Economics and Managerial

Decision Making
• Economics is “the study of the behavior of human beings in
producing, distributing and consuming material goods and
services in a world of scarce resources.”
• Management is the discipline of organizing and allocating a
firm’s scarce resources to achieve its desired objectives. Involves
the ability to organize and administer various tasks in pursuit of
certain objectives.
• How does managerial economics differ from “regular” economics?
• There is no difference in the theory; standard economic theory
provides the basis for managerial economics.
• The difference is in the way the economic theory is applied.
 Definitions of Managerial
Economics
• Integration of economic theory with business
practice for the purpose of facilitating decision
making and forward planning by management. –
Prof. Spencer Sigelman.
• The purpose of Managerial economics is to show
how economic analysis can be used in
formulating business policies – Prof. Joel Dean
• Managerial economics is the use of economic
analysis to make business decisions involving
the best use (allocation) of an organization’s
scarce resources.
 Introduction. The nature of managerial economic decision making

The role of managerial economics in managerial decision making

Managerial decision problems

Product price and output
Make or buy
Production technique
Internet strategy
Advertising media and intensity
Investment and financing

Economic concepts Decision making tools

Theory of consumer behaviour Numerical analysis
Theory of firm Statistical analysis
Theory of market structures and Forecasting
pricing Game theory
Optimisation

Managerial Economics
Use of economics concepts and
decision making tools to solve
managerial decision problems

Optimal solutions
Opportunity Cost
• Definition– the cost expressed in
terms of the next best alternative
sacrificed
• Helps us view the true cost of
decision making
• Implies valuing different choices.
Production Possibility Frontier
• Show the different combinations of goods
and services that can be produced with a
given amount of resources
• No ‘ideal’ point on the curve
• Any point inside the curve – suggests
resources are not being utilized efficiently
• Any point outside the curve – not attainable
with the current level of resources
• Useful to demonstrate economic growth and
opportunity cost
 Production Possibility Frontiers
If the country is at point A on
the PPF It can produce the
combination of Yo capital
goods and Xo consumer
goods
Capital Goods Assume a country can
produce two types of
Ym goods with its resources –
capital goods and
consumer goods

If it devotes all resources to capital goods it

could produce a maximum of Ym.
Yo A
If it devotes all its resources to consumer
goods it could produce a maximum of Xm

If it reallocates its resources

(moving round the PPF from A
to B) it can produce more
Y1 B consumer goods but only at
the expense of fewer capital
goods. The opportunity cost of
producing an extra Xo – X1
consumer goods is Yo – Y1
capital goods.

Xo X1Xm Consumer Goods

 Production Possibility
Frontiers
Capital Goods
Production It can only produce at
points outside the PPF
inside the PPF
if it finds a way of
– e.g. point
expanding its B
means or
resources theimproves
C the productivity of
Y1 country is not
those resources it
A usinghas.
already all This
its will

.
Yo resources
push the PPF further
outwards.

Xo X1
Consumer Goods
Positive and Normative Economics

• Health care can be

improved with more tax
• Positive Statements:
funding  Capable of being verified
or refuted by resorting to
• Pollution control is fact or further
effective through a investigation
system of fines
• Normative Statements:
• Society ought to provide  Contains a value
homes for all judgement which cannot
be verified by resort to
• Any strategy aimed at investigation or research
reducing factory closures
in deprived areas would
be helpful
Micro and Macroeconomics
•2major branches of
economics
• Micro
– derived for Greek
word micros meaning small
• Macro
– derived form Greek
word macros means
aggregative – whole – large
 Microeconomics

• Branch of economics which is concerned with

analysis of behavior of the individual
economic units or variables such as an
individual consumer or a producer or the
price of a particular product.
• Basicallydeals with individual decision
making and the problem of resource
allocation.
• Examines in particular as to how individual
consumers and producers behave and how
their behaviors interact
Importance and uses of microeconomics
• Explains price determination and allocation of
resources
• Direct relevance in business decision making
• Serves as a guide for business/ production
planning
• Serves as a basis for prediction
• Useful in determination of economic policies of the
government
• Serves as the basis for welfare economics
• Explain the phenomena of international trade
 Macroeconomics
• Branchof economics which deals with the
aggregate behavior of the economy as a
whole
• Macroeconomics is essentially aggregate
economics
• Study of economic system in general
• Study of very large, economy – wide
aggregate variables like national income,
total savings, total consumption, total
investment, money supply, unemployment,
price levels, economic growth rate etc.
Importance of macroeconomics
• Explains
the working of the
economy as a whole
• Knowledge is indispensable for
policy makers
• Usefulfor the planner for preparing
economic plans for the country’s
development
• Helpful in international comparison
Distinction between micro and
macroeconomics

MICRO- MACRO -

• Study of individual • Study of aggregate

• Individualistic • Aggregate approach

approach • Variables – aggregate
• Variables – demand, aggregate
individual demand, supply, price level etc.
supply, price etc.
Review of Economic Terms
• Microeconomics is the study of
individual consumers and producers
in specific markets.
 Supply and demand
 Pricing of output
 Production processes
 Cost structure
 Distribution of income and output
Review of Economic Terms
• Macroeconomics is the study of
the aggregate economy.
 National Income Analysis (GDP)
 Unemployment
 Inflation
 Fiscal and Monetary policy
 Trade and Financial relationships
among nations
Review of Economic Terms
• Scarcity is the condition in which resources are
not available to satisfy all the needs and wants of a
specified group of people.
• Resources are factors of production or inputs.
• Examples:
• Land – All Natural Resources
• Labor – All Human Resources
• Capital – All Manmade Productive Assets
• Entrepreneurship – All Enterprising Skills
Economics and Managerial
Decision Making
• Relationship to other business disciplines
 Marketing: Demand, Price Elasticity
 Finance: Capital Budgeting, Break-Even
Analysis, Opportunity Cost, Economic Value
Added
 Management Science: Linear
Programming, Regression Analysis,
Forecasting
 Strategy: Types of Competition, Structure-
Conduct-Performance Analysis
 Managerial Accounting: Relevant Cost,
Break-Even Analysis, Incremental Cost
Analysis, Opportunity Cost
Economics and Managerial
Decision Making
• Questions that managers must answer:
 What are the risks involved?

• Risk is the chance or possibility that actual future

outcomes will differ from those expected today.
• Types of risks:
• Changes in demand and supply conditions
• Technological changes and the effect of competition
• Changes in interest rates and inflation rates
• Exchange rates for companies engaged in international
trade
• Political risk for companies with foreign operations
Nature of Managerial
Economics
• Managerial economics aims at
providing decision making to firms.
• Itdraws heavily on the prepositions
of micro economic theory that
studies the phenomenon at
individual level i.e. behavior of
individual consumers, households
and firms.
Nature of Managerial
Economics
• The concepts of economics which ME
frequently uses are :
• Elasticity of demand.
• Marginal cost.
• Marginal revenue.
• Market structures and their significance
in pricing policies.
Nature of Managerial
Economics
• ME makes use of both Micro & Macro
economics.
• Micro economics assists the firm in
forecasting & macro economics studies the
aggregate levels. Macro economics
indicates the relationship between, for
example, level of consumption and
national income, level of national income
and employment etc.
Nature of Managerial
Economics
• Thishelps the management in
knowing the level of demand at a
future period of time, based on the
relationship between the national
income and the demand for a
particular product.
• Eg : Demand for cars, televisions,
refrigerators etc can have a impact
of changes in the level of national
income.
Nature of Managerial
Economics
• ME is prescriptive in nature. It
recommends how a thing should be
done in alternative conditions.
• Eg:It may be derived from economic
analysis that it is more profitable to
produce 100 units of a particular
product by using 5 machines and 15
workers than using 2 machines and
25 workers.
Nature of Managerial
Economics
• ME uses a scientific approach. In
practice some firms may use simple
rules based on past experience.
• However,the quality of decisions
made can be improved by using a
systematic approach.
• This is achieved by the study of ME.
Scope of ME
• The scope of ME is so wide that it touches
almost all areas of the manager’s decision
making.
• It deals with demand analysis,
forecasting, production function, cost
analysis, inventory management, resource
allocation, capital budgeting.
• A brief introduction to these areas will
give an idea of the scope of ME.
Scope of ME
• Demand Analysis and forecasting :
• A correct analysis of the future
demand for a companies product
enables a manager to take decisions
related to the production scheduling &
inventory management.
• For this he has to consider things such
as income elasticity and cross
elasticity.
• This process of accessing the future
demand is called as demand
forecasting.
 Scope of ME
• Production function :
• We know that resources are scarce and
have alternative uses. Inputs play a imp.
role in the economics of production.
• The factors of production should be
combined in a particular way to maximize
output.
• Alternatively, when the prices of some
inputs shoots up, a manager has to work
out a change in the use of inputs so as to
bring the total costs of production as low
as possible.
• Thus, production function helps ME.
Scope of ME
• Cost analysis :

• Cost analysis talks of determinants of costs, relationship

between costs and output, forecast of cost and profit etc.
which is essential for managerial decision making.

• Inventory management :

• Large capital of companies is blocked in inventory. If

this capital can be saved, it can be used for alternative
production priorities.

• Tools like ABC analysis etc. help the managers in

deciding the levels of inventory.
Scope of ME
• Pricing :
• Theprice of the product often
determines how much of what
product will be purchased.
• Merely knowing the cost of
production is not enough to set the
price. Various other aspects such as
the market conditions, conditions of
competition, various options
available for pricing also have to be
considered.