MANAGERIAL ECONOMICS
What is Economics? (Choices, Choices,
Choices)
It is how individuals and societies make
decisions about ways to use scarce
resources to fulfill wants and needs.
The Study of Economics
MACROECONOMICS
 The BIG picture
 Growth, employment, etc.
MICROECONOMICS
 How individuals make economic
decisions
CONCLUSION
Micro and Macro Economics are not
contradictory in nature, in fact, they are
complementary. As every coin has two
aspects- micro and macroeconomics are also
the two aspects of the same coin, where
one’s demerit is others merit and in this
way they cover the whole economy. The only
important thing which makes them different
is the area of application.
Economics: Five Economic Questions
Society must figure it out
 WHAT to produce?
 HOW MUCH to produce?
 HOW to produce it?
 FOR WHOM to produce?
 WHO makes these decisions?
Resources- the things used to make other
goods
BUT, there’s a FUNDAMENTAL PROBLEM:
Scarcity- unlimited wants and needs but
limited resources
Why do we have scarcity? Because ALL
resources, goods and services are limited-
WE MUST MAKE CHOICES!
Why Choices?
We make choices about how we spend our
money, time and energy so we can fulfill
our NEEDS and WANTS.
Wants and Needs, Needs and Wants.
Needs- “stuff” we must have to survive.
Generally: food, shelter, clothing
Wants- “stuff” we would really like to
have (fancy food, a nice house, clothing,
big screen TV’s, jewelry, conveniences.. Production is a co-operative process and
also known as LUXURIES not a job of any single factor.

You can’t have it all, (remember, we have 4 FACTORS OF PRODUCTION

scarcity...) so you have to choose how to
spend your money, time and energy. These
decisions involve picking one thing over
all the other possibilities. and that is
TRADE-OFF!
TRADE-OFFS
1. What you could have done instead of
coming to school or study?
2. Why did you make that trade-off?
A special kind of Trade-Off is an “
OPPORTUNITY COST”.
OPPORTUNITY COST
Three parts of the PRODUCTION Process
The value of the NEXT BEST CHOICE.
Ex: Sleeping is the opportunity cost of
studying for a test
1. Land - Natural Resources (Water,
natural gas, oil, tree) All the stuff
we find on, in, and under the land.
2. Labor - Physical and Intellectual
(labor is manpower).
3. Capital - Tools, Machinery,
Factories (The things we use to make
things) Human Capital is brainpower,
ideas and innovation.
4. Entrepreneurship - Investment
(Investing time, natural resources,
labor and capital are all risks
associated with production.
1. Factors of Production - what we need
to make goods and services.
2. Producers - company that makes goods
and/or delivers services.
3. Consumers - people who buy goods and
services (formerly known as
“stuff”).

When you choose to do one thing, its value

(how much it is worth) is measured by the
value of the NEXT BEST CHOICE. This can be
in time, energy, or even, MONEY.

PRODUCTION (Decision, Decision, Decision)

- is making something; is how many goods

and services a business makes.

GOODS- tangible (you can touch it) products

we can buy.
SERVICES- Work that is performed for others

FACTORS OF PRODUCTION

These are the parts necessary to produce

the finished product.

THE CIRCULAR FLOW MODEL (Produce. Sell.
Receive. Use)
The circular flow model is an economic
model that presents how money, goods, and
services move between sectors in
economic system.
THE CIRCULAR FLOW MODEL
CHAPTER 1: INTRODUCTION TO MANAGERIAL
ECONOMICS (Produce. Sell. Receive. Use)
The study of how to direct scarce resources
in the way that most efficiently achieves
a managerial goal.
MANAGEMENT
Management is the science and art of
getting things done through people in
formally organized groups. It includes a
number of functions: Planning, Organizing,
Staffing, Directing, and Controlling.
Manager
A person who directs resources to achieve
a stated goal.
The manager while directing the
efforts of his staff communicates to them
the goals, objectives, policies, and
procedures; coordinates their efforts;
motivates them to sustain their enthusiasm;
and leads them to achieve the corporate
goals.
MANAGERIAL ECONOMICS
Managerial Economics as a subject gained
popularity in USA after the publication of
an
the book Managerial Economics” by Joel
Dean in 1951.
Managerial Economics refers to the firm’s
decision-making process. It could be also
interpreted as “Economics of Management”.
Managerial Economics is also called as
“Industrial Economics” or “Business
Economics”.
In the words of E. F. Brigham and J. L.
Pappas Managerial Economics is “the
applications of economics theory and
methodology to business administration
practice”.
Managerial economics be defined as a body
of knowledge, techniques and practices
which give substance to those economic
concepts which are useful in deciding the
business strategy of a unit of management.
Therefore, focuses on those tools and
techniques, which are useful in decision-
making.
Managerial economics is primarily concerned
with the application of economic principles
and theories to five types of resource
decisions made by all types of business
organizations.
a. The selection of product or service
to be produced.
b. The choice of production methods and
resource combinations.
c. The determination of the best price
and quantity combination
d. Promotional strategy and activities.
e. The selection of the location from
which to produce and sell goods or
service to consumer.
The scope of managerial economics covers
two areas of decision making
a. Operational or Internal issues
b. Environmental or External issues
OPERATIONAL or INTERNAL ISSUES
Operational issues refer to those, which
wise within the business organization and
they are under the control of the
management.
Those are:
1. Theory of demand and Demand
Forecasting
2. Pricing and Competitive strategy
3. Production cost analysis
4. Resource allocation
5. Profit analysis
6. Capital or Investment analysis
7. Strategic planning
ENVIRONMENTAL or EXTERNAL ISSUES
An environmental issue in managerial
economics refers to the general business
environment in which the firm operates.
They refer to general economic, social and
political atmosphere within which the firm
operates. A study of economic environment
should include:
a. The type of economic system in the
country.
b. The general trends in production,
employment, income, prices, saving
and investment.
c. Trends in the working of financial
institutions like banks, financial
corporations, insurance companies
d. Magnitude and trends in foreign
trade;
e. Trends in labour and capital markets;
f. Government’s economic policies viz.
industrial policy monetary policy,
fiscal policy, price policy etc.
CHAPTER 2: KEY MEASURES AND RELATIONSHIPS
(Produce. Sell. Receive. Use)
Managerial Economics Is Applicable to
Different Types of Organizations
The organization providing goods and
services will often be called a
“business” or a “firm,” terms that
connote a for-profit organization. Wherein
the underlying goal of the organization is
to create profit.
However, managerial economics is relevant
to nonprofit 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.
REVENUE, COST AND PROFIT
  The total monetary value of the goods
or services sold is called revenue.
 The collective expenses incurred to
generate revenue over a period of
time, expressed in terms of monetary
value, are the cost.
 Some cost elements are related
to the volume of sales; that
is, as sales go up, the
expenses go up. These costs are
called variable costs.
 Other costs are largely
invariant to the volume of
sales, at least within a
certain range of sales volumes.
These costs are called fixed
costs.
 Businesses are viable on a
sustained basis only when the
revenue generated by the
business generally exceeds the
cost incurred in operating the
business. The difference
between the revenue and cost
(found by subtracting the cost
from the revenue) is called the
profit.
EXAMPLE:
The students realize they need to
determine whether they can make a profit
from a summer ice cream bar business. They
met the person who operated an ice cream
bar business in the building the previous
summer. He told them last summer he charged
$1.50 per ice cream bar and sold 36,000 ice
cream bars. He said the cost of the ice
cream bars—wholesale purchase, delivery,
storage, and so on—comes to about $0.30
per bar. He indicated his other main
costs—leasing the building, license, local
business association fee, and insurance—
came to about $16,000.
***Determine a rough estimate of the
revenue, costs, and profit if they were to
repeat the outcomes for the prior operator.
Based on this analysis, the students
are confident the summer business venture
can make money. They approach the owner of
the building and learn that if they want to
reserve the right of first option to lease
the building over the summer, they will
need to make a nonrefundable $6000 deposit
that will be applied to the lease. They
proceeded to make that deposit.
A few weeks later, all three students
were unexpectedly offered summer business
internships at a large corporation. Each
student would earn $10,000. However, the
work site for the internships is far from
the beach and they would be in an office
all day. They now must decide whether to
accept the internships and terminate their
plan to run a business at the beach or turn
down the internships.
If you were to decide? what will be your
decision?
ECONOMIC PROFIT VS ACCOUNTING PROFIT
Accounting Profits
Total revenue (sales) minus cost of
producing goods or services. Reported on
the firm’s income statement.
Economic Profits
Total revenue minus total opportunity cost.
OPPORTUNITY COST
Accounting Costs
 The explicit costs of the resources
needed to produce goods or services.
  Reported on the firm’s income where C is the total cost.
statement.
*Note we are measuring economic cost, not
Opportunity Cost accounting cost.
 The cost of the explicit and implicit Since profit is the difference between
resources that are foregone when a revenue and cost, the profit functions will
decision is made. be

Economic Profits π = R − C = $1.2 Q − $40,000

 Total revenue minus total opportunity
cost.
REVENUE, COST AND PROFIT FUNCTION
There is a relationship between the volume
or quantity created and sold and the
resulting impact on revenue, cost, and
profit. These relationships are called the
revenue function, cost function, and
profit function. These relationships can be
expressed in terms of tables, graphs, or
algebraic equations.
In a case where a business sells one kind
of product or service, revenue is the
product of the price per unit times the
number of units sold. If we assume ice cream
bars will be sold for $1.50 per piece, the
equation for the revenue function will be
(P = R - C)
Here π is used as the symbol for profit.
(The letter P is reserved for use later as
a symbol for price.)
AVERAGE COST
The average cost is another interesting
measure to track. This is calculated by
dividing the total cost by the quantity.
The relationship between average cost and
quantity is the average cost function. For
the ice cream bar venture, the equation for
this function would be
AC = C/Q = ($40,000 + $0.3 Q)/Q = $0.3 +
$40,000/Q.
(AC = TC/Q)
A. COMPLETE THE TABLE

R = $1.5 Q
(R= P x Q)

where R is the revenue and Q is the number

of units sold

The cost function for the ice cream bar

venture has two components: the fixed cost B. MAKE A GRAPHICAL PRESENTATION
component of $40,000 that remains the same
regardless of the volume of units and the BREAKEVEN ANALYSIS
variable cost component of $0.30 times the As the sales volume increases, revenue and
number of items. The equation for the cost cost increase and profit becomes
function is: progressively less negative, turns
C = $40,000 + $0.3 Q positive, and then becomes increasingly
(TC= FC + VC) positive. There is a zone of lower volume
levels where economic costs exceed revenues
and a zone on the higher volume levels where
revenues exceed economic costs.
The break-even point is the point at which
total cost and total revenue are equal,
meaning there is no loss or gain for your
small business. In other words, you've
reached the level of production at which
the costs of production equals the revenues
for a product.
When the price and unit contribution
margins are close, most of the revenue
generated from additional sales turns into
profit once you get above the breakeven
level. However, if you fall below the
breakeven level, the loss will grow equally
dramatically as the volume level drops.
Businesses like software providers, which
tend have mostly fixed costs, see a close
correlation between revenue and profit.
Businesses of this type tend to be high
risk and high reward.
On the other hand, businesses that
have predominantly variable costs, such as
a retail grocery outlet, tend to have
relatively modest changes in profit
relative to changes in revenue. If business
level falls off, they can scale down their
variable costs and profit will not decline
so much. At the same time, large increases
in volume levels beyond the breakeven level
can achieve only modest profit gains
because most of the additional revenue is
offset by additional variable costs.
IMPACT OF PRICE CHANGES
To examine the impact of price and
determine a best price, we need to estimate
the relationship between the price charged
and the maximum unit quantity that could be
sold. This relationship is called a demand
curve. Demand curves generally follow a
pattern called the law of demand, whereby
increases in price result in decreases in
the maximum quantity that can be sold.
The demand curve will move downward from
the left to the right, which expresses the
law of demand—as the price of a given
commodity increases, the quantity demanded
decreases, ceteris paribus.
We will consider a simple demand curve for
the ice cream venture. We will assume that
since the operator of the business last
year sold 36,000 units at a price of $1.50
that we could sell up to 36,000 units at
the same price this coming summer. Next,
suppose the students had asked the prior
operator how many ice cream bars he
believes he would have sold at a price of
$2.00 and the prior operator responds that
he probably would have sold 10,000 fewer
ice cream bars. In other words, he
estimates his sales would have been 26,000
at a price of $2.00 per ice cream bar.
P = 3.3 − 0.00005 Q
where P is price and Q is the maximum
number of ice cream bars that will sell at
this price.
*compute for the prices with the given
quantity and make a graphical presentation
In a fixed price market, the seller
decides a price and the buyers respond
with the volume of demand. However, in
economics, the common practice is to
describe the demand curve as the highest
price that could be charged and still sell
a quantity Q.
We can use the stated relationship in the
demand curve to examine the impact of
price changes on the revenue and profit
functions. (The cost function is
unaffected by the demand curve.) Again,
with a single type of product or service,
revenue is equal to price times quantity.
By using the expression for price in terms
of quantity rather than a fixed price, we
can find the resulting revenue function.
R = P Q = (3.3 − 0.00005 Q) Q = 3.3 Q −
0.00005 Q2.
By subtracting the expression for the cost
function from the revenue function, we get
the revised profit function:
π = (3.3 Q − 0.00005 Q2) − (40,000 +
$0.3 Q) = –0.00005 Q2 + 3 Q − 40,000.
*Note that the revenue and profit functions
are curved since they are quadratic
functions. From the graph of the profit
function, it can be seen that it is possible
to earn an economic profit with a quantity
as low as 20,000 units; however, the price
would need to be increased according to the
demand curve for this profit to
materialize. Additionally, it appears a
higher profit is possible than at the
previously planned operation of 36,000
units at a price of $1.50. The highest
profitability appears to be at a volume of
about 30,000 units. The presumed price at
this volume based on the demand curve would
be around $1.80.
The graph of a quadratic function is a curve
called a parabola. Parabolas may open
upward or downward and vary in "width" or
"steepness", but they all have the same
basic "U" shape. *Compute for the prices
with the given quantity and make a
graphical presentation.
MARGINAL ANALYSIS
Marginal analysis is an examination of the
associated costs and potential benefits of
specific business activities or financial
decisions. The goal is to determine if the
costs associated with the change in
activity will result in a benefit that is
sufficient enough to offset them.
For example, if a company has room in its
budget for another employee and is
considering hiring another person to work
in a factory, a marginal analysis indicates
that hiring that person provides a net
marginal benefit. In other words, the
ability to produce more products outweighs
the increase in labor costs.
Marginal in economics means having a little
more or a little less of something. It
refers to the effects of consuming and/or
producing one extra unit of a good or
service.
Economists analyze relationships like
revenue functions from the perspective of
how the function changes in response to a
small change in the quantity. These
marginal measurements not only provide a
numerical value to the responsiveness of
the function to changes in the quantity but MR > MC means the last unit of the control
also can indicate whether the business variable increased benefits more than it
would benefit from increasing or decreasing increased costs.
the planned production volume and in some
MR < MC means the last unit of the control
cases can even help determine the optimal
variable increased costs more than it
level of planned production.
increased benefits.
The marginal revenue measures the change in
If a company's marginal revenue is less
revenue in response to a unit increase in
than the marginal cost of producing more
production level or quantity. The marginal
units, it's an indication that the company
cost measures the change in cost
is producing too much. On the other hand,
corresponding to a unit increase in the
if a company's marginal revenue is greater
production level. The marginal profit
than its marginal cost, it indicates that
measures the change in profit resulting
the company is not producing enough units.
from a unit increase in the quantity.
Marginal measures for economic functions
are related to the operating volume and may
change if assessed at a different operating
volume level.

MARGINAL REVENUE: Change in total

benefits arising from a change in the
control variable, Q:

R
MR 
Q

MARGINAL COST: Change in total costs

arising from a change in the control
variable, Q:

C
MC 
Q

MARGINAL PRINCIPLE: To maximize net

revenue, the managerial control variable
should be increased up to the point where
MB = MC.

If marginal cost and marginal revenue are

equal, your business has reached its
optimal production level. At this level,
efficiency has reached its peak, and you've
maximized profits.
THE SHUTDOWN RULE
You may recall earlier in this chapter
that, before deciding to disregard the
$6000 nonrefundable down payment (to hold
the option to operate the ice cream
business) as a relevant economic cost, the
total cost of operating the business under
a plan to sell 36,000 ice cream bars at a
price of $1.50 per item would have exceeded
the expected revenue. Even after further
analysis indicated that the students could
improve profit by planning to sell 30,000
ice cream bars at a price of $1.80 each, if
the $6000 deposit had not been a sunk cost,
there would have been no planned production
level and associated price on the demand
curve that would have resulted in positive
economic profit. So the students would have
determined the ice cream venture to be not
quite viable if they had known prior to
making the deposit that they could instead
each have a summer corporate internship.
However, having committed the $6000 deposit
already, they will gain going forward by
proceeding to run the ice cream bar
business.
Earlier in the chapter, we cited one
condition for reaching a breakeven
production level where revenue would equal
or exceed costs as the point where average
cost per unit is equal to the price.
However, if some of the costs are already
sunk, these should be disregarded in
determining the relevant average cost. In
a circumstance where a business regards all
fixed costs as effectively sunk for the
next production period, this condition
becomes a statement of a principle known as
the shutdown rule: If the selling price per
unit is at least as large as the average
variable cost per unit, the firm should
continue to operate for at least a while;
otherwise, the firm would be better to shut
down operations immediately.
In this diagram, the firm will be willing
to produce at prices greater than or equal
to Pmin, since this is the minimum value
of the average variable cost curve. At
prices below Pmin, the firm will decide to
shut down and produce a quantity of zero
instead.
Two observations about the shutdown rule
are in order: In a circumstance where a
firm’s revenue is sufficient to meet
variable costs but not total costs
(including the sunk costs), although the
firm may operate for a period of time
because the additional revenue generated
will cover the additional costs, eventually
the fixed costs will need to be refreshed
and those will be relevant economic costs
prior to commitment to continue operating
beyond the near term. If a business does
not see circumstances changing whereby
revenue will be getting better or costs
will be going down, although it may be a
net gain to operate for some additional
time, such a firm should eventually decide
to close down its business. Sometimes, it
is appropriate to shut down a business for
a period of time, but not to close the
business permanently. This may happen if
temporary unfavorable circumstances mean
even uncommitted costs cannot be covered by
revenue in the near term, but the business
expects favorable conditions to resume
later.