Managerial Economics
Economics Defined
The word economy comes from a Greek word
Oikonomos which means “one who manages a
household.”
Economics deals with the allocation of scarce resources
among alternative uses to satisfy human wants.
Economics is the study of how society manages its
scarce resources.
Microeconomics
and Macroeconomics
• Microeconomics focuses
on the individual parts
of the
economy. Branch of economics that deals with the
behavior of individual economic units—consumers, firms,
workers, and investors—as well as the markets that
these units comprise.
– How households and firms make decisions and how
they interact in specific markets
• Macroeconomics looks at the economy as a whole. It is
the branch of economics that deals with aggregate
economic variables like inflation, unemployment, and
economic growth
Ten Principles of Economics
4
THE THEMES OF MICROECONOMICS
Trade-Offs
Consumers
Consumers have limited incomes, which can be spent on a wide
variety of goods and services, or saved for the future.
Workers
Workers also face constraints and make trade-offs. First, people
must decide whether and when to enter the workforce. Second,
workers face trade-offs in their choice of
employment. Finally, workers must sometimes decide how many
hours per week they wish to work, thereby trading off
labor for leisure.
Firms
Firms also face limits in terms of the kinds of products that they
can produce, and the resources available to produce them.
The Diverse Fields of Economics
Examples of microeconomic and macroeconomic concerns
Microeconomics
Macroeconomics
Production
Prices
Income
Employment
Production/Output
in Individual
Industries and
Businesses
Price of Individual
Goods and Services
Distribution of
Income and Wealth
How much steel
How many offices
How many cars
Price of medical
care
Price of gasoline
Food prices
Apartment rents
Wages in the auto
industry
Minimum wages
Executive salaries
Poverty
Employment by
Individual
Businesses &
Industries
Jobs in the steel
industry
Number of
employees in a firm
National
Production/Output
Aggregate Price
Level
National Income
Total wages and
salaries
Employment and
Unemployment in
the Economy
Total Industrial
Output
Gross Domestic
Product
Growth of Output
Consumer prices
Producer Prices
Rate of Inflation
Total corporate
profits
Total number of
jobs
Unemployment
rate
1.2
WHAT IS A MARKET?
● market Collection of buyers and sellers that, through
their actual or potential interactions, determine the price of
a product or set of products.
● market definition Determination of the buyers, sellers,
and range of products that should be included in a
particular market.
● arbitrage Practice of buying at a low price at one
location and selling at a higher price in another.
1.2
WHAT IS A MARKET?
Competitive versus Noncompetitive Markets
● perfectly competitive market Market with many buyers
and sellers, so that no single buyer or seller has a
significant impact on price.
Market Price
● market price
Price prevailing in a competitive market.
1.3
REAL VERSUS NOMINAL PRICES
● nominal price Absolute price of a good, unadjusted for inflation. For
example the nominal price of butter was Taka 50 in 2005 and Taka 80
in 2015.
● real price: Price of a good relative to an aggregate measure of
prices; price adjusted for inflation. Real price of butter in 2015 = (CPI
2005/CPI 2015)* Nominal price in 2015.
● Consumer Price Index
Measure of the aggregate price level.
● Producer Price Index Measure of the aggregate price level for
intermediate products and wholesale goods.
POSITIVE
VERSUS are
NORMATIVE
ANALYSIS
• Positive statements
statements that
attempt to describe
the world as it is. Positive economics studies economic
behavior without making judgments. It describes what exists
and how it works.
– Called descriptive analysis
• Normative statements are statements about how the world
should be. Normative economics, also called policy
economics, analyzes outcomes of economic behavior,
evaluates them as good or bad, and may prescribe courses of
action.
– Called prescriptive analysis
POSITIVE VERSUS NORMATIVE
ANALYSIS
• Positive or Normative Statements?
?
– An increase in the minimum wage will cause a
decrease in employment among the least-skilled.
POSITIVE
?
– Higher federal budget deficits will cause interest
rates to increase.
POSITIVE
?
Fundamental Economic Problem
• There are three fundamental economic problems for every human
society. It is immaterial whether it is centrally planned, mixed or
advanced industrial society.
• They are what commodities are produced, how these goods are
made and for whom they are produced.
• What: Which goods and services a society chooses to produce and
in what quantities.
• How: how goods are produced; choice of technologies; division of
labor who will do what.
• For whom: for whom are goods produced? Distribution of products
among household; what pattern it takes; where the income goes.
Individual’s Economizing Problem
•
•
•
•
Limited Income
Unlimited Wants
A Budget Line
Attainable and Unattainable
Combinations
• Tradeoffs & Opportunity Costs
• Choice
• Income Change
Individual’s Economizing Problem
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Economic System
• Market, Command and Mixed System
– We have indicated three fundamental problems in the previous
section. One can solve those problems in different way. It is a
question of organization that what, how and for whom can be
dealt with. The three available systems try to address those
problems under their respective market system.
– A market economy is one in which individuals private firms
market the major decisions about production and consumption.
A system of prices, market, of profits and losses, of incentives
and rewards determines what, how and for whom. In extreme
case the economy is seen practicing laissez-faire which means
non-interference from the government side in economic
decision making.
What is Managerial Economics
 Douglas - “Managerial economics is .. the application of
economic principles and methodologies to the decisionmaking process within the firm or organization.”
 Pappas & Hirschey - “Managerial economics applies
economic theory and methods to business and
administrative decision-making.”
 Salvatore - “Managerial economics refers to the application
of economic theory and the tools of analysis of decision
science to examine how an organisation can achieve its
objectives most effectively.”
INTRODUCTION OF MANAGERIAL ECONOMICS
Concept of Managerial Economics (contd.)
Following diagram shows how does the managerial economics provide the
link between traditional economics and decision sciences
Management
Problems
Economic Theory
Decision Sciences
Managerial
Economics
Economic Methodology:
Descriptive Model
Prescriptive Model
Study of Functional Areas:
Accounting, Finance, and
Marketing
Optimal
Decision
17
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
What is Managerial Economics (contd.)
It is an application of that part of microeconomics
that focuses on
 Risk
 Demand
 Production
 Cost
 Pricing, and
 Market Structure.
 It helps rational decision making through MODEL
BUILDING
Stories of Four Great Economists
Adam Smith (1723 – 1790) was a
Scottish Economist.
He is said FATHER OF ECONOMICS
He is also FATHER OF CAPITALISM
His Book: WEALTH OF NATIONS
We want to talk about POVERTY not
wealth.
His main theory is “There is an
invisible hand that determine
everything – Don’t disturb it”
What is the invisible hand?
•
Invisible hands – demand
and supply – determines
quantity and price
P
S
D
Q
Economics is very easy
• Teach a Parrot to say Demand and Supply –
then the parrot becomes an economist.
• Ask her any questions – she will say ‘demand
and supply’ – then she is a great economist.
David Ricardo
• David Ricardo 1772-1823
• His theory said, increase in
agricultural production
would ultimately decline.
Thomas Malthus
• Thomas Robert Malthus,
(1766-1834), English
economist and
demographer.
Malthus
• He was a Church Priest.
• Once he noted he had never seen a dead bird.
(except bats and crows).
• He searched the reasons.
• Bird die on a flowing stream and the body is
taken away by the water.
• Birds commit suicide when food is not available.
– A tragic case – God cannot do this.
• He investigated further and studied economics –
especially Ricardo
Population Theory
His theory: population
growth will always tend
to outrun the food
supply,
* There will be hunger,
famine, war, disasters,
* Population Control is
needed.
* This is called
Malthusianism
Karl Marx
Karl Heinrich Marx (1818 – 1883) was a
German
philosopher,
economist,
sociologist,
historian, journalist and
revolutionary socialist. His ideas played a
significant
role
in
establishing
communism. He published various books.
Das Kapital (1867–1894);
His thinking,
Factors of Production
Congealed Labor theory
Exploitation
Dialectic Materialism
John m Keynes
 1883 – 21 April 1946 – A British
Economist.
 Studied Mathematics
 Very young professor, most learned
young man,
 Wanted to marry an illiterate
women,
 Then what happened??
-- Wrote a book “General Theory”
Could not sell.
Lord Keynes (continued)
•
•
•
•
•
•
•
•
Went to stock market,
Dominated stock market,
Became rich,
Became Lord,
Married,
Divided economics into Macro and Micro,
An interview of his wife.
He successfully introduced mathematics in
economics
1.1
THE THEMES OF MICROECONOMICS
Theories and Models
In economics, explanation and prediction are
based on theories. Theories are developed
to explain observed phenomena in terms of
a set of basic rules and assumptions.
A model is a mathematical representation,
based on economic theory, of a firm, a
market, or some other entity.
The Process of Model-building
• The economics ‘method’
• The steps: the hypothetical-deductive approach
– make assumptions about behaviour
– work out the consequences of those assumptions
– make predictions
– test the predictions against the evidence
– PREDICTIONS SUPPORTED? The model is accepted
as a good explanation (for the moment)
– PREDICTIONS REFUTED? Go back and re-work the
whole process
Definitions
&
assumptions
Theoretical
analysis
If predictions
not supported by
data, model is
amended or
discarded
Predictions
Predictions
tested
against data
If predictions
borne out by
data, the model
is valid, for
the moment
32
Economic Laws
Idea
• Check the Idea
• Prove it. If proved then
Hypothesis
• Prove the Hypothesis
• If Proved then
Theory
Law
• Prove the theory
• If proved then
• Law is valid every where,
Economic Policy
Criteria for judging economic outcomes:
• Efficiency, or allocative efficiency. An efficient
economy is one that produces what people want at the
least possible cost.
• Equity, or fairness of economic outcomes.
• Growth, or an increase in the total output of an
economy.
• Stability, or the condition in which output is steady or
growing, with low inflation and full employment of
resources.
Figure 1 The Circular Flow
MARKETS
FOR
GOODS AND SERVICES
•Firms sell
Goods
•Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
•Buy and consume
goods and services
•Own and sell factors
of production
FIRMS
•Produce and sell
goods and services
•Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
•Households sell
•Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of Taka
Copyright © 2004 South-Western
Assumptions
Assumption: The economy composed of
households and firms only
Households: own factors of production,
consume goods and service
Firms: hire factors of production to
produce goods and services
The Production Possibilities FrontierModel: The
Production Possibilities Frontier
The production possibilities frontier is a graph
that shows the combinations of output
that the economy can possibly produce
given the available factors of production
and the available production technology.
Figure 2 The Production Possibilities Frontier
Quantity of
Garments
Produced
3,000
D
C
2,200
2,000
A
Production
possibilities
frontier
B
1,000
0
300
600 700
1,000
Quantity of
Rice Produced
Figure 3 The Production Possibilities Frontier
Quantity of
Garments
Produced
3,000
D
C
2,200
2,000
A
Production
possibilities
frontier
B
1,000
0
300
600 700
1,000
Quantity of
Rice Produced
The Margin: The Key Unifying
Concept in Microeconomics
Marginal Benefit & Marginal Cost
Marginal Analysis
15
a
c
MC
MB = MC
e
10
5
b
d
MB
0
1
2
3
Quantity of Pizza
Value of the Firm
The present value of all expected future profits
Economic Cost of Resources
• Opportunity cost of using any resource is:
– What firm owners must give up to use the
resource
• Market-supplied resources
– Owned by others & hired, rented, or leased
• Owner-supplied resources
– Owned & used by the firm
1-43
Total Economic Cost
• Total Economic Cost
– Sum of opportunity costs of both market-supplied
resources & owner-supplied resources
• Explicit Costs
– Monetary payments to owners of market-supplied
resources
• Implicit Costs
– Nonmonetary opportunity costs of using ownersupplied resources
1-44
Economic Cost of Using Resources
(Figure 1.1)
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Economic Profit versus Accounting
Profit
• Economic profit = Total revenue – Total economic cost
= Total revenue – Explicit costs – Implicit costs
• Accounting profit = Total revenue – Explicit costs
• Accounting profit does not subtract implicit costs
from total revenue
• Firm owners must cover all costs of all resources
used by the firm
– Objective is to maximize economic profit
1-46