Managerial Economics: A Comprehensive Overview

BEC 30325: MANAGERIAL ECONOMICS Session 01 INTRODUCTION TO MANAGERIAL ECONOMICS Dr. Sumudu Perera

Session Outline Nature and scope of Managerial Economics Goals and Constraints of business organizations The Theory of the firm The nature and importance of profit Economic Profit and Accounting Profit Quantitative techniques in Managerial Economics

Managerial Economics Managerial Economics is the integration of economic theory with decision science tools, so as to make decision making effective and efficient. The application of economic theory and the tools of decision science to examine how an organization can achieve its aims or objectives most efficiently.

Managerial Economics deals with: How decisions should be made by managers to achieve the firm s goals-in particular, how to maximize profit

Managerial Decision Problems Economic theory Microeconomics Macroeconomics Decision Sciences Mathematical Economics Econometrics MANAGERIAL ECONOMICS Application of economic theory and decision science tools to solve managerial decision problems OPTIMAL SOLUTIONS TO MANAGERIAL DECISION PROBLEMS

Managerial Decision Problems 6 Product price and output Make or buy Production techniques Stock levels Advertising and media Labour hiring and training Investment and financing

Decision Sciences : 7 Tools and Techniques for Analysis Numerical Analysis Statistical Estimation Forecasting Game Theory Optimization Simulation

Economic Concepts: 8 Framework for Decisions Theory of consumer behaviour Theory of the firm Theory of market structures and pricing

The goals of a firm : 9 Economic Goals; Maximizing or Satisficing? Profit Market share Revenue growth Return on investment Technology Customer satisfaction Shareholder value

Non-economic goals and objectives 10 A good place for our employees to work Provide high quality products/ services to the customers Act as a good citizen in the society

Optimal Decision 11 Given the goals that the firm is pursuing, the optimal decision in managerial economics is one that bring the firm closest to this goal.

Questions that managers must answer, 12 What are the economic conditions in a particular market? Market structure? Government regulations? Future conditions? International dimensions? Technology? Macroeconomic factors? It should be emphasized that practically in all managerial decisions the task of the manager is the same. Namely, each goal involves the optimization problem.

13 The manager attempts either to maximize or minimize some objective function, frequently subject to some constraints. And for all goals that involve an optimization problem, the basic general economic principles apply.

14 Economics Vs. Managerial Economics Economics Managerial Economics Study of economic theory Application of economic theory Belongs to positive economics Belongs to normative economics Examine the human behavior on using scarce resources on unlimited needs and wants Study the way of applying economic theory for decision making in firms Limited Scope Wide scope

Why is Managerial Economics Important? 15 To estimate economic relationships To make decisions related to internal issues Effectively utilize resources (What/how much/how/to whom, to produce) Pricing Face price and non-price competitions Maximizing sales, revenues, profits To identify the impact of external factors on the firm To use theoretical concepts in economics to actual behavior of firms A powerful analytical engine .

Theory of the Firm Combines and organizes resources for the purpose of producing goods and/or services for sale. Internalizes transactions, reducing transactions costs. Primary goal is to maximize the wealth or value of the firm.

Example -Theory of the Firm Johns, an entrepreneur decides to set up a firm by recruiting people to work for wages, by purchasing a property for the factory. Johns believes that it is very much efficient and less costly to run a business through a firm, rather than him doing everything alone. He believes that a general contract agreed with laborers to perform a number of tasks for specific wages and benefits is less costly than specific contracts for each task undertaken. He can also internalize many functions such as Finance, Marketing, IT, Research and Development etc without giving those tasks to external parties.

Value of the Firm The present value of all expected future profits

Alternative Theories Sales maximization Adequate rate of profit Management utility maximization Principle-agent problem Satisficing behavior

Definitions of Profit Business / Accounting Profit: Total revenue minus the explicit or accounting costs of production. Economic Profit: Total revenue minus the explicit and implicit costs of production. Opportunity Cost: Implicit value of a resource in its best alternative use.

Example Accounting vs Economic profit Aniq is a final year student and he also works as a part-time gym instructor at the College gymnasium. During his free hours he engages in training athletes, for which he receives an allowance of Rs.10000 per month. He has to incur a cost of Rs.1200 per month for his travelling and another Rs.600 on laundry on his sports clothes. Other than that, on the days that he comes to the gym he has to spend on a protein drink which would cost him Rs. 800 per month on average. If he was to be occupied elsewhere during his free time, he could have worked at the college cafeteria and earned Rs. 5,500 per month. Identify the explicit, implicit and economic costs of this scenario separately, and compare the accounting and economic profits of engaging in as a gym instructor.

Function of Profit Profit is a signal that guides the allocation of society s resources. High profits in an industry are a signal that buyers want more of what the industry produces. Low (or negative) profits in an industry are a signal that buyers want less of what the industry produces.

The Changing Environment of Managerial Economics Globalization of Economic Activity Goods and Services Capital Technology Skilled Labor Technological Change Telecommunications Advances The Internet and the World Wide Web

Decision Science Tools 24 Numerical analysis Statistical estimation Forecasting Game theory Optimization Simulation Department of Business Economics, FMSC, USJP

Basic Training: Rules of Differentiation Constant Function Rule: Power Function Rule: Y = f(X) =0 dY dX b aX = 1 b dY dX dU dX dV dX = Sum-and-Differences Rule dY dX dV dX dU dX = + U V Product Rule

26 ( ) V ( ) Quotient Rule dU dV V U dY dX dX dX = 2