 Economics 

is a science that deals with efficient and effective allocation of scarce resources to satisfy
unlimited needs and wants. 
 Management is defined as all the activities and tasks undertaken to achieve goals.
 Planning, organizing, leading and controlling are the four functions of management that make use of or
deal with resources to achieve certain goals, such as in a business setting.=
 MANAGERIAL ECONOMICS is a science that deals with the effective and efficient use of scarce
resources in a business setting. It is simply using the concepts of economics to manage a firm.
 These resources are classified as LAND, LABOR, CAPITAL AND ENTREPRENEURSHIP
 Economics is a social science that studies the efficient and effective allocation of scarce resources
to satisfy unlimited needs and wants of the people.
 Economics has two major branches, microeconomics and macroeconomics.
 Microeconomics deals with decisions of individuals and firms in resource-allocation. Macroeconomics, on
the other hand, looks at the behavior and performance of the economy as whole. Since Managerial
Economics is used by managers in addressing issues in a firm level, this means that this field of study is a
sub-branch of Microeconomics
 Microeconomics is a broader concept as compared to Managerial Economics
 Microeconomics forms the foundation of managerial economics. 

Managerial Economics deals with allocating the scarce resources in a manner that minimizes the cost. As we have
already discussed, Managerial Economics is different from microeconomics and macro-economics. Managerial
Economics has a more narrow scope - it is actually solving managerial issues using microeconomics. Wherever there are
scarce resources, managerial economics ensures that managers make effective and efficient decisions concerning
customers, suppliers, competitors as well as within an organization. The fact of scarcity of resources gives rise to four
fundamental questions:

1. What to produce?
2. How to produce?
3. How many to produce?
4. For whom to produce?

Seven important things to know AND UNDERSTAND about Managerial Economics

1. Managerial Economics can be defined as the blending of economic theory with business practices so as to ease
decision-making and future planning by management.
2. Managerial Economics assists the managers of a firm in a rational solution of obstacles faced in the firm’s activities.
It makes use of economic theory and concepts. It helps in formulating logical managerial decisions.
3. The key of Managerial Economics is the micro-economic theory of the firm. It lessens the gap between economics in
theory and economics in practice. Managerial Economics is a science dealing with effective use of scarce resources.
It guides the managers in taking decisions relating to the firm’s customers, competitors, suppliers as well as relating
to the internal functioning of a firm.
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4. Managerial economics uses both Economic theory as well as Econometrics for rational managerial decision making.
Econometrics is defined as use of statistical tools for assessing economic theories by empirically measuring
relationship between economic variables. It uses factual data for solution of economic problems
5. The study of Managerial Economics helps in enhancement of analytical skills, assists in rational configuration as well
as solution of problems. While microeconomics is the study of decisions made regarding the allocation of resources
and prices of goods and services, macroeconomics is the field of economics that studies the behavior of the
economy as a whole (i.e. entire industries and economies). Managerial Economics applies micro-economic tools to
make business decisions. It deals with a firm.
6. The use of Managerial Economics is not limited to profit-making firms and organizations. But it can also be used to
help in decision-making process of non-profit organizations (hospitals, educational institutions, etc). It enables
optimum utilization of scarce resources in such organizations as well as helps in achieving the goals in most efficient
manner. Managerial Economics is of great help in price analysis, production analysis, capital budgeting, risk analysis
and determination of demand.
7. Managerial Economics is associated with the
economic theory which constitutes “Theory of
Firm”. Theory of firm states that the primary aim
of the firm is to maximize wealth. Decision making
in managerial economics generally involves
establishment of firm’s objectives, identification of
problems involved in achievement of those
objectives, development of various alternative
solutions, selection of best alternative and finally
implementation of the decision.

The role of managerial economist can be summarized as follows:

1. He studies the economic patterns at macro-level and analysis its significance to the specific firm he is working in.
2. He has to consistently examine the probabilities of transforming an ever-changing economic environment into
profitable business avenues.
3. He assists the business planning process of a firm.
4. He also carries cost-benefit analysis.
5. He assists the management in the decisions pertaining to internal functioning of a firm such as changes in price,
investment plans, type of goods /services to be produced, inputs to be used, techniques of production to be
employed, expansion/ contraction of firm, allocation of capital, location of new plants, quantity of output to be
produced, replacement of plant equipment, sales forecasting, inventory forecasting, etc.
6. In addition, a managerial economist has to analyze changes in macro- economic indicators such as national
income, population, business cycles, and their possible effect on the firm’s functioning.
7. He is also involved in advising the management on public relations, foreign exchange, and trade. He guides the
firm on the likely impact of changes in monetary and fiscal policy on the firm’s functioning.
8. He also makes an economic analysis of the firms in competition. He has to collect economic data and examine all
crucial information about the environment in which the firm operates.
9. The most significant function of a managerial economist is to conduct a detailed research on industrial market.
10. In order to perform all these roles, a managerial economist has to conduct an elaborate statistical analysis.
11. He must be vigilant and must have ability to cope up with the pressures.
12. He also provides management with economic information such as tax rates, competitor’s price and product, etc.
They give their valuable advice to government authorities as well.

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PROFIT MAXIMIZATION HYPOTHESIS

Throughout the discussion , we will assume that the main goal of the firm is to maximize profit? Earning a profit is
different from maximizing profit. Maximizing profit involves identifying the best price and quantity (produced) to get
the highest profit as much as possible.

Profit Maximization Rule Definition

The Profit Maximization Rule states that if a firm chooses to maximize its profits, it must choose that level of output
where Marginal Cost (MC) is equal to Marginal Revenue (MR) and the Marginal Cost curve is rising. In other words, it
must produce at a level where MC = MR.

Profit Maximization Formula

The profit maximization rule formula is

MC = MR

Marginal Cost is the increase in cost by producing one more unit of the good.

Marginal Revenue is the change in total revenue as a result of changing the rate of sales by one unit. Marginal Revenue
is also the slope of Total Revenue. This means that this is the
amount to which we expect the Total Revenue to change as
the quantity being sold or demanded changes.

Total Revenue (TR) = Price x Quantity Sold

Profit = Total Revenue (TR)– Total Costs (TC)

or

Net Income = Sales - Expenses (Accounting term)

Therefore, profit maximization occurs at the most significant

gap or the biggest difference between the total revenue and
the total cost.

At A, Marginal Cost < Marginal Revenue, then for each

additional unit produced, revenue will be higher than the cost
so that you will generate more. Why generate more ? This is
because you can still produce more while still having a an additional cost that is lower than the additional revenue.
Sellers have this mindset that they will keep on producing or selling as long the additional cost is lower than the
additional benefit (Cost-Benefit analysis).

At B, Marginal Cost > Marginal Revenue, then for each extra unit produced, the cost will be higher than revenue so that
you will create less.

Thus, optimal quantity produced should be at MC = MR.

You might ask why go for “Q’ to optimize profit when the MR=MC. Why not go for A when MR is greater than MC? If we
are to put values in this discussion, you will realize that even though point A allows the firm to enjoy higher marginal

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( additional) revenue than its additional cost, the profit is still lower compared to when they operate at point Q. This is
the point of PROFIT MAXIMIZATION .

Application of Marginal Cost = Marginal Revenue

The MC = MR rule is quite versatile so that firms can apply the rule to many other decisions.

For example, you can apply it to hours of operation. You decide to stay open as long as the added revenue from the
additional hour exceeds the cost of remaining open another hour.

It can also be applied to advertising. You should increase the number of times you run your TV commercial as long as the
added revenue from running it one more time outweighs the added cost of running it one more time.

Profit Maximization Example

In the early 1960s and before, airlines typically decided to fly additional routes by asking whether the extra revenue
from a flight (the Marginal Revenue) was higher than the per-flight cost of the flight.

In other words, they used the rule Marginal Revenue = Total Cost/quantity

Then Continental Airlines broke from the norm and started running flights even when the added revenues were below
average cost. The other airlines thought Continental was crazy – but Continental made huge profits.

Eventually, the other carriers followed suit. The Limitations of the Profit Maximization Rule (MC = MR)
per-flight cost consists of variable costs,
including jet fuel and pilot salaries, and those are Before we discuss the limitations, please remember that Profit is TR
very relevant to the decision about whether to less TC and TR is Price X Quantity.
run another flight.
Further, changing the price can change the quantity being
However, the per-flight cost also includes demanded, thus changing the TR, the MR and the profit.
expenditures like rental of terminal space,
(As early as now, please do know that Demand and Quantity
general and administrative costs, and so on.
Demanded are different.)
These costs do not change with an increase in
the number of flights, and therefore are
irrelevant to that decision.

Limitations of MR=MC rule

1. Real World Data

In the real world, it is not so easy to know exactly your Marginal Revenue and Marginal Cost of the last products sold.
For example, it is difficult for firms to know the price elasticity of demand ( degree of sensitivity of Demand brought by a
change in price) for their goods – which determines the MR.

2. Competition

The use of the profit maximization rule also depends on how other firms react. If you increase your price, and other
firms may follow, demand may be inelastic (not sensitive to the change in price). But, if you are the only firm to increase
the price, demand will be elastic (sensitive to the change in price).

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3. Demand Factors

It is difficult to isolate the effect of changing the price on demand. Demand may change due to many other factors apart
from price.

4. Barriers to Entry

Increasing prices to maximize profits in the short run could encourage more firms to enter the market. Therefore firms
may decide to make less than maximum profits and pursue a higher market share.

Aside from profit maximization, the other economic They may also pursue non-economic objectives such as:
objectives that a firm may pursue are
1. workplace environment
1. market share 2. product quality
2. profit margin 3. service to community
3. return on investment
4. technological advancement
5. customer satisfaction
6. shareholder value

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