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MANAGERIAL ECONOMICS 1st Semester AY 2018

Course Instructor: MELANI CORONEL QUILLOY, LPT, MBA

At the end of the lesson students should be able to:

Demonstrate Familiarity with the different subject areas related to managerial economics.

Demonstrate Knowledge of:

- the meaning of managerial economics

- the difference between positive and normative economics.

Demonstrate Understanding of:

- the relationship between managerial economics to other disciplines in business

- the methods used in the development of scientific theories

- how economic theory relates to the organization

Demonstrate Ethical Values in:

Practicing the use of ethical perspectives in working with others and making rational choices.

Some Terminologies:

 business - any situation where there is a transaction between two or more parties.

 manager - A person who directs resources to achieve a stated goal.

 economics - The science of making decisions in the presence of scarce resources.

 microeconomics - Study of behavior of individual economic agents

 model - in general terms is a representation of a system, which is simplified in order to illustrate the
important features and relationships involved.

Managerial Economics definitions

 The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.
(Michael R. Baye)

 To quote Mansfield, “Managerial economics is concerned with the application of economic concepts and
economic analysis to the problems of formulating rational managerial decisions.

 Spencer and Siegelman have defined the subject as “the integration of economic theory with business
practice for the purpose of facilitating decision making and forward planning by management.”

 Managerial economics is about the application of economic theory and methods to business decision-
making. (Nick Wilkinson)

Managerial Economics & Microeconomics

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 Generally, managerial economics applies microeconomic theory to business problems

 Microeconomics studies the actions of individual consumers and firms; managerial economics is an applied
specialty of this branch

 How to use economic analysis to make decisions to achieve firm’s goal of profit maximization

Microeconomics is the study of how individual firms or consumers do and/or should make economic decisions
taking into account such things as:

1. Their goals, incentives, objectives.

2. Their choices, alternatives, problems.

3. Constraints such as inputs, resources, money, time, technology, competition, supply & demand factors.

4. All (cash & noncash) incremental or marginal benefits and costs.

5. The time value of money.

Difference between the emphasis of microeconomics and that of managerial economics

 Microeconomics tends to be descriptive, explaining how markets work and what firms do in practice, while
the managerial economics is often prescriptive, stating what firms should do, in order to reach certain
objectives.

 At this point it is necessary to make another very important distinction: that between positive and normative
economics. This is sometimes referred to as the ‘is/ought’ distinction

 Essentially positive statements are factual statements whose truth or falsehood can be verified by empirical
study or logic. Normative statements involve a value judgement and cannot be verified by empirical study or
logic.

Approaches to the study of economics

Positive Economics

The study of what is - of how the economy actually works

Normative Economics

The study of what should be; it is used to make value judgments, identify problems, and prescribe solutions

Nature and Scope of Managerial Economics

 The most important function in managerial economics is decision making.

 It involves the complete course of selecting the most suitable action from two or more alternatives.

 The primary function is to make the most profitable use of resources which are limited such as labor, capital,
land etc.

 A manager should be very careful in taking decisions as the future is uncertain; he ensures that the best
possible plans are made in the most effective manner to achieve the desired objective which is profit
maximization.
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Issues addressed by managerial economics

1 identification of problem
2 recommending solutions
3 setting of objectives
4 considering constraints
5 identifying strategies
6 measuring variables
8 making assumptions needed for analysis
9 assessing risk and uncertainty
10 resolving conflicts
11 setting criteria for selecting strategies among different possible courses of actions
12 scanning the environment

Relationship with economic theory

The main branch of economic theory with which managerial economics is related is microeconomics, which deals
essentially with how markets work and interactions between the various components of the economy. In particular,
the following aspects of microeconomic theory are relevant:
 theory of the firm
 theory of consumer behaviour (demand)
 production and cost theory (supply)
 price theory
 market structure and competition theory
Relationship with decision sciences
The decision sciences provide the tools and techniques of analysis used in managerial economics. The most
important aspects are as follows:
 numerical and algebraic analysis
 optimization
 statistical estimation and forecasting
 analysis of risk and uncertainty
 discounting and time-value-of-money techniques
Relationship with business functions

All firms consist of organizations that are divided structurally into different departments or units, even if this is not
necessarily performed on a formal basis. Typically the units involved are:

 production and operations

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 marketing

 finance and accounting

 human resources

Elements of managerial economics

BUSINESS FIRMS AND BUSINESS DECISIONS

 Business firms are a combination of manpower, financial, and physical resources which help in making
managerial decisions. Societies can be classified into two main categories - production and consumption.
Firms are the economic entities and are on the production side, whereas consumers are on the consumption
side.

 Business decisions made by the managers are very important for the success and failure of a firm.

 The impact of goods production, marketing, and technological changes highly contribute to the complexity
of the business environment.

Managerial Economics Is a Tool for Improving Management Decision Making

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Steps for Decision Making

 Define the Problem

 Determine the Objective

 Discover the Alternatives

 Forecast the Consequences

 Make a Choice

Scientific theories

A scientific theory does two things:

1. it describes or explains relationships between phenomena that we observe, and

2. it makes testable predictions.

Theories are indispensable to any science, and over time they tend to be gradually improved, meaning that
they fit existing observations better and make more accurate forecasts. When a theory is initially developed it is
usually on the basis of casual observation, and is sometimes called a hypothesis.

This then needs to be tested and in order to do this an empirical study is required.

An empirical study is one which involves real-world observations. Such studies can be either experimental or
observational: the former involve a situation where the investigator can control the relevant variables to isolate the
variables under investigation and keep other factors constant. This is often done in laboratory conditions, for
example in testing the effect of heat on the expansion of a metal.

In business and economic situations this is usually not possible, so an observational study must be performed.
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An investigator may for example be interested in the effect of charging different prices on the sales of a
product. However, it may be difficult to isolate the effect of price from the effects of promotion, competitive factors,
tastes, weather and so on, which also are affecting sales.

The analysis of the data in the study involves statistical techniques, such as regression analysis, and then
inferences are drawn from this regarding the initial theory, in terms of its acceptance or rejection. The whole process
of testing economic theories is often referred to as econometrics.

It is obviously of vital importance to managers to have good theories on which to base their decision-making.

A ‘good’ theory has the following characteristics:

1 It explains existing observations well. (specific)

2 It makes accurate forecasts. (accurate)

3 It involves mensuration, meaning that the variables involved can be measured reliably and accurately.
(measureable)

4 It has general application, meaning that it can be applied in a large number of different situations, not just
a very limited number of cases. (general application)

5 It has elegance, meaning that the theory rests on a minimum number of assumptions. (minimum
assumptions)

Summary

1 Managerial economics is about the application of economic theory and methods to business decision-making.

2 The term business must be considered in very broad terms, to include any transaction between two or more
parties. Only then can we fully appreciate the breadth of application of the discipline.

3 Decision-making involves a number of steps: problem perception, definition of objectives, examination of

constraints, identification of strategies, evaluation of strategies and determination of criteria for choosing among
strategies.

4 Managerial economics is linked to the disciplines of economic theory, decision sciences and business functions.

5 The core elements of the economic theory involved are the theory of the firm, consumer and demand theory,
production and cost theory, price theory and competition theory.
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6 Positive statements are statements of fact that can be tested empirically or by logic.

7 Normative statements express value judgements.

8 The application of economic principles is useful in making both of the above types of statement.

9 A theory is a statement that describes or explains relationships between phenomena that we observe, and which
makes testable predictions.