1. Chapter 1 Introduction to Managerial Economics | Profit (Economics) | Economics


A. Definition of Managerial Economics: It is application of economic theory and the tools of analysis of decision science to examine how a firm can achieve its aims or objectives most efficiently. Firm in macroeconomic analysis Circular flow of income describes the way in which a country’s economy flows backward and forward between the sectors in the economy. It shows how the household and firm interact in the resource and product markets. A simple circular flow assumes that the economy is divided into only into two sectors. a) i) 2 Sector Economy - The Simple Circular Flow


We assumed that: households receive their income from the firm by providing factors of production they own ii) firms sell their entire output(supply of goods & services) to households iii) households spend their entire income on goods and services. So all goods produced are sold. Purchase of goods and services
supply of goods & services

supply of factors of production


wages, interest, rent, profit

(i) The household is the owner of factors of production and they are suppliers and sellers of factors of production (resources) to the firms whilst firms are the buyers. (ii) The bottom half of the diagram shows the flow of the factors of production owned by households to the firms. (iii) The firms in return pay wages, rent, interest and profits to household as income. (iv)The top half of the flow shows the flow of goods and services produced from households to firms and the corresponding flow of money payments for goods and services from households to firms as households’ consumption.


Imperfect market mechanism In imperfect market. (ix)So. a firm should exist to purchase these goods and transform them into goods and services for sale. The Rationale of the firm It would be very costly for individual household to enter into each production and distribution process. (viii) But. (vi)The above diagram shows how two sectors interact in the product market and resource market. What is profit? Profit is a reward for: Bearing risks An entrepreneur will bear all the risk associated with production. 2 .MANAGERIAL ECONOMICS – ECO556 (v) The circular flow of income illustrates the basic principle of national income accounting where the value of total outputs equals the value of total income. (vii) The illustration assumed that household spends all their income to buy goods and services. new production techniques. They also save part of their income. Innovations Development of new products. and new modes of marketing will provide higher return. (The economies generated in production and distribution would lower the cost of production and provide higher returns to resource owners. it is able to enjoy profits for long period of time. Thus. firms can generate profit since there is less competition Monopoly status If a firm is a monopoly. Thus. I. The reward for the risk is profit. household does not spend all their income for consumption. what happens if the household does not consume all their income to buy goods and services but save part of it in the Financial Institutions? C. Objectives of the firm The primary goal of a firm is to maximize profit (minimize cost). in the real life. Resource owners (households) then purchase these goods and services with the income generated form the sale of their services or resources. it is able to curtail/prevent other firms form entering the market.

5.it binds the firm because of some prior agreement such as a long-term lease on a building.it occurs when a department of a firm is assigned a budget for the next year and managers are given orders to maximize production subject to this budgeted amount. or a contract with a labor union that represents the firm’s employees. How to calculate profit? Profit = TR – TC Accounting profit Economic profit = TR – explicit costs = TR – explicit costs – implicit costs Other goals: Sales maximization Revenue Maximization Market share maximization Employment Working environment for workers Provide good product and services to customer Act as a good citizen II. both individual and corporate. 3. 4.it includes the array of federal. and employment law. state. 3 . and local laws that must be obeyed by all citizens. including wrongful termination and sexual harassment matters. Technological constraint 2.MANAGERIAL ECONOMICS – ECO556 Function of profit Profits act as a signal for reallocation of resources to reflect changing demand and taste. Contractual constraint . Areas where managers seem to have some legal difficulty include environmental law. Decision Problems Firms usually face many constraints such as: 1. Financial constraint . Legal constraint . Moral constraint . especially those relating to pollution and the disposal of hazardous wastes.it applies to actions that are not illegal but are sufficiently inconsistent with generally accepted standards of behavior to be considered improper.

MANAGERIAL ECONOMICS – ECO556 - it sets physical limits on the amount of output per unit of time that can be generated by particular machines or workers. 4 .

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