Managerial Economics by Hirschey, Mark 1

Part I: Nature and scope of Managerial

Economics Description
This section explores the use of economic theory in making sound management decision.
Like, in choosing what promotional strategies to be used: social media flat form, print ads, radio
or television, and others.
Learning Objective:
After completing the module, the students are expected to:
1. Establish better understanding of the different economic concepts;
2. Understand the role of the firm’s in the Economy;
3. Identify the different objectives of the Firm’s;
4. Pair some of economic theory and common problem areas in the firms’ operations.
Duration:
Start: October 12, 2020 (12:00nn) End: October 23, 2020 (12:00nn)

What is Economics?
One standard definition for economics is the study of the production, distribution, and
consumption of goods and services. A second definition is the study of choice related to the
allocation of scarce resources. The first definition indicates that economics includes any business,
nonprofit organization, or administrative unit. The second definition establishes that economics is
at the core of what managers of these organizations do. (http://www.opentextbooks.org.hk/)

What is Managerial Economics?

Managerial Economics is a subfield of economics that places special emphasis on the
choice aspect. The purpose of managerial economics is to provide economic terminology and
reasoning for the improvement of managerial decisions.

It applies economic theory and methods to understand different business situations and
assist in different business and administrative decision making. Managerial economics encompasses
economic models that prescribes rules for improving managerial decisions, through the recognition
of how economic forces affect organizations and influence the performance of the firm. Through
the proper understanding of economic forces, management can develop tools for effective forward
business planning and in addressing current business situations.

Managerial economics identifies ways to efficiently achieve goals. For example, suppose an
established brand slowly losing to the new entrant firms in the market, thus the management seeks
re- invent its marketing strategies. Managerial economics can be used to identify changes
 Managerial Economics by Hirschey, Mark 2

in consumer taste and preferences, project demand given the presents of new competitors and
pricing strategies to help create more customer- relevant marketing strategies.

Managerial Economics in a Fast Changing Business Environment

The present business world has become very dynamic, complex, uncertain and risky.
Therefore, taking appropriate, correct and timely decision has become a challenging and tedious
task. The existence/ survival and growth of business basically depends on such decisions.
Undoubtedly, Managerial Economics is a friend, philosopher and guide to the business leaders and
managers. Further, the growing complexity of decision-making process, the increasing use of
economic logic, concepts, theories and tools of economic analysis in the process of decision-making
and rapid increase in the demand for professionally trained managerial man power increased the
importance of the study of managerial economics as a separate discipline of managerial curriculum.
(http://Economics/Managerial%20Economics/mp102.pdf)

“Managerial Economics is economics applied in decision-making. It is a special branch of

economics bridging the gap between the economic theory and managerial practice. Its stress is
on the use of the tools of economic analysis in clarifying problems in organizing and evaluating
information and in comparing alternative courses of action.” -W. W. Haynes

“Managerial Economics is the integration of economic theory with business practice for
the purpose of facilitating decision-making and forward planning by management.” - Spencer &
Siegelman

“The purpose of Managerial Economics is to show how economic analysis can be used in
formulating business policies.” -Joel Dean

Why Managerial Economics Is Relevant for Managers

In a civilized society, we rely on others in the society to produce and distribute nearly all
the goods and services we need. However, the sources of those goods and services are usually
not other individuals but organizations created for the explicit purpose of producing and
distributing goods and services. Nearly every organization in our society—whether it is a
business, non-profit entity, or governmental unit—can be viewed as providing a set of goods,
services, or both. The responsibility for overseeing and making decisions for these organizations
is the role of executives and managers.
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Managerial Economics Is Applicable to Different Types of Organizations

Managerial economics is relevant to non-profit organizations and government agencies
as well as conventional, for-profit businesses. Although the underlying objective may change
based on the type of organization, all these organizational types exist for the purpose of
creating goods or services for persons or other organizations. Economics provides a framework
for analyzing regulation, both the effect on decision making by the regulated entities and the
policy decisions of the regulator.
The role of Managerial Economics to Managerial decision making

Organization Management
Economic
Decision Areas Quantitative
Concepts
Issues
Microeconomic Methods
Problems Theories Statistical analysis
Strategies and more Macroeconomic Forecasting
Theories Methods
Labor Economics Optimization
More…… analysis
More….

Managerial Economics
Use of economic concepts and quantitative methods to solve
management decision problems.

Optimal solutions to management

decision problems

To establish appropriate decision rules, managers must understand the economic

environment in which they operate.
For example, a grocery retailer may offer consumers a highly price-sensitive product,
such as milk, at an extremely low mark- up over cost—say, 1%or 2%—while offering less price-
 Managerial Economics by Hirschey, Mark 4

sensitive products, such as non-prescription drugs, at mark- ups of as high as 40% over cost.
Managerial economics describes the logic of this pricing practice with respect to the goal of
profit maximization.

Similarly, managerial economics can reveal that auto import quotas reduce the availability
of substitutes for domestically produced cars, raise auto prices, and create the possibility of
monopoly profits for domestic manufacturers. It does not explain whether imposing quotas is good
public policy; that is a decision involving broader political considerations. Managerial economics
only describes the predictable economic consequences of such actions.

Managerial economics is also a normative science as it suggests the best course of an action
after comparing pros and cons of various alternatives available to a firm. It also helps in formulating
business policies after considering all positives and negatives, all good and bad and all favours and a
disfavours. Besides conceptual/theoretical study of business problems, practical useful solutions are
also found. For instance, if a firm wants to raise 10% price of its product, it will examine the
consequences of it before raising its price. The hike in price will be made only after ascertaining that
10% rise in price will not have any adverse impact on the sale of the firm.

Managerial economics offers a comprehensive application of economic theory and

methodology to managerial decision making. It is as relevant to the management of nonbusiness,
nonprofit organizations such as government agencies, cooperatives, schools, hospitals, museums,
and similar institutions, as it is to the management of profit-oriented businesses.

What is a Firm?
A. Nature of the Firm
A firm is a collection of resources that is transformed into products demanded by consumers.

Firm exists to produce final goods and services needed by the society, and at the same
time creates employment for the household, while earning profits to the owners who had taken
the risk in putting up a business. Accordingly, Ronald Coase (1937), explain the economic
reasons for the existent of the firm, “firms emerge because of transaction costs… Instead,
individuals provide their services to other individuals inside the firm according to the firm’s
organizational structure. This removes transaction costs that would otherwise been
encountered in the free market”.
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A firm is an association of individuals who have organized themselves for the purpose of
turning inputs into output. The firm organizes the factors of production to produce goods and
services to fulfill the needs of the households. Each firm lays down its own objectives which is
fundamental to the existence of a firm.

The major objectives of the firm are:

 To achieve the Organizational Goal
 To maximize the Output
 To maximize the Sales
 To maximize the Profit of the Organization
 To maximize the Customer and Stakeholders Satisfaction
 To maximize Shareholder’s Return on Investment
 To maximize the Growth of the Organization

Goals of the Firm

A business enterprise is a combination of people, physical and financial assets, and
information (e.g., financial, technical, marketing). People directly involved include customers,
stockholders, management, labor, and suppliers. Society in general is affected by business
because the business community uses scarce resources, pays taxes, provides employment, and
produces much of society’s material and services output.

The model of business is called the theory of the firm. In its simplest version, the firm is
thought to have profit maximization as its primary goal. The firm’s owner manager is assumed
to be working to maximize the firm’s short-run profits. Today, the emphasis on profits has been
broadened to encompass uncertainty and the time value of money. In this more complete
model, the primary goal of the firm is long- term expected value maximization.

Expected value maximization Optimization of profits in light of uncertainty and the

time value of money
B. Measurement of Profit
Measurement of Profit, is the common and mostly used evaluation tool of the firms’
performance. It is generally the reward of the Capitalist for risk and uncertainty in relation to
the creation of business.
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Profit refers to the earnings of the firm after deducting all related cost incurred in the
production and selling of the products, or in other way of stating is the residual of sales revenue
deducting the actual (explicit) cost of doing business. This definition of profit is commonly
referred to as business profit or accounting profit.
Total Sales/Revenue (x) = Number of sold/unit X Selling price of the Commodity Total Cost (x)
= Fixed Cost + Variable Cost Profit (π) = Total Sales – Total Cost

In economic thought, profit is also define as the excess revenue after cost. However, the
efforts and time spent of the entrepreneur in the business, the cost related to miss
opportunities of earnings outside the business, and other implicit cost were not part of the
Accounting profit computation. Thus, Economic Profit, try to calculate for the economic value
of all related implicit cost and be added to the total cost of doing business.
Total Economic Cost (x) = Explicit Cost + Implicit Cost
Economic Profit (π) = Total Sales – Total Economic Cost

For example:

Ye Wanwan and Su Quanci both from a Filipino Chinese family, decided to put up their own Milk
Tea Shop. From the business data they had gathered, the average cost of renting a 15square meter
space is Php 15,000.00, while the unit cost of each regular size of milk tea is Php 24.00, and a total
of Php 10,000.00 for the insurance, business associations and other monthly legal fees. The
business will have a sure sale of 10,000 cups in a month at a price of Php 45.00/cup.
Problem details:
Unit cost Php 24.00/cup Variable cost
Rental cost Php 15,000.00 Fixed cost
Other cost Php 10,000.00 Fixed Cost
Sure Sold out 10,000cups of Milk Tea
Selling Price Php 45.00/ cup

Total cost (x) = Fixed Cost + Variable Cost

Fixed Cost = 15, 000.00 + 10, 000.00
= 25,000.00Php 25, 000.00 is the monthly total fixed cost that the
owners need to pay, with or without ouput.
 Managerial Economics by Hirschey, Mark 7

Variable Cost (1,000cups) = 10,000 x 24.00

= 240,000.00 Php 240,000.00 is the monthly total
variable cost incurred with
10,000cups of milk tea.
Total cost (10,000) = 25, 000.00 + 240, 000.00
= 265, 000.00 Php 265, 000.00 is the monthly Total cost
incurred in producing and selling of 10, 000
cups of milk tea.
Total Sales/Revenue (x) = Number of sold/unit X Selling price of the Commodity
TS (10,000) = 10,000 x 45.00
= 450,000.00 Php450, 000.00 is monthly total sales in selling
10,000cups of Milk tea.
Profit (π) = Total Sales – Total Cost
= 450,000.00 – 265, 000.00
= 185, 000.00 Php 185, 000.00 is the monthly total expected profit from the Milk Tea
business venture by Ye Wanwan and Su Quanci, in a month.

If Ye Wanwan and Su Quanci, who are both a Licensed Architecture, will choose to work in an
Architectural firm, both will be given a Junior Architect position and earned Php 60,000.00each
per month.

Php 60, 000.00each opportunity cost (implicit cost)

Total Economic cost (x) = (Fixed Cost + Variable Cost) + implicit cost

Opportunity cost = 60,000 x 2

= 120, 000.00Php 120, 000.00 is the monthly total
opportunity cost incurred by the owners if
they choose to open a Milk Tea Shop, than
be an employees of a company.
Fixed Cost = 15, 000.00 + 10, 000.00
= 25,000.00Php 25, 000.00 is the monthly total fixed cost that the
owners need to pay, with or without ouput.
Variable Cost (1,000cups) = 10,000 x 24.00
= 240,000.00 Php 240,000.00 is the monthly total
variable cost incurred with
10,000cups of milk tea.
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Total Economic cost (10,000) = 25, 000.00 + 240, 000.00 + 120, 000.00
= 385, 000.00 Php 385, 000.00 is the monthly Total cost
incurred in producing and selling of 10, 000
cups of milk tea.
Total Sales/Revenue (x) = Number of sold/unit X Selling price of the Commodity
TS (10,000) = 10,000 x 45.00
= 450,000.00Php450, 000.00 is monthly total sales in selling
10,000cups of Milk tea.

Economic Profit (π) = Total Sales – Total Economic Cost

= 450,000.00 – 385, 000.00
= 65, 000.00 Php 65, 000.00 is the monthly total expected Economic profit from the
Milk Tea business venture by Ye Wanwan and Su Quanci, in a month.

Firms are established to maximize the value it can provide to all its shareholders and
Managerial Economics can make it happen. Managerial Economics consists of applying
economic principles and concepts towards adjusting with various uncertainties faced by a
business firm, and has a very important role to play by helping managements in successful
decision making and forward planning.