics and Related Disciplines

Management Decision Problems

Economic Concepts

Decision Sciences

Managerial Economics Optimal Solutions to Managerial Decision Problems

 Managerial Economics
Use of Economic Concepts and Decision Science Methodology to Solve Managerial Decision Problems

Circular Flow of Economic Activity

Individuals and firms are fundamental participants in a market economy They interact in two arenas
Product market Factor market

Prices and profits serve as signals for regulating flow of money and resources through factor market and flows of money and goods through product market

Firm

An entity/organization which organizes factors of production to produce goods and services that will meet the demands of individual consumers and other firms Types
Sole proprietorship Partnerships Corporations

Firm: Rationale for existence

Firms exist as organizations because the total cost of producing any rate of output is lower than if the firm did not exist Reasons
Transaction costs (external transactions versus internal operations) Government intervention

THE GOALS OF A FIRM

Economic Goals:
Maximizing or Satisficing 1. Profit 2. Market share 3. Revenue growth 4. Return on investment 5. Technology 6. Customer satisfaction 7. Shareholder value

THE GOALS OF A FIRM continued

Non-economic Objectives:
1. A good place for our employees to work

2. Provide good products/services to our customers

3. Act as a good citizen in our society

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.

Roles of Managers:
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? How a hospital can treat more patients without a decrease in patient care?

Roles of Managers continued

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?

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? 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?

Profit measurement

Profit = revenue - cost Accounting profit = Revenue Explicit costs Economic profit = Revenue (Explicit cost + Implicit costs)
Implicit costs are costs associated with foregone opportunities (opportunity cost of resources in particular use)

Opportunity cost is the value foregone (possible in next best use)

Profit maximization

Profit in current period Profit over longer period

Present value analysis

Expression of Economic Relationship

Economic relationship can be expressed in following three ways:

Table Equation Graph