Managerial Economics

Handout 01
What is Economics?

Economics is the study of how people allocate scarce resources for production, distribution, and
consumption, both individually and collectively.

 Economics is the science, which studies human behaviour as a relationship between ends
and scarce means, which have alternative uses.
 Two major types of economics are microeconomics, which focuses on the behavior of
individual consumers and producers, and macroeconomics, which examine overall
economies on a regional, national, or international scale.
 Economics is especially concerned with efficiency in production and exchange and uses
models and assumptions to understand how to create incentives and policies that will
maximize efficiency.
 Economists formulate and publish numerous economic indicators, such as gross domestic
product (GDP) and the Consumer Price Index (CPI).
 Capitalism, socialism, and communism are types of economic systems.

What Is Scarcity?

Scarcity refers to the basic economic problem, the gap between limited – that is, scarce –
resources and theoretically limitless wants. This situation requires people to make decisions
about how to allocate resources efficiently, in order to satisfy basic needs and as many
additional wants as possible. Any resource that has a non-zero cost to consume is scarce to
some degree, but what matters in practice is relative scarcity. Scarcity is also referred to as
"paucity."

 Scarcity is when the means to fulfill ends are limited and costly.
 Scarcity is the foundation of the essential problem of economics: the allocation of limited
means to fulfill unlimited wants and needs.
 Even free natural resources can become scarce if costs arise in obtaining or consuming
them, or if consumer demand for previously unwanted resources increases due to changing
preferences or newly discovered uses.

What Is Managerial Economics?

1- Mansfield says:

“... is concerned with the application of economic principles and methodologies to the decision
process within the organization. It seeks to establish rules and principles to facilitate the
attainment of the desired economic goals of management.”

2- Spencer and Siegelman think:

It is “the integration of economic theory with business practice for the purpose of facilitating
decision making and forward planning by management.”

Managerial Economics ---- Dr Humaira Asad ---- Handout 01 ---- 22 Dec 2019
 Model describing how Managerial Economics works

What is Homo Economicus?

Homo economicus is a financial term that some economists use to describe a rational human
being.

KEY TAKEAWAYS
Homo economicus is a model for human behavior, characterized by an infinite capability to make
rational decisions.

 The model is generally used in economics and was first proposed by John Stuart Mills in an
1836 essay defining the characteristics of political economy.
 Modern research has proved that the theory of an economic man is a flawed model.

Understanding Homo Economicus

Homo economicus, or economic human, is the figurative human being characterized by the
infinite ability to make rational decisions. Certain economic models have traditionally relied on
the assumption that humans are rational and will attempt to maximize their utility for both
monetary and non-monetary gains. Modern behavioral economists and neuroeconomists,
however, have demonstrated that human beings are, in fact, not rational in their decision making,
and argue a "more human" subject (that makes somewhat predictable irrational decisions) would
provide a more accurate tool for modeling human behavior.
Transaction Cost Theory

Transaction cost economics is understood as alternative modes of organizing transactions

(governance structures – such as markets, hybrids, firms, and bureaus) that minimize
transaction costs (Williamson 1979). Transaction cost theory (Williamson 1979, 1986) posits that
the optimum organizational structure is one that achieves economic efficiency by minimizing
Managerial Economics ---- Dr Humaira Asad ---- Handout 01 ---- 22 Dec 2019
the costs of exchange. The theory suggests that each type of transaction produces coordination
costs of monitoring, controlling, and managing transactions. Williamson has defined transaction
costs broadly as the costs of running the economic system of firms. He has argued that such costs are
to be distinguished from production costs and that a decision-maker can make a choice to use a
firm structure or source from the market by comparing transaction costs with internal
production costs. Thus, cost is the primary determinant of such a decision.

Managerial Economics ---- Dr Humaira Asad ---- Handout 01 ---- 22 Dec 2019