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Roles played by business managers are becoming increasingly more challenging as complexity in the business world grows. Business decisions are increasingly dependent on constraints imposed from outside the economy in which a particular business is based—both in terms of production of goods as well as the markets for the goods produced. The impact of rapid technological change on innovation in products and processes, as well as in marketing and sales techniques, figures prominently among the factors contributing to the increasing complexity of the business environment. Moreover, because of increased globalization of the marketplace, there is more volatility in both input and product prices. The continuous changes in the economic and business environment make it ever more difficult to accurately evaluate the outcome of a business decision. In such a changing environment, sound economic analysis becomes all the more important as a basis of decision making. Managerial economics is a discipline that is designed to provide a solid foundation of economic understanding in order for business managers to make well-informed and well-analyzed managerial decisions. THE ECONOMICS There are a number of issues relevant to businesses that are based on economic thinking or analysis. Examples of questions that managerial economics attempts to answer are: What determines whether an aspiring business firm should enter a particular industry or simply start producing a new product or service? Should a firm continue to be in business in an industry in which it is currently engaged or cut its losses and exit the industry? Why do some professions pay handsome salaries, whereas some others pay barely enough to survive? How can the business best motivate the employees of a firm? The issues relevant to managerial economics can be further focused by expanding on the first two of the preceding questions. Let us consider the first question in which a firm (or a would-be firm) is considering entering an industry. For example, what led NATURE OF MANAGERIAL
Frederick W. Smith the founder of Federal Express, to start his overnight mail service? A service of this nature did not exist in any significant form in the United States, and people seemed to be doing just fine without overnight mail service provided by a private corporation. One can also consider why there are now so many overnight mail carriers such as United Parcel Service and Airborne Express. The second example pertains to the exit from an industry, specifically, the airline industry in the United States. Pan Am, a pioneer in public air transportation, is no longer in operation, while some airlines such as TWA (Trans World Airlines) are on the verge of exiting the airlines industry. Why, then, have many airlines that operate on international routes fallen on hard times, while small regional airlines seem to be doing just fine? Managerial economics provides answers to these questions. In order to answer pertinent questions, managerial economics applies economic theories, tools, and techniques to administrative and business decision-making. The first step in the decision-making process is to collect relevant economic data carefully and to organize the economic information contained in data collected in such a way as to establish a clear basis for managerial decisions. The goals of the particular business organization must then be clearly spelled out. Based on these stated goals, suitable managerial objectives are formulated. The issue of central concern in the decisionmaking process is that the desired objectives be reached in the best possible manner. The term "best" in the decision-making context primarily refers to achieving the goals in the most efficient manner, with the minimum use of available resources—implying there be no waste of resources. Managerial economics helps the manager to make good decisions by providing information on waste associated with a proposed decision. APPLICATIONS ECONOMICS Some examples of managerial decisions have been provided above. The application of managerial economics is, by no means, limited to these examples. Tools of managerial economics can be used to achieve virtually all the goals of a business organization in an OF MANAGERIAL
Pappas cite the example of a nonprofit hospital. and support staff). In addition to nonprofit business organizations. The hospital administrator can use the concepts and tools of managerial economics to determine the optimal allocation of the limited resources available to the hospital. Typical managerial decision making may involve one of the following issues: • • • Deciding the price of a product and the quantity of the commodity to be produced Deciding whether to manufacture a product or to buy from another manufacturer Choosing the production technique to be employed in the production of a given product Deciding on the level of inventory a firm will maintain of a product or raw material Deciding on the advertising media and the intensity of the advertising campaign Making employment and training decisions Making decisions regarding further business investment and the mode of financing the investment • • • • It should be noted that the application of managerial economics is not limited to profitseeking business organizations. Mark Hirschey and James L. a hospital does strive to provide its patients the best medical care possible given its limited staff (doctors. and other resources. tools of managerial economics can explain the effects of imposing automobile import quotas on the availability of domestic cars. While managerial economics is helpful in making optimal decisions. equipment. one should be aware that it only describes the predictable economic consequences of a managerial decision. nurses. While a nonprofit hospital is not like a typical firm seeking to maximize its profits. prices charged .efficient manner. schools. and museums) can use the techniques of managerial decision making to achieve goals in the most efficient manner. Tools of managerial economics can be applied equally well to decision problems of nonprofit organizations. For example. government agencies and other nonprofit organizations (such as cooperatives. space.
while consumers form the basic economic entities on the consumption side. tools. which describes how businesses make a variety of decisions. which describes the structure and characteristics of different market forms under which business firms operate. physical and financial resources. This latter question encompasses broader political considerations involving what economists call value judgments. and pay taxes. an idealized version of a real-world firm. since the theory provides a broad framework within which issues relevant to managerial decisions are analyzed.for automobiles. THE THEORY OF THE FIRM Discussing the theory of the firm is an useful way to begin the study of managerial economics. which describes decision making by consumers. provide employment. prices of automobiles will increase. . and (3) the theory of market structure and pricing. The basic economic model of a business enterprise is called the theory of the firm. and the extent of competition in the auto industry. (2) the theory of consumer behavior. and a variety of information. The behavior of firms is usually analyzed in the context of an economic model. however. Analysis of managerial economics will reveal that fewer cars will be available. and the extent of competition will be reduced. ECONOMIC CONCEPTS USED IN MANAGERIAL ECONOMICS Managerial economics uses a wide variety of economic concepts. A firm can be considered a combination of people. In the process of accomplishing this. whether imposing automobile import quotas is good government policy. Firms exist because they perform useful functions in society by producing and distributing goods and services. If economic activities of society can be simply put into two categories—production and consumption—firms are considered the most basic economic entities on the production side. and techniques in the decision-making process. These concepts can be placed in three broad categories: (1) the theory of the firm. Managerial economics does not address. they use society's scarce resources.
and thus. market value. assume that a firm expects a profit of $10. such as book value. and liquidating value. $10.091 at the present ([$10. to obtain an estimate of the present value of expected profits.000 in two years from now is equal to about $16. Let us assume that the prevailing interest rate is 10 percent per annum. In this more complete model.529).529 (since [$20.091 and $16. the present value of future expected profits is $25. the present value of expected profits. the firm's owner-manager is assumed to maximize the firm's short-term profits (current profits and profits in the near future). one must identify the stream of net cash flow in future years.000 in a year from now is only equal to about $9.000/(1 + 0. break-up value. of the business firm. Thus. the firm's owner is the manager of the firm.000 in the second year it is assumed that the firm earns no profits after two years. Defining present value of expected profits is based on first defining "value" and then defining "present value.091.620 (equal to the sum of $9.000 in one year and $20. Once this is accomplished. going-concern value.PROFIT MAXIMIZATION AND THE FIRM.000/(1 +0. the present value of an expected profit of $20.000 profit expected in a year from now is about $9." Many concepts of value. In this version of the theory. Under the simplest version of the theory of the firm it is assumed that profit maximization is its primary goal. these expected future profit values are converted into present value by discounting these values by an appropriate interest rate.1)] = $9. Today. The present value of . the goal of maximizing short-term profits is replaced by goal of maximizing long-term profits.1)2] = $16. Therefore. are encountered in business and economics. Thus. even when the profit maximizing assumption is maintained. the present value of a $10. For illustration.529). the notion of profits has been broadened to take into account uncertainty faced by the firm (in realizing profits) and the time value of money (where the value of a dollar further and further in the future is increasingly smaller than a dollar today). Similarly. The value of the firm is defined as the present value of expected future profits (net cash flows) of the firm.091)—that is.
thereby establishing a floor for minimum labor costs. warehouse space. and maximizing this profit is considered the primary goal of a firm in most models. health and safety standards. but also various external constraints that may limit the firm's ability to achieve its organizational goals. find the present value of expected future profits by subtracting the present value of expected future costs from the present value of expected future revenues. and laws and government regulations. laws and regulations have to be observed. fuel efficiency requirements. contractual obligations. antipollution regulations. The legal restrictions can constrain decisions regarding both production and marketing activities. Thus. key raw materials. Labor contracts. alternatively. specialized machinery and equipment. Contractual obligations also constrain managerial decisions.expected profits is a key concept in understanding the theory of the firm. managers often face constraints on plant capacity that are exacerbated by limited investment funds available for expansion or modernization. The first external constraint of resource scarcity refers to the limited availability of essential inputs (including skilled labor). and fair pricing and marketing practices. and other resources. energy. PROFIT MAXIMIZATION VERSUS OTHER MOTIVATIONS BEHIND MANAGERIAL DECISIONS. business managers must consider not only the short-term and long-term implications of decisions made within the firm. Labor contracts may also determine the number of workers employed at any time. one can. Finally. Moreover. THE CONSTRAINED PROFIT MAXIMIZATION. Examples of laws and regulations that limit managerial flexibility are: the minimum wage. It should be noted that expected profit in any one period can itself be considered as the difference between the total revenue and the total cost in that period. These constraints relate to resource scarcity. Profit maximization is subject to various constraints faced by the firm. . for example. In their attempt to maximize the present value of profits. may constrain managers' flexibility in worker scheduling and work assignment. technology.
Under such a structure. difficult to interpret company support for a charitable organization as an integral part of the firm's long-term value maximization. or as an attempt to make the firm more noticeable in the marketplace? As it is virtually impossible to provide definitive answers to these and similar questions. The critics argue that business managers are interested. and (3) the firm is a collection . the attempt to analyze these issues has led to the development of alternative theories of firm behavior. (2) the managers of firms aim at maximizing their own personal utility or welfare. employee welfare. rather than truly attempting to maximize the value (the discounted present value) of the firm. if the firm's size is increasing. The act of maximization itself has been criticized. It is. for example. prestige. there is a feeling that managers often aim merely to "satisfice" (seek solutions that are considered satisfactory). A modem firm is frequently organized as a corporation in which shareholders are the legal owners of the firm. and the manager acts on their behalf. Some of the preeminent alternate models assume one of the following: (1) a firm attempts primarily to maximize its size or growth. but profits are not. given the constraints). and the welfare of the larger society. they may be interested in power. community well-being. This question is often rhetorically posed as: does a manager really try to find the sharpest needle in a haystack or does he or she merely stop upon finding a needle sharp enough for sewing needs? Under the structure of a modern firm. In particular.The present value maximization criterion as a basis for the study of the firm's behavior has come under severe criticism from some economists. at least partly. it is hard to determine the true motives of managers. leisure. in factors other than the firm's profits. rather than its present value. it is difficult to determine whether a manager merely tries to satisfy the stockholders of the firm while pursuing other goals. Similarly. can one attribute the manager's decision to expand as being motivated by the increased prestige associated with larger firms. rather than really try to optimize or maximize (seek to find the best possible solution.
given the market price of the commodity the firm is producing). others can outcompete the firm and drive it out of existence. Before arriving at the decision whether to maximize profits or to satisfice. Competition also has its effects through the capital markets. if a firm does not decide on the most efficient alternative (implying the need to seek the minimum costs for each output level. and sales promotion. Numerous academic studies have shown that intense competition in the markets for goods and services of the firm usually forces the manager to make value maximization decisions. short-term firm-growth maximization strategies have often been found to be consistent with long-term value maximization behavior. managers themselves have strong financial incentives to seek profit maximization for their firms. when all costs are taken into account. Thus. While each of the alternative theories of the firm has increased our understanding of how a modern firm behaves.of individuals with widely divergent goals. which in turn. an important basis for returns on common stocks in the long run. As one would expect. managers pursuing their own interests will most likely be replaced. Thus. rather than a single common. Managers who insist on goals other than maximizing shareholder wealth risk being replaced. many other . in almost all such hostile takeovers. a number of academic studies indicate that managerial compensation is closely correlated to the profits generated for the firm. since large firms have advantages in production. identifiable goal. managers are forced to maximize profits in order to maximize firm value. Thus. managers (like other economic entities) have to analyze the costs and benefits of their decisions. An inefficiently managed firm may also be bought out. Similarly. none has been able to completely take the place of the basic profit maximization assumption for several reasons. decisions that appear merely aimed at a satisfactory level of performance turn out to be consistent with value-maximizing behavior. Moreover. are determined by the firm's value (the discounted present value of expected profits). stockholders are primarily interested in their returns on stocks and stock prices. Sometimes. distribution.
Thus. the owner of a firm . however. In other words. BUSINESS VERSUS ECONOMIC PROFITS. This surplus is available to the firm for various purposes. An economist would. The concept of economic profit essentially recognizes that owner-supplied inputs must also be paid for. the resulting profit is often referred to as economic profit. one must have a clear understanding of profits. an accountant would not consider the owner's effort as a cost item. and space) are accounted for in determining costs in the definition used by an economist.goals that do not seem to be oriented to maximizing profits may be intimately linked to value or profit maximization—so much so that the value maximization model even provides an insight into a firm's voluntary participation in charity or other socially responsible behavior. but includes more items in figuring costs. As discussed above. For example. rather than considering only explicit accounting costs. These costs are sometimes referred to as implicit costs—their value is imputed based on a notion of opportunity costs widely used by economists. costs of inputs supplied by an owner are based on the values these inputs would have received in the next best alternative activity. An economist also defines profit as the difference between sales revenue and costs of doing business. While the term profit is very widely used. For illustration. value the owner's service to his firm at what his labor would have earned had he worked elsewhere. Thus. inputs supplied by owners (including labor. It is this concept of profit that is used by economists to explain the behavior of a firm. Profit in accounting is defined as the excess of sales revenue over the explicit accounting costs of doing business. an economist's definition of profit differs from the one used by accountants (which is also usually used by the general public and the business community). assume that the owner of the firm works for ten hours a day at his business. profits are central to the goals of a firm and managerial decision making. to understand the theory of firm behavior properly. an economist will subtract the implicit costs from business profit. Thus. to compute the true profit. capital. If the owner does not receive any salary.
of doing business. a given firm attempts to maximize profits. the total fixed cost does not vary over the short run—only the total variable cost does. however would be positive. called the average cost. economic profits (the excess of accounting profits over implicit costs) would be equal to zero. the firm calculates the marginal cost. The marginal cost at any level of output is the increase in the total cost due to an increase in production by one unit—essentially. If all firms are operating under a competitive market structure. Other firms do the same. the marginal cost is the additional cost of producing the last unit of output. As the fixed costs remain fixed over the short run. it is said to be reaping above-normal profits. Assume that profit is the excess of sales revenue over cost (now assumed to be composed of both explicit and implicit costs). It is important for the firm to also calculate the cost per unit of output. profits decline for all firms. Let us assume throughout the discussion that a firm uses an economist's definition of profits. The total cost is made up of total fixed cost (due to the expenditure on fixed inputs) and total variable cost (due to the expenditure on variable inputs). as discussed above. As pointed out earlier. in equilibrium. Ultimately. In addition to the average cost. important questions remain: How does the firm decide on the output level that maximizes its profits? Should the firm continue to produce at all if it is not profitable? A manufacturing firm. that the profit maximization is the firm's primary goal. The average cost is made up of two components: the average fixed cost (the total fixed cost divided by the number of units of the output produced) and the average variable cost (the total variable cost divided by the number of units of the output produced). motivated by profit maximization. It can also be assumed.will not be in business in the long run until he recovers the implicit costs (also known as normal profit). the average fixed cost declines as the . calculates the total cost of producing any given output level. When a firm makes profits above the normal profits level. accounting profits (equal to explicit costs). Of course. in addition to recovering the explicit costs. HOW A FIRM ARRIVES AT A PROFIT-MAXIMIZING POINT. Given this objective.
level of production increases. however. The combination of the declining average fixed cost (true for the entire range of production) and the Ushaped average variable cost results into an U-shaped behavior of the average total cost. The average variable cost. In other words. often simply called the average cost. for example. given the fixed inputs. without going into finer details. efficiency gains reach a maximum—the decline in the average variable cost eventually comes to a halt. can be $10 per unit of the product under consideration). that the marginal cost curve intersects the average and the average variable cost curves at their minimum cost points. Given the fixed inputs. It is assumed that the firm can sell as many units as it wants at the given market price indicated by this horizontal line. The U-shape of the average variable cost curve is explained as follows. The logic for the shape of the marginal cost curve is similar to that for the average variable cost—both relate to variable costs. p is the firm's average . First decreasing and then increasing average variable cost lead to the U-shape for the average variable cost. in addition to the three cost curves. After this point. the average variable cost starts increasing as the level of production continues to increase. the horizontal line is the demand curve a perfectly competitive firm faces in the market—it can sell as many units of output as it deems profitable at price "p" per unit (p. the average variable cost refers to the average variable cost per unit of output produced. This is caused by increased efficiency due to specialization and other reasons. economists refer to this as the U-shaped nature of the average variable cost. on the other hand. But while the marginal cost refers to the increase in total variable cost due to an increase in the production by one unit. As more and more variable inputs are used in conjunction with the given fixed inputs. first decreases and then increases. output of the relevant product increases more than proportionately as the levels of variable inputs used increase. Essentially. In a graphic rendering of this concept there would be a horizontal line. It is important to notice. The marginal cost also displays a U-shaped pattern—it first decreases and then increases.
While every firm's primary motive is to maximize profits. similar to that applied to firms or producers. leads to lower. Since the firm receives p dollars for every successive unit it sells. in general. like firms. depends on the structure of the market it is operating under. in general. consumers are assumed to be maximizing their utility or satisfaction. Nevertheless. the consumer's income also . are subject to constraints—their consumption and choices are limited by a number of factors. the addition to total production beyond the point where marginal revenue equals marginal cost. not higher. the theory of consumer behavior. including the amount of disposable income (the residual income after income taxes are paid for). In other words. consumers. The decision to consume by consumers is described by economists within a theoretical framework usually termed the theory of demand. studying the theory of consumer behavior is quite important. While firms are assumed to be maximizing profits. In other words. Of course. First. Second. they consume what firms produce. the lower the product's price the more a consumer buys. THE THEORY OF CONSUMER BEHAVIOR Consumers play an important role in the economy since they spend most of their incomes on goods and services produced by firms. In general. p is also the marginal revenue for the firm. profits. the price of the product determines how much of the product the consumer buys.revenue per unit of output. provide greater utility to a consumer. its output decision (consistent with the profit maximizing objective). Before we discuss important market structures. Thus. the marginal cost will be higher than the marginal revenue. The demand for a particular product by an individual consumer is based on four important factors. given that all other factors remain unchanged. more goods and services will. we briefly examine another key economic concept. What is the ultimate objective of a consumer? Economists have an optimization model for consumers. when its marginal revenue equals marginal cost. If the firm produces beyond this point of equality between the marginal revenue and marginal cost. A firm maximizes profits.
Again. As price increases. the total of individual supplies yields the market supply for a particular commodity. Individual consumer demands thus provide the basis for the market demand for a product. given all other factors. in general. the market demand curve shows quantities of the commodity demanded at different prices. a consumer buys more of a commodity the greater is his or her income. The interaction between market demand and supply determines the equilibrium or market price (where demand equals supply). in turn. forms the basis for profits for the firm producing that product. the quantity supplied increases.determines how much of the product the consumer is able to buy. As price increases. quantity demanded falls. Shifts in demand curve and/or supply curve lead to changes in the equilibrium price. given all other factors. Third. THEORIES ASSOCIATED WITH DIFFERENT MARKET STRUCTURES . the market supply curve shows quantities of the commodity supplied at different prices. Most important of all. The market demand plays a crucial role in shaping decisions made by firms. As mentioned earlier. given that all other factors remain constant. consumer tastes and preferences also affect consumer demand. The amount supplied by an individual firm depends on profit and cost considerations. prices of related products are also important in determining the consumer's demand for the product. a producer produces the profit maximizing output. In general. The market price and the price mechanism play a crucial role in the capitalist system—they send signals both to producers and consumers. Finally. The total of all consumer demands yields the market demand for a particular commodity. it helps in determining the market price of the product under consideration which.
There is no industry in the world that can be considered perfectly competitive in the strictest sense of the term. as the firm can sell additional units at . buyers do not care from whom they buy so long as the price charged is also the same. Each individual simply decides how much to buy or sell at the given market price. The market for wheat. The first condition. oligopoly.As mentioned earlier. and monopoly. existence of many buyers and sellers. Perfect competition is the idealized version of the market structure that provides a foundation for understanding how markets work in a capitalist economy. monopolistic competition. However. for example. while not meeting all three conditions. Some markets for agricultural commodities. and perfect mobility of resources or factors of production. requires that the product sold by any one seller is identical with the product sold by any other supplier—if products of different sellers are identical. As pointed out earlier. can be considered a reasonable approximation. in order to maximize profits. existence of many buyers and sellers. there are token examples of industries that come quite close to having perfectly competitive markets. The implication of the third condition is that resources move to the most profitable industry. come reasonably close to being characterized as perfectly competitive markets. the market price for the product is also the marginal revenue. firms' profit maximizing output decisions take into account the market structure under which they are operating. also leads to an important outcome: each individual buyer or seller is so small relative to the entire market that he or she does not have any power to influence the price of the product under consideration. a perfectly competitive firm will stop production where marginal revenue equals marginal cost. There are four kinds of market organizations: perfect competition. In the case of a perfectly competitive firm. Three conditions need to be satisfied before a market structure is considered perfectly competitive: homogeneity of the product sold in the industry. the homogeneity of product. The second condition. PERFECT COMPETITION. a supplier has to look at the cost and revenue sides.
relative ease of entry into the industry is considered another important requirement of a monopolistically competitive market organization. the products are not considered identical. A monopolist must reduce price to increase sales. The sellers under monopolistic competition differentiate their product. since the firm differentiates its products from those of others. This characteristic is often called product differentiation. Many industries that we often deal with have market structures that are characterized by monopolistic competition or oligopoly. Thus.the going market price. MONOPOLISTIC COMPETITION. a monopolist's price is always above the marginal revenue. however. when the horizontal line is above the average cost at the profit maximizing output). it will actually shut down the production right away if the price is less than the average variable cost. The price . unlike under perfect competition. As a result. even though a monopolist firm also produces the profit maximizing output. Usually if an industry has 50 or more firms (producing products that are close substitutes of each other). As in the case of perfect competition. This is not so for a monopolist. As in the case of perfect competition. A firm under monopolistic competition has a bit of control over the price it charges. A firm would exit the market if at the profit maximizing point the horizontal line is below the average cost curve. it does not produce to the point where price equals marginal cost (as does a perfectly competitive firm). monopolistic competition is characterized by the existence of many sellers. where marginal revenue equals marginal cost. a firm under monopolistic competition determines the quantity of the product to produce based on the profit maximization principle—it stops production where marginal revenue equals marginal cost of production. Regarding entry and exit decisions. Apparel retail stores (with many stores and differentiated products) provide an example of monopolistic competition. it is said to have a large number of firms. one can now state that additional firms would enter an industry—whenever existing firms are making above normal profits (that is. one very important difference between perfect competition and monopolistic competition. In addition. There is.
such as the automobile industry. Thus. the cost per unit of product falls from the use of any plant (generally. In the United States.associated with the product (at the equilibrium or profit maximizing output) is higher than marginal cost (which equals marginal revenue). Unlike under monopolistic competition. These barriers can exist because of large financial requirements. and the quantity produced is simultaneously lower. The interdependence. or simply existence of patent rights with the firms currently in the industry. it has perceptible effects on the sales and profits of its competitors in the industry. Oligopoly is a fairly common market organization. barriers to entry to an oligopolistic market. OLIGOPOLY. though not insurmountable. both the steel and automobile industries (with three or so large firms) provide good examples of oligopolistic market structures. if an oligopolistic firm changes its price or output. The net result of the profit maximizing decisions of monopolistically competitive firms is that price charged under monopolistic competition is higher than under perfect competition. Thus. up to a point). . Probably the most important characteristic of an oligopolistic market structure is the interdependence of firms in the industry. actual or perceived. arises from the small number of firms in the industry. availability of raw materials. Economies of scale in production implies that as the level of production rises. economies of scale lead to an obvious advantage for a large producer. Several industries in the United States provide good examples of oligopolistic market structures with obvious barriers to entry. access to the relevant technology. however. Thus. There are huge. an oligopolist always considers the reactions of its rivals in formulating its pricing or output decisions. where significant financial barriers to entry exist. production under monopolistic competition does not take place to the point where price equals marginal cost of production. An oligopolistic industry is also typically characterized by economies of scale.
In such a case the average cost of production keeps falling and reaches a minimum at an output level that is sufficient to satisfy the entire market. Provision of local telephone services in the United States provides an example of such a monopoly. For this reason. rivals do not match the price increase. Monopoly can be considered as the polar opposite of perfect competition. rival firms will be eliminated until only the strongest firm (now the monopolist) is left in the market. several industries in the United States have monopolies. A good example of a natural monopoly is the electricity industry. a monopoly may arise due to declining cost of production for a particular product. as can ownership of critical raw materials (to produce a good) by a single firm. Natural monopolies are usually regulated by the government. If an oligopolistic firm cuts its price. Generally speaking. Finally. There are many factors that give rise to a monopoly. however. it is met with price reductions by competing firms. One of these circumstances refers to an oligopoly in which there are asymmetric reactions of its rivals when a particular oligopolist formulates policies. if it raises the price of its product. however. A monopoly. which reaps the benefits of economies of scale and yields decreasing average cost. Local electricity companies provide an example of a monopolist.There is no single theoretical framework that provides answers to output and pricing decisions under an oligopolistic market structure. MONOPOLY. It is a market form in which there is only one seller. prices may remain stable in an oligopolistic industry for a prolonged period. can also be legally created by a government agency when it sells a market franchise to sell a particular product or to provide a particular service. Often a monopoly so established is also regulated by the appropriate government agency. Patents can give rise to a monopoly situation. at first glance. Such an industry is popularly dubbed as the case of a natural monopoly. While. price and output decisions of a monopolist are similar to a monopolistically competitive firm. a monopolistic form may appear to be rarely found market structure. Analyses exist only for special sets of circumstances. In such an industry. with the major distinction that there are a large .
While a manager does not solve the optimization problem. TOOLS OF DECISION SCIENCES AND MANAGERIAL ECONOMICS Managerial decision making uses both economic concepts and tools. In determining the output level consistent with the maximum profit.number of firms under monopolistic competition and only one firm under monopoly. statistical estimation. Thus. numerical analysis. and game theory. and techniques of analysis provided by decision sciences. it nevertheless suggests that managerial decisions are necessarily constrained by the market structure under which a firm operates. consistent with stated managerial objectives. Nevertheless. While most of these methodologies are fairly technical. In the profit . MARKET STRUCTURES AND MANAGERIAL DECISIONS. While the preceding discussion of market structures does not cover the full range of managerial decisions. at any output level. constrained by cost and capacity considerations. a monopolist also does not produce to the point where price equals marginal cost (a condition met under a perfectly competitive market structure). Optimization techniques are probably the most crucial to managerial decision making. As a result. Given that alternative courses of action are available. The major categories of these tools and techniques are: optimization. he or she may use the results of mathematical analysis. the manager attempts to produce the most optimal decision. forecasting. the price charged by a monopolist is higher than the marginal revenue. an optimization problem can be stated as maximizing an objective (called the objective function by mathematicians) subject to specified constraints. the first three are briefly explained below to illustrate how tools of decision sciences are used in managerial decision making. the firm maximizes profits. Managerial decisions both in the short run and in the long run are partly shaped by the market structure relevant to the firm. OPTIMIZATION.
Suppose a statistician has data on sales of American-made automobiles in the United States for the last 25 years. This condition is obtained from an optimization exercise. A number of statistical techniques are used to estimate economic variables of interest to a manager. Assume that the relationship between the time series on sales of American-made automobiles and the real disposable income of . that is. a firm may want to estimate its cost function. and is used to develop a mathematical model showing how a set of variables are related. An automobile industry example can be used for the purpose of illustrating the forecasting method that employs simple regression analysis. He or she has also determined that the sale of automobiles is related to the real disposable income of individuals. a manager may want to know the average price received by his competitors in the industry. In other cases. For example. The estimates of costs and demand are usually based on data supplied by the firm. the profit maximizing condition requires that the firm choose the production level at which marginal revenue equals marginal cost. Thus. Estimating a relationship among variables requires a more advanced statistical technique. the conditions for the optimal decision may be different. they are much more advanced. In this case.maximization example. the simple statistical concepts of mean (average) and standard deviation are used. A firm may also want to know the demand function of its product. This mathematical relationship can also be used to generate forecasts. Depending on the problem a manager is trying to solve. The statistician also has available the time series (for the last 25 years) on real disposable income. the relationship between a cost concept and the level of output. The statistical estimation technique employed is called regression analysis. In some cases. statistical estimation techniques employed are simple. STATISTICAL ESTIMATION. as well as the standard deviation (a measure of variation across units) of the product price under consideration. the relationship between the demand for its product and different factors that influence it.
planning for the future is a critical aspect of managing any organization—business. Intuition. the forecaster can identify the general . that is. for example. or otherwise. such as forthcoming years' sales volume projections. this forecasting technique bases the future forecast on the past data. Forecasting is a method or a technique used to predict many future aspects of a business or any other operation. for instance. There are numerous forecasting techniques that can be used to accomplish this goal. the long-term success of any organization is closely tied to how well the management of the organization is able to foresee its future and develop appropriate strategies to deal with the likely future scenarios. While the term "forecasting" may appear to be rather technical. to convert a feeling about the future outcome into a precise number that can be used. however. Suppose that a forecast expert has been asked to provide quarterly estimates of the sales volume for a particular product for the next four quarters. can provide such a projection based on the experience of the firm during the last 25 years. and an awareness of how well the economy is doing may give the manager of a business firm a rough idea (or "feeling") of what is likely to happen in the future. A fairly rigorous mathematical technique is used to find the straight line that most accurately represents the relationship between the time series on auto sales and disposable income. a retailing firm that has been in business for the last 25 years may be interested in forecasting the likely sales volume for the coming year. FORECASTING. How should one go about preparing the quarterly sales volume forecasts? One will certainly want to review the actual sales data for the product in question for past periods. In fact. Forecasting methods can help predict many future aspects of a business operation. nonprofit. good judgment. It is not easy. as a projection for next year's sales volume.consumers is actually linear and it can thus be represented by a straight line. Using these historical data. A forecasting technique. For example. Suppose that the forecaster has access to actual sales data for each quarter during the 25-year period the firm has been in business.
Thus by reviewing historical data. Read more: Managerial Economics benefits http://www. for example— examines the cause-and-effect relationships of this variable with other relevant variables.referenceforbusiness.level of sales.html#ixzz0hO1TK4lt . Thus. this category of forecasting techniques uses past time series on many relevant variables to forecast the volume of sales in the future. such as the level of consumer confidence. such as. historical data on these factors (variables) can also be used to generate forecasts of future sales. if the forecaster is able to identify the factors that influence sales. For illustration. consider a forecasting method in which a statistician forecasting future values of a variable of business interest—sales. peak sales occurring around the holiday season. Understanding such a pattern can often lead to better forecasts of future sales of the product.com/encyclopedia/Man-Mix/ManagerialEconomics. a regression equation is estimated to generate future forecasts (based on the past relationship among variables). the interest rate at which consumers can finance their excess spending through borrowing. There are many forecasting techniques available to the person assisting the business in planning its sales. A further review of the data may reveal some type of seasonal pattern. Under this forecasting technique. He or she can also determine whether there is a pattern or trend. In addition. and the state of the economy represented by the percentage of the labor force unemployed. such as an increase or decrease in sales volume over time. the forecaster can often develop a good understanding of the pattern of sales in the past periods. changes in consumers' disposable incomes.
Decision relating to demand. DEAN. ii) Managerial Economics . 4. Decision related to Cost and production. 5. 2. Macro economic factor.Managerial Economics is often interchangeable with Business Economics. 3.lays more emphasis on the managerial functions in any business firm. . Decision relating to profit management. Decision relating to price and market. Managerial functions are decision making and forward planning.means Economics necessary to be understood for running any business. though there is some difference between these two terms: i) Business Economics . author of the first managerial economics text books defines managerial economics as "the use of economic analysis in the formulation of business policies" SCOPE & IMPORTANCE OF MANAGERIAL ECONOMICS: Out of two major managerial functions served by the subject matter under managerial economics are decision making and forward planning: Lets explore the scope for decision making: 1.
Economists also are comfortable with probabilities and will build models incorporating them.Role of managerial economist When an economist needs a price. interest rate or other quantity to use in an analysis. We are trained in doing simulation studies. We are trained in doing simulation studies.Economists are trained to think in terms of marginal changeEconomists are generally well-versed in mathematics and statistics and tend to approach problems using those tools. . he will tend to look to the product and financial markets for an answer rather than "building it up" from accounting costs. interest rate or other quantity to use in an analysis. he will tend to look to the product and financial markets for an answer rather than "building it up" from accounting costs. Economists also are comfortable with probabilities and will build models incorporating them. When an economist needs a price. Economists are trained to think in terms of marginal change Economists are generally well-versed in mathematics and statistics and tend to approach problems using those tools.
whether at all a company needs to invest in a certain product based on External Factors is a Crucial Decision to make. it is very critical to keep track of Changing Consumer Preferences Potential Product Demand Resource Availabilty and Supply Constraints. That makes a managerial economist well equipped with Theorotical and practical (application based) knowledge. A managerial economist can judge these factors and provide a practical decision based on Cost-Benefit Analysis. Knowing the Micro and Macro economics is the edge where any managerial economist scores over others. . if any Domestic and Overseas Competition A managerial economist helps in such critical factor analysis. For any company. He/She is well aware of the Economical Aspects combined with Business Decision Making. Most important of all.Roles and responsibilities of managirial economist A Managerial Economist is well acquainted with Micro and Macro aspects of the Economy.
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