ACCTG 1102 – MANAGERIAL ECONOMICS

What is Managerial Economics?

It is the study of how to direct scarce resources in the way that most efficiently achieves a
managerial goal.

MANAGEMENT – the process of planning, leading, organizing, and controlling resources to

achieve goals

A manager is an individual who:

1. direct the efforts of others, including those who delegate tasks within an organization;
2. purchase inputs to be used in the production of goods and services
3. are in charge of making other decisions (ex. product price or quality)

ECONOMICS – the study of how society allocates scarce resources to satisfy human wants

Scarcity- limitation that exists in obtaining all the goods and services that people want

What are the economic problems that a society must confront because of scarcity?
1. What to produce and how much?
2. How shall goods be produced?
3. For whom shall goods be produced?

Resources – anything used to produce a good or service or, more generally, to achieve a goal

Economic Resources (Factors of Production):

Land – all natural resources, given by and found in nature and are therefore not man-made
Ex. soil, river, forest, minerals
Rent – income earned from land

Labor – human effort exerted in the production of goods and services

Wages – income earned from labor

Capital – man-made goods used in the production of goods and services

Ex. building, machinery, raw materials
Interest – income earned from capital

Entrepreneur – person who combines the other economic resources for use in the production of
goods and services
Profit – income earned by the entrepreneur

Branches of Economics:
MICROECONOMICS – focuses on the behavior of individual agents within the economy
(ex. budget spending habits of household and individual, savings of individuals,
combination of goods and services that best fits the needs and wants of individuals)
MACROECONOMICS – looks at the economy as a whole
(ex. growth of production, rate of employment, inflationary increase in prices,
government surplus or deficit, import and export)

The Role of Business in the Society

1. To provide goods and services that the consumers need and cannot produce on their own
2. To contribute to the needs of the society and maximize social well-being
3. To maximize profit or value of the firm
The Economics of Effective Management

An effective manager must:

1). Identify Goals and Constraints

Have a well-defined goals because achieving different goals entails making different
decisions. A decision-maker faces constraints that affect the ability to achieve a goal. Constraints
are an artifact of scarcity. It makes it difficult for managers to achieve goals.

2). Recognize the Nature and Importance of Profits

The overall goal of most firms is to maximize profits or the value of the firm.

Opportunity cost – what a firm’s owner give up to use resources to produce goods and services

Two kinds of inputs or resources:

Market-supplied resources – resources owned by others and hired, rented or leased by the firm
(ex. labor service of skilled and unskilled workers, raw materials from commercial
suppliers, capital equipment rented from suppliers)
Explicit cost – monetary payment made for market-supplied inputs

Owner-supplied resources – money provided to the business by its owners, time and labor
services provided by the firm’s owners and any land, building or capital equipment owned and
used by the firm
Implicit cost – nonmonetary opportunity cost of using a firm’s own resources
Ex: 1. The opportunity cost of cash provided to a firm by its owners (equity capital)
2. The opportunity cost of using land or capital owned by the firm
3. The opportunity cost of the owner’s time spent managing the firm or working for
the firm in some other capacity

Total Economic Cost – sum of opportunity costs of market-supplied resources plus opportunity
cost of owner-supplied resources
- the opportunity cost of all resources used by a firm to produce goods and services

ACCOUNTING PROFIT – the difference between total revenue and explicit costs
Accounting Profit = Total revenue – Explicit costs

ECONOMIC PROFIT – the difference between total revenue and total economic cost
Economic Profit = Total revenue – Total economic cost
= Total revenue – Explicit costs – Implicit costs

Since the owners of the firms must cover the costs of all resources used by the firm, maximizing
economic profit, rather than accounting profit, is the objective of the firm’s owners.

The Role of Profits

“By pursuing self-interest – the goal of maximizing profits – a firm ultimately meets the needs of
society” – Adam Smith
Profit signal the owners of resources where the resources are most highly valued by society. By
moving scarce resources to the production of goods most valued by society, the total welfare of
society is improved.
The Five Forces Framework and Industry Profitability

A snip from the book of Michael R. Baye, “Managerial Economics and Business Strategy, 7thE”

Five Forces Framework by Michael Porter

Five categories or forces that impact the sustainability of industry profits:
1) Entry
The ability of existing to sustain profits depends on how barriers to entry affect the ease
with which other firms can enter the industry.
• Formation of new companies
• Globalization strategies by foreign companies
• Introduction of new product lines by existing firms
Barriers to entry:
1. Cost of entry
2. Economies of scale
3. Access to distribution channel
4. Product differentiation
5. Switching cost
6. Government policy
2) Power of Input Suppliers
Industry profits are lower when suppliers have the power to negotiate favorable terms for
their inputs.
3) Power of Buyers
Industry profits are lower when customers or buyers have the power to negotiate
favorable terms for the products or services produced in the industry.
4) Industry Rivalry
Rivalry is less intense in concentrated industries, those with relatively few firms.
5) Substitutes and Complements
Substitute goods – are goods that can satisfy the same necessity and can replace each
other, either perfectly or in part
Complementary goods – are products that are sold separately but are used together, each
creating a demand for the other

The presence of close substitutes decreases industry profitability.

References:
Baye, Michael R. (2010). Managerial Economics and Business Strategy (7th ed.). New York,
NY: McGraw-Hill/Irwin
Thomas, Christopher R. and Maurice, Charles (2016). Managerial Economics: Foundations of
Business Analysis and Strategy (12th ed). New York, NY: McGraw-Hill Education