MANAGERIAL ECONOMICS
LESSON 1: BASIC ECONOMIC CONCEPTS
Why do we have to learn economics?
- Our ordinary life is filled with
economic reality
- Human activity is an endless web
of demand and supply, consume
and produce
- PROVIDES AN INSIGHT ON
ISSUES CONCERNING HUMAN
WELFARE SUCH AS The
problems of unemployment,
inflation, population growth and,
especially, poverty which is
believed to be the root cause of
many social problems
- We are all economist
Economics is a subject that we must
confront in our everyday lives. As a
matter of fact, we already spend a great
deal of our time thinking about economic
issues: prices, buying decisions, use of
our time, to be financially stable and so
on.
Economics and Economy
The word economy comes from a Greek
word “Oikonomia” for "one who
manages a household."
Fundamental economic problem:
scarce resources.
Scarcity... means that society has
limited resources and therefore cannot
produce all the goods and services
people wish to have.
Economics is the study of how society
manages its scarce resources.
Definitions of Economics
- Economics is wealth getting and
wealth using activities of man.
- Economics is the study of
people's way of earning and
enjoying life such that it improves
societies and makes human
civilization possible.
- Economics is a social science
which deals with the production,
exchange, distribution, and
consumption of goods and
services.
- Economics is a social science
that deals with efficient allocation
of scarce resources in order to
satisfy human wants.
Considering all the above definitions,
there are four(4)significant concepts in
the definition of economics: first, as a
science; second, as a social science as
it involves choices; third, it deals with
the concept of scarcity of resources; and
last, it gives us an understanding of
insatiable human wants.
Macroeconomics vs.
Microeconomics
There are two big branches in the
study of economics namely,
macroeconomics and microeconomics
Macroeconomics is concerned with the
study of the aggregate economy or the
economy of one's country as a whole.
Macroeconomics considers the
performance of the four sectors in the
economy; the household, business,
government and foreign sectors.
Macroeconomics talks about Gross
Domestic Product, inflation,
unemployment, imports, exports, etc.
Microeconomics is concerned with the
study of the behavior of individual firm or
industry in the economy or it looks only
at specific economic units of a country.
Microeconomics examines the factors
that influence individual economic
choices and how the choices of various
decision makers (individual consumers,
firm or industry, and government
agency) are coordinated by markets. In
this branch of economics, we deal on
the price of a specific product, the
number of employees employed in a
specific firm, or the expenditures of a
specific firm. Microeconomics also
explains how the demand and supply of
certain product determine equilibrium
price in the market.
Concepts of Economics
The study of economics has its
own language and uses specific terms.
1. Wealth - refers to anything that has a
useful value; it is sometimes classified
as money, stocks, real estate, mineral
deposits, resources and the like.
2. Consumption - refers to the process
of direct utilization of goods and
services by the household sector, the
business sector and the rest of the
world.
3. Production - refers to the creation of
utility or a process by which economic
goods are created.
4. Exchange - is the process of trading
goods and services for money, goods
for goods, goods for services, services
for services. It is a mechanism by which
workers can trade the various products
resulting from specialization and division
of labor.
5. Distribution - is the process of
allocating scarce resources to both the
household and business sector and the
rest of the world.
Classification of Resources
Economists call all the resources
that are used to produce go and
services as factors of production or
simply the inputs or the me for
production. These resources are
classified in economics as labor, capital
and entrepreneur. Land and capital are
non-human resources while labor and
entrepreneurs are human resources.
These resources are scarce, their use
calls for a payment. The payment for the
factors of production is called cost of
production.
1. Land refers to God-given resources
used in production. It includes all natural
resources, such as mineral deposit.
water resources, wild animals and trees
from the forest Payment for the use of
land is called rent.
2. Labor refers to the physical and
mental exertions of man to produce
goods and services. Wages is a general
term used for the payment of labor.
3. Capital is a man-made resource used
to produce other goods and services.
These include all types of structures
used in the process of production such
as buildings, equipment, machineries,
land improvements such as the site of
the Mall of Asia and the PICC. Raw
materials and tools are examples of
capital. Interest is the income payment
for capital.
In economics, money is not
considered as capital. Yes money is
man-made but it cannot be used directly
to produce another good. Can you give
examples of goods that are made out of
money?
4. Entrepreneur is someone who
combines land, labor, and capital to
produce goods and services. He is the
one who assumes the risks in the quest
for profit. Entrepreneur is also the
manager, the supervisor, or the
innovator. He is also the risk-bearer.
Normal profit is the income pay for
entrepreneurs. Normal profit is different
from profit or pure profit. Normal profit is
always positive while profit can be
positive, negative or even zero. Profit =
Total Revenue – Total Cost
How people make decisions
Economics deals with choices and
opportunity cost.
OPPORTUNITY COST
Opportunity cost is an economics term
that refers to the value of what you have
to give up in order to choose something
else.
- There is no such thing as a free
lunch.
- To get one thing, we usually have
to give up another thing.
- Making decisions requires trading
off one goal against another.
Concept of Cost – Implicit and - Bought a franchise for a large
Explicit Cost sum of money. How much money have
been invested otherwise?
Economic (Opportunity) cost include
explicit and explicit cost. - Opportunity cost of owner’s time
above salary paid.
According to the Institute of Cost and
Work Accountants, - How much could the owner get
paid elsewhere?
“Cost implies measurement in monetary
terms of the number of resources used
for the purpose of production of goods
and rendering of services.”

In other words, the cost can be defined

as the amount of money for which any
commodity or service is generated.

Explicit and Implicit Costs

- Explicit costs
ECONOMIC METHODOLOGY
- Tangible expenses: Bills that the
owner has to pay. PROCESS OF ECONOMIC POLICY
FORMULATION
- Wages, insurance, and food
ingredients.

- Implicit costs

- Opportunity costs of doing

business.
Economics being a science is a
- Opportunity cost of capital. systematized body of knowledge. It uses
scientific method in gathering and
analyzing data and making conclusions.
DESCRIPTIVE ECONOMICS – involves
compiling or gathering of data relevant
to a particular problem. Data may come
from primary data or secondary sources.
The facts are then studied, arranged
and generalized upon to come up with
an economic theory, principle or law.
An economic theory is a generalization
based on a variety of facts about why or
how an economic event occurs. Theory,
principle or law is a generalization
because it explains how economic
variables generally behave when certain
conditions exist. For example, an
economic theory would be "if the price of
goods goes up, people will buy less of
it." Economic theories or principles are
useful because they explain certain
economic behavior or conditions. These
are helpful in solving economic
problems and serve as a guide in
economic planning and formulating
economic programs.
An economic theory or principle which is
put into action becomes an economic
policy or applied economics. Policies
are courses of action based on
economic principles and are intended to
solve a specific economic problem and
to achieve economic goals. Economic
policies are typically implemented and
administered by the government.
LESSON 2: SCARCITY AND THE ECONOMIC SYSTEM
The effectiveness of economic policies
can be assessed in either of two ways,
known as positive and normative
economics.
Positive economics attempts to
describe how the economy and
economic policies work without resorting
to value judgments. The distinguishing
feature of positive economics is that it
can be tested and either confirmed or
rejected based on facts of positive
economics because it can be tested by
referring to the statistical data of
Normative economics involves the use
of value judgments to assess the
performance of the economy and
economic policies. For a country to
attain growth, agriculture must be the
top priority over the industry. This
statement belongs to the realm of
normative economics because it is
based on a value judgment and
therefore cannot be tested, confirmed,
or refuted.
Inductive or empirical method is
applied when researches are conducted
from facts to theory or from specific
observations to making generalized
explanations about the observed
phenomenon.
Deductive method precedes from
general behavior to particular behavior
or from theory to facts
SCARCITY AND THE ECONOMIC
SYSTEM
Scarcity is a condition wherein the
needs and wants far exceed the
available resources. It is the basic
economic problem facing all men. This
means that there were never enough
economic goods and services available
to satisfy human wants.
Indicators of Scarcity
The concept of scarcity poses the
reason why we study economics. It is
said that the fundamental problem in
economics is the scarcity of resources.
Take it out and there may be no need to
study economics. Here are some
indicators of scarcity.
1. Why do products have price?
2. Why do resources have ownership?
3. Why are there rich and poor?
4. Why is there a need for man to work?
5. Why is there a need to conserve
natural resources?
THE BASIC ECONOMIC PROBLEMS
The problem in economics is to
determine the most efficient and
effective way to allocate resources.
ECONOMIC SYSTEMS
An economic system is a set of
economic institutions that dominates a
given economy. An institution is a set of
rules of conduct, established ways of
thinking, or ways of doing things. The
principal objective of an e system is to
solve the basic economic problems.
There are four main types of economy
systems: the traditional, market
economy, command economy and a
mixed economy.
1. Traditional Economic System. In
the traditional economic system,
economic decisions are made based on
customs and traditions. The economy
generally repeats the decisions made at
an earlier time or by an earlier
generation. The basic problems of what,
how and for whom to produce are
decided by customs and traditions.
2. Market Economy or Free
Enterprise Economy or Capitalism.
The basic problems of what, how and
for whom to produce are decided by the
market system or simply the demand
and supply condition. The factors of
production are owned and managed by
private individuals or corporations. The
essential characteristics of this
economic system are private ownership
presence of competition, economic
freedom and profit motivation.
3. Command System or the Centrally
Planned Economy or Socialism /
Communism. This economic system
relies on the government to decide how
the country's resources would best be
allocated. The essential characteristics
of the command economy are: no
private ownerships, no free competition,
no profit-motivation and central
economic planning is present. Most
countries with a command economy
have recognized the role of competition
and the importance of international trade
for the growth of the economy and have
started to open up their economy to
eventually adapt the market system,
hence, a transition to a mixed economy.
4. Mixed System or Mixed Economy.
This economic system is a combination
of the market economy and command
economy. Generally, most countries in
the world can be categorized as mixed
economic system like the Philippines.
There is public and private ownership of
resources and enterprises. Countries
already recognize the advantages of a
market system because of competition-
competition makes the market efficient
while the command economic system
recognizes the importance of
government intervention in directing the
economy.
Comparative Characteristic of Pure
Capitalism and Socialism
ECONOMIC GOALS
The Millennium Development Goals
In the beginning of the 21st
century, leaders from both developed
and developing countries gathered and
agreed to achieve concrete, measurable
development objectives adoption of the
Millennium Declaration. These the
Millennium Development Goals (MDGs)
are associated with the United Nations
development agenda to be achieved for
2015. These are:
Goal 1. Eradicate extreme poverty
and hunger - Halve between 1990 and
2015, the proportion of people whose
income is less than the poverty
threshold; the proportion of underweight
among under five-year old children; and
the proportion of families not meeting
100% energy requirement.
Goal 2. Achieve universal primary
education. Ensure that by 2015,
children everywhere, boys and girls
alike, will be able to complete a primary
schooling.
Goal 3. Promote gender equality and
empower women. Eliminate gender
disparity in primary and secondary
education preferably by 2005 and in all
levels of education no later than 2015.
Goal 4. Reduce child mortality.
Reduce the mortality rate between 1990
and 2015.
Goal 5. Improve maternal health.
Reduce maternal mortality ratio by three
quarters, between 1990 and 2015.
Goal 6. Combat HIV/AIDS, malaria
and other diseases - Have halted by
2015 and begun to reverse the spread
of HIV/AIDS.
Goal 7. Ensure environmental
sustainability. Integrate the principle of
sustainable development into country
policies and programs and reverse the
loss of environmental resources. Goal 8.
Develop a global partnership for
development. Develop further an open,
rule-based, predictable, and non-
discriminatory trading and financial
system.
The Sustainable Development Goals
(SDGs)
The Sustainable Development
Goals (SDGs), also known as the
Global Goals, were adopted by the
United Nations in 2015 as a universal
call to action to end poverty, protect the
planet, and ensure that by 2030 all
people enjoy peace and prosperity.
The 17 SDGs are integrated—
they recognize that action in one area
will affect outcomes in others, and that
development must balance social,
economic and environmental
sustainability.
Countries have committed to
prioritize progress for those who're
furthest behind. The SDGs are designed
to end poverty, hunger, AIDS, and
discrimination against women and girls.
The creativity, knowhow,
technology and financial resources from
all of society is necessary to achieve the
SDGs in every context.
How can you contribute as a member
of this society in solving some of our
economic problems?
“The ultimate resource in economic
development is people. It is people, not
capital or raw materials that develop an
economy.”
 Peter Drucker
Scope of Managerial Economics
From the point of view of a firm,
managerial economics, may be defined
as economics applied to “problems of
choice” or alternatives and allocation of
scarce resources by the firms. Thus,
managerial economics is the study of
allocation of resources available to a
firm or a unit of management among the
activities of that unit. Managerial
economics is concerned with the
application of economic concepts and
analysis to the problem of formulating
rational managerial decisions. There are
four groups of problem in both
decisions-making and forward planning.
 Resource Allocation
 Inventory and Queuing Problem
 Pricing Problem
 Investment Problem
Resource Allocation
Scarce resources have to be
used with utmost efficiency to get
optimal results. These include
production programming and problem of
transportation, etc. How does resource
allocation take place within a firm?
Naturally, a manager decides how to
allocate resources to their respective
uses within the firm, while as stated
above, the resource allocation decision
outside the firm is primarily done
through the market. Thus, one important
insight you can draw about the firm is
that withi it resources are guided by
manager in a manner that achieves the
objectives of the firm.
Inventory and Queuing Problem
Inventory problems involve
decisions about holding of optimal levels
of stocks of raw materials and finished
goods over a period. These decisions
are taken by considering demand and
supply conditions. Queuing problems
involve decisions about installation of
additional machines or hiring of extra
labour in order to balance the business
lost by not undertaking these activities.
Pricing Problem
Fixing prices for the products of
the firm is an important decision-making
process. Pricing problems involve
decisions regarding various methods of
prices to be adopted.
Investment Problem
Forward planning involves
investment problems. These are
problems of allocating scarce resources
over time. For example, investing in new
plants, how much to invest, sources of
funds, etc.
Why is managerial economics so
valuable to such a diverse group of
decision makers? The answer to this
Self-Instructional Material 10
question lies in the meaning of the term
managerial economics.
The Manager
A manager is a person who directs
resources to achieve a stated goal. This
definition includes all individuals who
1. Direct the efforts of others,
including those who
delegate tasks within an
organization such as a firm,
a family, or a club;
2. Purchase inputs to be used
in the production of goods
and services such as the
output of a firm, food for the
needy, or shelter for the
homeless; or
3. Are in charge of making
other decisions, such as
product price or quality. A
manager generally has
responsibility for his or her
own actions as well for the
actions of individuals,
machines, and other inputs
under the manager’s
control. This control may
involve responsibilities for
the resources of a
multinational corporation or
for those of a single
household. In each
instance, however, a
manager must direct
resources and the behavior
of individuals for the
purpose of accomplishing
some task. While much of
this book assumes the
manager’s task is to
maximize the profits of the
firm that employs the
manager, the underlying
principles are valid for
virtually any decision
process.
Prof. Evan J Douglas,
‘Managerial economics’ is concerned
with the application of economic
principles and methodologies to the
decision-making process within the firm
or organization under the conditions of
uncertainty. It seeks to establish rules
and principles to facilitate the attainment
of the desired economic goals of
management.”
The subject matter of economics
compromises a number of concepts and
theories.
The application of these concepts and
theories in the process of business
decision making is known as managerial
economics. In other words, managerial
economics undertakes the study of
economic tools that are used in
business decision making.
INTRODUCTION: ECONOMICS AND
MANAGERIAL DECISION MAKING
Managerial Economics is one of the
most important and useful courses in
your curriculum of studies.
Self-Instructional Material 11
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.
These two definitions clearly point to the
relationship between economics and
managerial decision making.
Managerial Economics is the use of
economic analysis to make business
decisions involving the best use of an
organization's scarce resources.
Some of the popular definitions of
managerial economics are given as
follows:
According to Mansfield, "Managerial
economics is concerned with the
application of economic concepts and
economics to the problems of
formulating rational decision making."
In the words of Spencer, "Managerial
economics is the integration of
economic theory with business practice
for the purpose of facilitating decision
making and forward planning by
management
According to Douglas, "Managerial
economics is concerned with the
application of economic principles and
methodologies to the decision-making
process within the firm or organization. It
seeks to establish rules and principles to
facilitate the attainment of the desired
economic goals of management".
Managerial Economics has to meet
the needs of a management executive
in a business organisation. A business
executive is called upon to make a
choice in alternative lines of action as a
part of the process of decision-making.
He is also required to prepare a plan of
action for the future. It should, therefore,
be clear that managerial economics, like
the parent discipline of economics has
to serve as a science of making a
choice. Similarly, like economics, it has
to guide a business executive in making
certain predictions. Besides, there are
other areas where managerial
economics draws heavily from the
science of economics.
 To D.C. Hayue : Managerial
Economics is a "fundamental academic
subject which seeks to understand and
to analyse the problems of business
decision- taking’.
 Savage and Small believe that
Managerial Economics concerns
efficient direction of a business
organisation so as "to make a
productive enterprise out of human and
material resources.
 To Brigham and Pappas, Managerial
Economics is "the application of theory
and methodology to business
administration practice".
 Malcolm McNair and Richard Meriam
have defined Business Economics as
Self-Instructional Material 12
"consisting of the use of economic  Resource allocation
modes of thought to analyse business Decisions
situations.  Pricing Decisions
 Decisions Related to
 Another important definition which is Segmentation
very often quoted is the one by Milton  Expansion Decision
Spencer and Louis Siegelman.
According to them, "Managerial Use of Economic theories, laws and
Economics is the integration of methodologies
economic theory with business practice
Managerial Economics
for the purpose of facilitating decision-
making and forward planning by Application of Quantitative methods
management'.
 Statistical Tools
CONCLUSION  Mathematical Tools
 Econometric Tools
Thus, all the above definitions seem to
suggest the same thing : that
Managerial Economics is a science
dealing with the application of the
economic theory to business
management.

In other words, Managerial Economics

can be viewed to lie between economics
on the one hand and business
management on the other. The former
consists of a theory with an accepted
methodology and an analytical rigour.
The latter, on the other hand is
concerned with the problems of
decision-making. As such, Managerial
Economics provides an insight into the
application of economics to solving
business problems. It does so by
formulating optimal solutions to a wide
range of business problems.

BUSINESS DECISIONS

 Financial Decisions
 Product Decisions

Self-Instructional Material 13
LESSON 3: MARKET DEMAND AND
MARKET SUPPLY
- MICROECONOMICS
- MARKET
- MARKET DEMAND
- MARKET SUPPLY
- MARKET EQUILIBRIUM
- CHANGES IN DEMAND AND
SUPPLY
WHAT IS MICROECONOMICS?
Microeconomics is one of the big
branches of economics that deals with
the study of an individual unit in the
economy such as the individual
consumer and the firm.
THE BASIC DECISION-MAKING
UNITS
- A FIRM IS AN ORGANIZATION THAT
TRANSFORMS RESOURCES
(INPUTS) INTO PRODUCTS
(OUTPUTS). FIRMS ARE THE
PRIMARY PRODUCING UNITS IN A
MARKET ECONOMY.
- AN ENTREPRENEUR IS A PERSON
WHO ORGANIZES, MANAGES, AND
ASSUMES THE RISKS OF A FIRM,
TAKING A NEW IDEA OR A NEW
PRODUCT AND TURNING IT INTO A
SUCCESSFUL BUSINESS.
- HOUSEHOLDS ARE THE
CONSUMING UNITS IN AN
ECONOMY.
THE CIRCULAR FLOW OF
ECONOMIC ACTIVITY
SHOWS THE CONNECTIONS
BETWEEN FIRMS AND HOUSEHOLDS
IN INPUT AND OUTPUT MARKETS
INPUT MARKETS AND OUTPUT
MARKETS
- OUTPUT, OR PRODUCT, MARKETS
ARE THE MARKETS IN WHICH
GOODS AND SERVICES ARE
EXCHANGED.
- INPUT MARKETS ARE THE
MARKETS IN WHICH RESOURCES-
LABOR, CAPITAL, AND LAND USED
TO PRODUCE PRODUCTS, ARE
EXCHANGED.
Self-Instructional Material 14

- Payments flow in the opposite direction
as the physical flow of resources,
goods, and services (counterclockwise).
CIRCULAR FLOW FOR
MICROECONOMICS
The circular flow model for
microeconomics is a model of an
economy showing the interaction among
consumer and producer as they
exchange goods and services in the
product market (upper loop) and the
exchange factors of production in the
resource market (lower loop).
To understand the scope of
microeconomics is to take one particular
industry like the shoe industry. Figure
3.1 shows that there are two groups of
people interacting in an industry, the
PRODUCER and CONSUMER.
MARKET
Markets bring together buyers and
sellers in the product market or resource
market. A market exists as long as there
are buyers and sellers who agree on the
price; hence, a transaction takes place.
The agreed price is called the market
price or equilibrium price.
THE ECONOMICS OF DEMAND
- DEMAND FUNCTION
- DEMAND SCHEDULE
- DEMAND CURVE
DEMAND
Demand refers to the quantity of a
product or service that the buyer is
willing and able to purchase at a certain
price. Of course, buyers want low price
rather than a high price given all other
things or equal (ceteris paribus)
assumptions.
Self-Instructional Material 15
  The demand schedule is the
simplest form of the demand
relationship
 It is merely a list of
prices and
corresponding quantities
of a product or service
that would be demanded
over a particular time
period by some
The Law of Demand individual or group of
individuals at uniform
The Law of Demand states that "the prices
higher the price (P) of the good, the  Table 3.1 shows the
lesser the quantity demanded (Q)," or demand schedule for
alternatively stated, "the lower the price, gasoline
the higher the quantity demanded all  Note the inverse
other thing held equal or constant." relationship between
price and quantity
A buyer is a buyer if he is willing and if demanded; this is
he is able to buy the goods. Willing to referred to as the law of
buy means he really want and has the demand
interest over the goods while able to buy
if he has the ability to pay. Most people
in the field of marketing and selling may
fail to achieve their goals, if they may
not be able to detect who their buyers
are. One may be very good in sales
demonstration making people interested
and willing to buy but do these target
buyers have the money with which to
buy? Otherwise, they are not buyers. Constrained Utility Maximization &
Consumer Behavior (1 of 4)
Which of the following is the reason that
lowers the demand of car in the market?  Demand is based on the
theory of consumer choice
A.Product price increase  Each consumer must
choose among
B. Reduction in registration fee
combinations of goods &
services that maximize
C.Insulting the price of the tire
satisfaction or utility,
D. increasing accident rates subject to a constraint on

Self-Instructional Material 16
 the amount of funds
available
 Economists have identified
two basic reasons for the
increase in quantity
demanded as the result of a
price reduction:
DETERMINANTS OF DEMAND
The demand curve reflects the
relationship between price and quantity
demanded, but price is not the only
variable or factor can influence the
consumer's demand. Other non-price
determinants of demand or the other
factors that may affect demand are as
follows:
1. INCOME. HAS DIRECT RELATION
FOR NORMAL GOODS BUT IF THE
PRODUCT IS AN INFERIOR GOOD,
ITS RELATIONSHIP TO DEMAND IS
INVERSE.
2. TASTES AND PREFERENCES.
HAVE DIRECT RELATION TO
DEMAND. IF ONE'S TASTE IS IN
FAVOR OF THE PRODUCT, THE
HIGHER WILL BE THE DEMAND FOR
IT.
3. PRICES OF RELATED GOODS AND
SERVICES. FOR SUBSTITUTE
GOODS LIKE RICE AND BREAD, IF
PRICE OF RICE INCREASES,
DEMAND OF BREAD INCREASES, SO
RELATION IS DIRECT BUT INVERSE
FOR COMPLEMENTARY GOODS LIKE
BREAD AND BUTTER. IF PRICE OF
BREAD INCREASES, OTHER THINGS
CONSTANT, THE DEMAND FOR
BUTTER DECLINES.
4. BUYER'S EXPECTATIONS ABOUT
FUTURE PRICES. HAS DIRECT
RELATION TO DEMAND. IF PRICE IS
EXPECTED TO INCREASE, PEOPLE
TEND TO PANIC BUY, HENCE,
DEMAND INCREASES.
5. NUMBER OF BUYERS. HAS
DIRECT RELATION TO DEMAND.
THE MORE THE NUMBER OF
BUYERS THE HIGHER THE DEMAND.
DEMAND FUNCTION
The law of demand which shows the
inverse relations between price and the
quantity can be illustrated in three
different ways through a demand
function, demand schedule and a
demand curve.
Demand function is s a mathematical
description of the relationship of price
and demand. the DEMAND function
using the formula:
Demand function is expressed in terms
of a mathematical equation as follows:
Qd = 80 - 4P
The demand function above shows the
slope or coefficient of the price is-4
which means that for every peso
increase in price, quantity demanded
decreases by 4 units. The constant term
Self-Instructional Material 17
80 is the maximum quantity the market
can absorb, and that is when the
product is free and has a zero price.
DEMAND SCHEDULE
Demand schedule is a list or table that
shows the inverse relations between
price and quantity demanded, all other
things constant or equal.
The demand function can be expressed
in a tabular form called demand
schedule.
Demand function is expressed in terms
of a mathematical equation as follows:
Qd=80-4P
DEMAND CURVE
Demand curve is a locus of points that
shows the inverse relations between
price and quantity demanded all other
things constant or equal.
Change in Quantity Demanded vs
Change in Demand
A change in quantity demanded (AQ)
occurs when there is a change in the
price of the good itself.
Change in demand occurs when there
is a change in any determinants of
demand such as income, number of
buyers, price expectations, etc.
If the non-price determinants of a
demand identified above are allowed to
vary, the entire demand curve will shift
either to the left or the right. Such a shift
of the demand curve is called a change
in demand.
A change in demand is represented by a
shift of the demand curve to the right, if
there is an increase in demand, D1 to
D2, and a shift to the left if demand
decreases from D1 to D3, of the above
figure.
A change in demand is represented by a
shifts of the demand curve to the right, if
there is an increase in demand, D, to D,
and a shift to the left if demand
decreases from D, to D, of the above
figure.
Self-Instructional Material 18
SUPPLY Quantity supplied falls.

Supply shows the different quantities of All other things constant except the
good that sellers are willing and able to price, ceteris paribus
sell at any given time at various possible
prices other things equal.
SUPPLY FUNCTION

Given supply function as follows:

Q=-10+5 P

Where: Q is quantity supplied P is the

price

The Law of Supply

The law of supply demonstrates the

quantities that will be sold at certain
prices. But unlike the law of demand,
the supply curve shows an upward
slope. This means that the higher the
SUPPLY SCHEDULE
price, the higher the quantity supplied.
Produces supply more at a higher price The function shows the coefficient or
because it will mean higher revenue. the slope of the price is 5 and a
constant term-10. The coefficient is
Law of Supply (direct
interpreted that for every peso increase
relationship/positive)
in price, quantity supplied will increase
Law of Supply- refers to the relationship by 5 units while the constant term -10
between price and the quantity of a implies that if price is zero, no one will
good or service that firms are willing to ever supply the good and is tantamount
produce. The higher the price of the to say that no one will supply if price is
product leads to more supplies and below P2.00.
more companies making the product.

Self-Instructional Material 19
Table 3.2 Supply Schedule
Price - 2, 5, 10, 15, 20
Quantity supplied - 0, 15, 40, 65, 90
The supply schedule above shows that
as price increases the corresponding
quantity supplied also increases as
shown in Table 3.2.
SUPPLY CURVE
Supply curve is a locus of points that
shows the direct relations between
price and quantity supply all other
things constant or equal.
Figure 3.6 Supply Curve
P - 20, 15, 10, 0
20, 40, 60, 80
The Supply Curve is upward sloping to
the right as shown in Fig. 3.6.
DETERMINANTS OF SUPPLY
Aside from the price of the product
there are non-price factors that
determine or affect the supply of a
product. These are the following:
1. Production costs has an inverse
relation to supply. High production cost
discourages sellers hence there will be
a decrease in supply (has a negative
or inverse relation on supply)
2. Technology has a direct relation to
supply. An improved technology
encourages producers hence there will
be an increase in supply. (has a
positive or direct relation on supply)
3. The price of related goods or price
of competing products has an
inverse relation to supply. For farmers,
palay and corn are competing products,
if the price of palay increases farmers
will plant palay rather than corn its
competing product to take advantage of
higher price of palay. (has a negative
or inverse relation on supply)
4. Firm's expectations about future
prices has an inverse relation to
supply. If the price of rice is expected to
increase, traders tend to hoard, hence,
there will be a decrease in present
supply. (has a negative or inverse
relation on supply)
5. Number of suppliers has a direct
relation to supply. The more number of
sellers, the higher supply. (has a
positive or direct relation on supply)
Change in Quantity Supplied versus
Change in Supply
Self-Instructional Material 20
A change in quantity supplied occurs
when there is a change in the price of
the good itself all other things constant
or equal.

a. Finding the equilibrium price (Pe)

and equilibrium quantity (Q)
mathematically

A Change in supply occurs whenever Consider the demand function. Q, 8 80-

any of the non-price determinants of 4P and supply function Q = -10+ 5P.
supply changes. An increase in supply The equilibrium price can be
is represented by a shift of the supply determined as follows:
curve to the right. Alternatively, a
decrease in a supply is represented by Condition:
a shift of the supply curve to the left. Q = Qs, substituting the equation P =
10
In Fig. 3.8, a shift to the right of the 804P-10 + 5P
supply curve (S, to S,) represents an 80+10= 5P + 4P
increase in supply, while a shift to the 90= 9P
left (5, to S,) means a decrease in P = 90/9
supply.
Is the equilibrium price really P10? To
MARKET EQUILIBRIUM find if it so, substitute
P=10 and check. Is QQ, if so then P, =
The term EQUILIBRIUM means that all 10
forces in the market are in balance. Substituting
P=10,
MARKET EQUILIBRIUM is attained Q 80-4(10)=40Q-10+5(10) = 40
where quantity demanded is equal to
quantity supplied: Qd= Qs Then we can conclude that P, = 10 and
Q = 40 units

Self-Instructional Material 21

Figure 3.9 is the result of combining
demand curve in Fig. 3.3 and supply
curve in Fig. 3.6. The intersection of the
demand curve D and Supply curve S is
at point E indicates that the equilibrium
price is P10 and equilibrium quantity is
40 units.
A surplus is the excess of the quantity
supplied over quantity demanded.
Example, at P15, the buyers would be
wiling to purchase 20 units, but
producers would have produced and
offered 65 units.
A surplus brings the market price down
to equilibrium price, sellers would kept
to reduce the price than to incur
additional storage cost or experience
spoilage of perishable products that
can cause or great loss.
Surplus and Shortage Defined
What is a surplus?
A surplus is the amount by which the
quantity supplied of a product exceeds
the quantity demanded at a specific
price.
- A surplus may only occur above the
equilibrium price.
What is a shortage?
A shortage is the amount by which the
quantity demanded of a product
exceeds the quantity supplied at a
specific price.
- A shortage may only occur below the
equilibrium price.
TABULAR ANALYSIS
Modified True or False: True if
statement is correct. If false, provide
correct answer.
1. At P = P2.00, shortage is 90 units
2. At P = P5.00, surplus is 50 units
3. At P=12.00, surplus is 20 units
4. At P = P10, surplus is 10 units
5. Pe= 45.00,
6. Qe= 10 units
Self-Instructional Material 22
Modified True or False: True if
statement is correct. If false, provide
correct answer.
1. At P = P2.00, shortage is 90 units - F
2. At P = P5.00, surplus is 50 units -F
3. At P P12.00, surplus is 20 units - T
4. At P = P10, surplus is 10 units -F
5. Pe = P45.00 - F
6. Qe = 10 units - F
EFFECT OF AN INCREASE IN
DEMAND
An increase in the demand for the good
is shown by a rightward shift of the
demand curve, D1 to D2 in Figure 3.10
holding supply unchanged. Effect is
change in equilibrium from point E to
point A said shift of the demand curve
gives rise to new equilibrium price
P12.50 from P10.00 and equilibrium
quantity of 50 units from 40 units.
Demand curve may shift to the right
with increase in consumers income if
product is a normal good, and if
consumers change their taste in favor
of a certain goods etc.
Income to Normal Goods = Positive
Relation
Demand curve shifted to the right
EFFECT OF AN INCREASE –
DECRESE IN DEMAND and SUPPLY
A decrease in demand as in Figure 3.11
is shown by a leftward shift of the
demand curve from D1 to D2 supply is
unchanged. This causes change in
equilibrium point from E to B resulting to
a decrease in both the equilibrium price
and the equilibrium quantity from P10.00
to P7.50 and from 40 to 30 units
respectively.
EFFECT OF AN INCREASE –
DECREASE IN DEMAND and SUPPLY
Self-Instructional Material 23
 S1 to S2 in Fig. 3.13. The equilibrium
point changes from E to D. This causes
an increase in the equilibrium price from
P10.00 to P12.50 and a decrease in the
equilibrium quantity from 40 to 30 units.

EFFECT OF SIMULTANEOUS
CHANGES IN THE DEMAND AND
SUPPLY

An improvement in technology
increases supply for the commodity,
hence, a rightward shift of the supply
curve from S1 to S2 in Figure 3.12. The
equilibrium point changes from point E
to C results to a decrease in the
equilibrium price from P10 to P7.50 and
an increase in the equilibrium quantity to
50 units from the original 40 units. Supply curve shifts to the right as well
as the demand curve. Equilibrium point
EFFECT OF AN INCREASE – at E, changes to point A as in Figure
DECREASE IN DEMAND and SUPPLY 3.14. These changes result to an
increase in equilibrium quantity from 40
to 60 units the price remaining
unchanged (i.e. there is an equal
increase in demand and supply).

EFFECT OF SIMULTANEOUS
CHANGES IN THE DEMAND AND
SUPPLY

An increase in taxes discourage sellers,

so supply for the commodity decreases,
hence supply curve shifts to the left from

Self-Instructional Material 24
Fig. 3.15 shows that supply curve shifts EFFECT OF SIMULTANEOUS
to the right and demand curve shifts to CHANGES IN THE DEMAND AND
the left with the equilibrium point shifting SUPPLY
from E to B. These changes lead to a
decrease in the equilibrium price from
P10.00 to P5.00 while quantity does not
change (i.e. the decrease in demand is
exactly the same as the increase in
supply. The effect on equilibrium
quantity depends on whether the
decrease in demand is larger than the
increase in supply.

EFFECT OF SIMULTANEOUS
CHANGES IN THE DEMAND AND
SUPPLY

Fig. 3.17 depicts the supply curve and a

Fig. 3.16 shows that supply curve shifts
to the left and demand curve to the right
causing a change in equilibrium point
from E to C These changes cause an
increase in equiliorium price from P 10
to 15 while equilibrium quantity is
constant at 40 units (i.e. the increase in
demand is offset by an equal decrease
in supply).
demand curve shifting to the left with the
equilibrium point changing from point E
to point D. These changes result to a
decline in equilibrium quantity from 40 to
20 units with no change in equilibrium
price at P10.00. (i.e. there 15 an equal
decrease in demand and supply).
Therefore, a decrease in demand and
supply leads to a decrease in the
equilibrium quantity while the equilibrium
price of the product remains constant or
equal.

Self-Instructional Material 25
For most purpose economics can be
divided into two broad categories,
microeconomics and macroeconomics.
Macroeconomics as the name suggests
is the study of the overall economy and
its aggregates such as Gross National
Product, Inflation, Unemployment,
Exports, Imports, and Taxation Policy,
etc.
Macroeconomics addresses
questions about changes in investment,
government spending, employment,
prices, and exchange rate of the rupee
and so on. Importantly, only aggregate
levels of these variables are considered
in the study of macroeconomics. But
hidden in the aggregate data are
changes in output of a number of
individual firms, the consumption
decision of consumers like you, and the
changes in the prices of goods and
services. Although macroeconomic
issues are important and occupy the
time of media and command the
attention of the newspapers, micro
aspects of the economy are also
important and often are of more direct
application to the day to day problems
facing a manager. Microeconomics
deals with individual actors in the
economy such as firms and individuals.
Managerial economics can be thought
of as applied microeconomics and its
focus is on the interaction of firms and
individuals in markets.
When you read a newspaper or
switch on a television, you hear
economic terminology used with
increasing regularity. For a manager,
some of these economic terms are of
direct relevance and, therefore, it is
essential to not only understand them
but also apply them in relevant
situations. For example, GDP growth
rate could impact the product a manager
is marketing, change in money supply
by the RBI could impact inflation and
affect the demand for your product,
fiscal deficit could affect interest rates
and, therefore, investment spending by
a manager, etc. The focus of managerial
economics is on how the firm reacts to
changes in the economic environment in
which it operates and how it predicts
these changes and devises the best
possible strategies to achieve the
objectives that underlie its existence.
The economy is the institutional
structure through which individuals and
firms in a society coordinate their
desires. Economics is the study of how
human beings in a society go about
achieving their wants and desires. It is
also defined as the study of allocation of
scarce resources to satisfy individual
wants or desires. The latter is perhaps
the best way to broadly define the study
of economics in general. The emphasis
is on allocation of scarce resources
across competing ends. You should
recognize that human wants are
unlimited and, therefore, choice is
necessary.
Self-Instructional Material 26
 Choices necessarily involve
trade-offs. For example, if you wish to
acquire an MBA degree, you must take
time-off to devote to study. Your time
has many uses and when you devote
more time to study you are allocating it
to a particular use in order to achieve
your goal. Economics would be a most
uninteresting subject if resources were
unlimited and no trade-offs was involved
in decision-making. There are many
general insights economists have
gained into how the economy functions.
Economic theory ties together
economists’ terminology and knowledge
about economic institutions. An
economic institution is a physical or
mental structure that significantly
influences economic decisions.
Corporations, Governments, markets
are all economic institutions. Similarly,
cultural norms are the standards people
use when they determine whether a
particular activity or behaviour is
acceptable. For example, Hindus avoid
meat and fish on Tuesdays. This has an
economic dimension as it has a direct
impact on the sale of these items on
Tuesdays. Further, economic policy is
the action usually taken by the
government, to influence economic
events. And finally, economic reasoning
helps in thinking like an economist.
Economists analyze questions and
issues on the basis of trade-offs, i.e.,
they compare the cost and the benefits
of every issue and make decisions
based on those costs and benefits.
The market is perhaps the single
most important and complex institution
in our economy. A market is not
necessarily a physical location, but a
description of any state that involves
exchange. The exchange could be
instantaneous or it could be over time,
i.e., exchange which is agreed today but
where the transaction takes place, say
after 3 months. You will learn in this
course the myriad functions that
markets perform, most significantly
bringing buyers and sellers together.
Markets could be competitive or
monopolistic, with a large number of
firms or a small number of firms, with
free entry and exit or government
licensing restricting entry of firms and so
on. The major point is that firms operate
in different types of markets and use the
well- established principles of
managerial economics to improve
profitability. Managerial economics
draws on economic analysis for such
concepts as cost, demand, profit and
competition.
- attempts to bridge the gap
between the purely analytical
problems that intrigue many
economic theorists and the day-
to-day decisions that managers
must face.
- offers powerful tools and
approaches for managerial
policy-making.
It will be relevant to present here
several examples illustrating the
problems that managerial economics
can help to address. These also
explain how managerial economics
is an integral part of business.
Demand, supply, cost, production,
Self-Instructional Material 27
 market, competition, price, etc. are
1.2. Appropriate Definitions
Managerial economics can be
defined as the study of how to direct
scarce resources in the way that most
efficiently achieves a managerial goal.
- McNair and Merriam,
“Managerial economics is the use of
economic modes of thought to analyze
business situations.”
- Prof. Evan J Douglas,
‘Managerial economics’ is concerned
with the application of economic
principles and methodologies to the
decision-making process within the firm
or organization under the conditions of
uncertainty.”
- Spencer and Siegel man define
it as “The integration of economic theory
with business practices for the purpose
of facilitating decision-making and
forward planning by management.”
- Hailstones and Rothwel,
“Managerial economics is the
application of economic theory and
analysis to practice of business firms
and other institutions.”
A common thread runs through
all these descriptions of managerial
economics which is using a framework
of analysis to arrive at informed
important concepts in real business
decision
decisions to maximize the firm’s
objectives, often in an environment of
uncertainty. It is important to recognize
that decisions taken while employing a
framework of analysis are likely to be
more successful than decisions that are
knee jerk or gut feel decisions.
It is a very broad discipline in the
sense that it describes useful methods
for directing everything from the
resources of a household to maximize
household welfare to the resources of
the firm to maximize profits. To
understand the nature of decisions that
confronts managers of firms, imagine
that you are the manager of a company
that makes computers. You must make
a host of decisions to succeed as a
manager. Should you purchase
components such as disk drive and
chips from the other manufacturers or
produce them within your firm? Should
you specialize in making of one type of
computers or produce several types?
How many computers should you
produce and at what price should you
sell them? How many employees should
you hire, and how should you
compensate them? How can you ensure
that employee work hard? And produce
quality products? How can the actions of
Self-Instructional Material 28
the rival computer firms affect your
decisions?
The key to making sound
decisions is to know what information is
needed to make an informed decision
and then to collect and process the
data. If you work for a large firm, your
legal department can provide data about
the legal ramifications of alternative
decisions; your accounting department
1.3. Fundamental Nature of Managerial Economics
A close relationship between
management and economics has led to
the development of managerial
economics. Management is the
guidance, leadership and control of the
efforts of a group of people towards
some common objectives. While this
description does inform about the
purpose or function of management, it
tells us little about the nature of the
management process. Koontz and
O’Donnell define management as the
creation and maintenance of an internal
environment in an enterprise where
individuals, working together in groups,
can perform efficiently and effectively
towards the attainment of group goals.
Thus, management is:
 Coordination
 An activity or an ongoing process
 A purposive process
An art of getting things done by
other people.
can provide tax advise and basic cost
data; your marketing department can
provide you with the data on the
characteristics of the market for your
product; and your firm’s financial
analysts can provide summary data for
alternative methods of obtaining
financial capital. Ultimately, however,
the manager must integrate all of this
information, process it, and arrive at a
decision.
On the other hand, economics as stated
above is engaged in analyzing and
providing answers to manifestations of
the most fundamental problem of
scarcity. Scarcity of resources results
from two fundamental facts of life:
 Human wants are virtually unlimited
and insatiable, and
 Economic resources to satisfy these
human demands are limited.
Thus, we cannot have everything
we want; we must make choices broadly
in regard to the following:
 What to produce?
 How to produce? and
 For whom to produce?
These three choice problems have
become the three central issues of an
economy as shown in Fig. 1.1.
Economics has developed several
concepts and analytical tools to deal
Self-Instructional Material 29
with the question of allocation of scarce
resources among competing ends. The
non-trivial problem that needs to be
addressed is how an economy through
its various institutions solves or answers
the three crucial questions posed above.
There are three ways by which this can
be achieved.
- entirely by the market
mechanism
- entirely by the government or
finally, and
- more reasonably, by a
combination of the first two
approaches.
Realistically all economies
employ the last option, but the relative
roles of the market and government vary
across countries. For example, in India
the market has started playing a more
important role in the economy while the
government has begun to withdraw from
certain activities. Thus, the market
mechanism is gaining importance. A
similar change is happening all over the
world, including in China. But there are
economies such as Myanmar and Cuba
where the government still plays an
overwhelming part in solving the
resource allocation problem. Essentially,
the market is supposed to guide
resources to their most efficient use. For
example, if the salaries earned by MBA
degree holders continue to rise, there
will be more and more students wanting
to earn the degree and more and more
institutes wanting to provide such
degrees to take advantage of this
opportunity. The government may not
force this to happen, it will happen on its
own through the market mechanism.
The government, if anything, could
provide a regulatory function to ensure
quality and consumer protection.
According to the central deduction of
economic theory, under certain
conditions, markets allocate resources
efficiently. ‘Efficiency’ has a special
meaning in this context. The theory says
that markets will produce an outcome
such that, given the economy’s scarce
resources, it is impossible to make
anybody better-off without making
somebody else worse-off.
Fig. 1.1. Problem of choice.
In rich countries, markets are too
familiar to attract attention. Yet, a certain
awe is appropriate. Let us take an
incident where Soviet planners visited a
vegetable market in London during the
early days of perestroika, they were
impressed to find no queues, shortages,
or mountains of spoiled and unwanted
vegetables. They took their hosts aside
and said: “We understand, you have to
say it’s all done by supply and demand.
But can’t you tell us what’s really going
Self-Instructional Material 30
on? Where are your planners and what
are their methods?”
The essence of the market
mechanism is indeed captured by the
supply and demand diagram. At the
place where the curves intersect, a price
is set such that demand equals supply.
There, and only there, the benefit from
consuming one more unit exactly
matches the cost of producing it. If
output were less, the benefit from
consuming more would exceed the cost
of producing it. If output were higher, the
cost of producing the extra units would
exceed the extra benefits. So the point
where supply equals demand is
“efficient”.
However, the conditions for
market efficiency are extremely
demanding— far too demanding ever
to be met in the real world. The theory
requires “perfect competition”:
- there must be many buyers and
sellers;
- goods from competing suppliers
must be indistinguishable;
- buyers and sellers must be fully
informed; and
- markets must be complete—
that is, there must be markets
not just for bread here and now,
but for bread in any state of the
world.
(What is the price today for a loaf to
be delivered in Timbuktu on the second
Tuesday in December 2014 if it rains?)
In other words, market failure is
pervasive.
It comes in four main varieties:
a) Monopoly: By reducing his sales, a
monopolist can drive up the price of
his good his sales will fall but his
profits will rise. Consumption and
production are less than the efficient
amount, causing a deadweight loss
in welfare.
b) Public Goods: Some goods cannot
be supplied by markets. If you
refuse to pay for a new coat, the
seller will refuse to supply you. If
you refuse to pay for national
defense, the “good” cannot easily be
withheld. You might be tempted to
let others pay. The same reasoning
applies to other “nonexcludable”
goods such as law and order, clean
air, and so on. Since private sellers
cannot expect to recover the costs of
producing such goods, they will fail
to supply them.
c) Externalities: Making some goods
causes pollution: the cost is borne
by people with no say in deciding
how much to produce. Consuming
some goods (education, anti-lock
brakes) spreads benefits beyond the
buyer, again, this will be ignored
when the market decides how much
to produce. In the case of “good”
externalities, markets will supply
too little; in the case of “bads” too
much.
d) Information: In some ways a
special kind of externality, this
deserves to be mentioned separately
because of the emphasis placed
upon it in recent economic theory.
To see why information matters,
consider the market for used cars. A
buyer, lacking reliable information,
may see the price as providing clues
Self-Instructional Material 31
 about a car’s condition. This puts
sellers in a quandary: if they cut
prices, they may only convince
people that their cars are rubbish.
The labour market, many
economists believe, is another such
‘market for lemons’. This may help
to explain why it is so difficult for
the unemployed to price themselves
into work. When markets fail, there
is a case for intervention. But two
questions need to be answered first.
- How much does market failure
matter in practice? And
- can governments put the failure,
right?
Markets often correct their own
failures. In other cases, an apparent
failure does nobody any harm. In
general, market failure matters less
in practice than is often supposed.
Monopoly, for instance, may seem to
preclude an efficient market. This is
wrong. The mere fact of monopoly
does not establish that any economic
harm is being done. If a monopoly is
protected from would be competitors
by high barriers to entry, it can raise
its prices and earn excessive profits.
If that happens, the monopoly is
undeniably harmful. But if barriers to
entry are low, lack of actual (as
opposed to potential) competitors
does not prove that the monopoly is
damaging: the threat of competition
may be enough to make it behave as
1.4. Scope of Managerial Economics
From the point of view of a firm,
managerial economics, may be defined
though it were a competitive firm.
Many economists would accept that
Microsoft, for instance, is a near-
monopolist in some parts of the
personal- computer software
business yet would argue that the
firm is doing no harm to consumers
because its markets remain highly
contestable. Because of that
persistent threat of competition, the
company prices its products keenly.
In this and in other ways it behaves
as though it were a smaller firm in a
competitive market.
Even on economic grounds
(never mind other considerations), there
is no tidy answer to the question of
where the boundary between state, i.e.,
governments and market should lie.
Markets do fail because of monopoly,
public goods, externalities, lack of
information and for other reasons. But,
more than critics allow, markets find
ways to mitigate the harm and that is a
task at which governments have often
been strikingly unsuccessful. All in all, a
strong presumption in favour of markets
seems wise. This is not because
classical economic theory says so, but
because experience seems to agree.
And as stated above, the real world
seems to be moving in the direction of
placing more reliance on markets than
on governments.
as economics applied to “problems of
choice” or alternatives and allocation of
Self-Instructional Material 32
scarce resources by the firms. Thus,
managerial economics is the study of
allocation of resources available to a
firm or a unit of management among the
activities of that unit. Managerial
economics is concerned with the
application of economic concepts and
analysis to the problem of formulating
rational managerial decisions. There are
four groups of problem in both
decisions-making and forward planning.
Resource Allocation
Scarce resources have to be
used with utmost efficiency to get
optimal results. These include
production programming and problem of
transportation, etc. How does resource
allocation take place within a firm?
Naturally, a manager decides how to
allocate resources to their respective
uses within the firm, while as stated
above, the resource allocation decision
outside the firm is primarily done
through the market. Thus, one important
insight you can draw about the firm is
that within it resources are guided by the
manager in a manner that achieves the
objectives of the firm.
1.5. Study of Managerial Economics
Study of managerial economics
essentially involves the analysis of
certain major aspects like:
Inventory and Queuing Problem
Inventory problems involve
decisions about holding of optimal levels
of stocks of raw materials and finished
goods over a period. These decisions
are taken by considering demand and
supply conditions. Queuing problems
involve decisions about installation of
additional machines or hiring of extra
labour in order to balance the business
lost by not undertaking these activities.
Pricing Problem
Fixing prices for the products of
the firm is an important decision-making
process. Pricing problems involve
decisions regarding various methods of
prices to be adopted.
Investment Problem
Forward planning involves
investment problems. These are
problems of allocating scarce resources
over time. For example, investing in new
plants, how much to invest, sources of
funds, etc.
(a) Demand Analysis, Estimation and
Forecasting
A business firm is an economic
organization, which is engaged in
Self-Instructional Material 33
transforming productive resources into
goods that are to be sold in the market.
A major part of managerial decisions
depend upon accurate estimates of
demand. A forecast of sales in future
aids the management in preparing
production schedules and employing
resources. It will help the management
to strengthen its market position and
profit base. It includes demand
determinants, demand forecasting, etc.
(b) Cost and Production Analysis
Cost estimates are very important
while taking decisions. The different
factors that cause variations in the cost
should be considered while planning.
The chief topics included under cost and
production analysis are cost concepts
and classifications, cost output
relationship, economies and
diseconomies of scale, production
functions and cost control.
(c) Pricing Decisions, Policies and
Practices
Pricing is very important area of
managerial economics. In fact, price is
the genesis of the revenue of a firm and
as such the success of the firm largely
depends upon the correctness of the
price decisions taken by the firm. The
important aspects dealt with under this
area are: Price determination in various
market forms, Pricing methods,
Differential pricing, Product-line pricing
and Price forecasting.
(d) Profits Management
Business firms are generally
organized for the purpose of making
profits and in the long run, profits
provides the chief measure of success.
In this connection, an important point
worth considering is the element of
uncertainty existing about profits
because of variations in costs and
revenues which in turn are caused by
factors both internal and external to the
firm. If knowledge about the future is
perfect, profit analysis would have been
a very easy task. However, in the world
of uncertainty, expectations are not
always realized so that profit planning
and measurement constitute the difficult
area of managerial economics. The
main topics dealt with are: cost of
capital, Rate of return and selection of
projects, important aspects covered
under this area are: Nature and
Measurement of Profit, Profit Policies
and techniques of Profit Planning like
Break-even Analysis.
(e) Capital Management
Of the various types and classes
of business problems, the most complex
and troublesome for the business
manager are likely to be those relating
to the firm’s capital investments.
Relatively large sums are involved, and
the problems are so complex that their
disposal not only requires considerable
time and labour but is a matter for top
level decision. Briefly capital
management implies planning and
control of capital expenditure.
Self-Instructional Material 34
Conclusion
Demand analysis and forecasting
help a manager at the earliest stage for
choosing the product and planning
output levels. A study of demand
elasticity goes a long way in helping the
firm to fix prices for its products. The
theory of cost also forms an essential
part of this subject. Estimation is
necessary for making output variations
with fixed plants or for the purpose of
new investments in the same line of
production or in a different venture. The
firm works for profits and optimal or near
1.6. Managerial Economics and Other Disciplines
Managerial economics is linked
with various other fields of study like:
(a) Microeconomic Theory
As stated in the introduction, the
roots of managerial economics spring
from microeconomic theory. Price
theory, demand concepts and theories
of market structure are few elements of
microeconomics used by managerial
economists. It has an applied bias as it
applies economic theories in order to
solve real world problems of enterprises.
(b) Macroeconomic Theory
This field has little relevance for
managerial economics but at least one
part of it is incorporated in managerial
economics, i.e., national income
maximum profits depend upon accurate
price decisions. Theories regarding
price determination under various
market conditions enable the firm to
solve the price fixation problems.
Control of costs, proper pricing policies,
break-even analysis, alternative profit
policies are some of the important
techniques in profit planning for the firm
which has to work under conditions of
uncertainty. Thus, managerial
economics tries to find out which course
is likely to be the best for the firm under
a given set of conditions.
forecasting. The latter could be an
important aid to business condition
analysis, which in turn could be a
valuable input for forecasting the
demand for specific product groups.
(c) Operations Research
This field is used in managerial
economics to find out the best of all
possibilities. Linear programming is a
great aid in decision-making in business
and industry as it can help in solving
problems like determination of facilities
on machine scheduling, distribution of
commodities and optimum product mix,
etc.
(d) Theory of Decision-Making
Self-Instructional Material 35
 Decision theory has been
developed to deal with problems of
choice or decision- making under
uncertainty, where the applicability of
figures required for the utility calculus
are not available. Economic theory is
based on assumptions of a single goal
whereas decision theory breaks new
grounds by recognizing multiplicity of
goals and persuasiveness of uncertainty
in the real world of management.
(e) Statistics
Statistics helps in empirical
testing of theory. With its help, better
decisions relating to demand and cost
functions, production, sales or
distribution are taken. Managerial
economics is heavily dependent on
statistical methods.
(f) Mathematics
Mathematics is yet another tool-
subject closely related to managerial
economics. This is because managerial
economics is metrical in character
1.7. Economic Analysis
Economic activity is the constant
effort to match ends to means because
of scarcity of resources. The optimal
economic activity is to maximize the
attainment of ends, the means and their
scarcities or to minimize the use of
resources, given the ends and their
estimating various economic
relationship, predicting relevant
economic quantities and using them in
decision-making and forward planning.
A knowledge of geometry, trigonometry
and algebra is not only essential but
certain mathematical tools and concepts
such as logarithms and exponentials,
vectors, determinants and matrix
algebra and above all calculus
differentials are the hand-maids.
(g) Management Theory and
Accounting
Maximization of profit has been
regarded as a central concept in the
theory of the firm in microeconomics. In
recent years, organization theorists
have talked about “satisfying” instead of
“maximizing” as an objective of the
enterprise. Accounting data and
statements constitute the language of
business. In fact, the link is so close that
“managerial accounting” has developed
as a separate and specialized field in
itself.
priorities. Decision-making by
management is truly economic in nature
because it involves choices among a set
of alternatives—alternative courses of
action. The optimal decision-making is
an act of optimal economic choice,
considering objectives and constraints.
Self-Instructional Material 36
This justifies an evaluation of
managerial decisions through concepts,
precepts, tools and techniques of
economic analysis of the following
types:
(a) Micro- and Macro-analysis
In micro-analysis the problem of
choice is focused on single individual
entities like a consumer, a producer, a
market, etc. Macro-analysis deals with
the problem in totality like national
income, general price level, etc.
(b) Partial and General Equilibrium
Analysis
To attain the state of stable
equilibrium, the economic problem may
be analyzed part by part—one at a time
—assuming “other things remaining the
same.” This is partial equilibrium
analysis. In general equilibrium analysis
the assumption of “given” or “other
things remaining equal” may be relaxed
and interdependence or interactions
among variables may be allowed.
1.8. Basic Characteristics: Decision-Making
Managerial economics serves as
‘a link between traditional economics
and the decision-making sciences’ for
business decision-making. The best way
to get acquainted with managerial
economics and decision-making is to
come face to face with real world
decision problems.
(c) Static, Comparative Static and
Dynamic Analysis
This is in reference to time
dimension. A problem may be analyzed
—allowing no change at a point of time
(static)—allowing once for all change at
a point of time (comparative static)—
allowing successive changes over a
period of time (dynamic).
(d) Positive and Normative Analysis
In positive economic analysis, the
problem is analyzed in objective terms
based on principles and theories. In
normative economic analysis, the
problem is analyzed based on value
judgment (norms). In simple terms,
positive analysis is ‘what it is’ and
normative analysis is ‘what it should be.’
For example, CEOs in private Indian
enterprises earn 15 times as much as
the lowest paid employee is a positive
statement, a description of what is. A
normative statement would be that
CEOs should be paid 4–5 times the
lowest paid employee.
Tata’s Vision 2000
Presently there are about 87
firms in the Tata empire. Of them, about
16 recorded losses in 1995–96. The
Tata’s companies that are in the
limelight are TISCO, TELCO, ACC, Tata
Exports and Tata Chemicals.
Self-Instructional Material 37
 Contribution of bottom companies
— In terms of turn-over: 35% of total of
group.
20 companies— In terms of net
profit: 0.2% of total sales of group
— In terms of assets and net
worth <1% of total sales of group.
The question is—Do such non-
performers warrant an existence or will
the group be better off if it could hive off
the divisions, or else amalgamate them
with other existing units?
On the three basics—Last two
companies are way below the group
providing 4.2% return on shareholders;
1.9% returns on capital employed.
Keeping these figures in mind,
Tatas planned refocusing exercises like
 Divestment-mergers
 Amalgamations-takeovers.
 To create a learner and suggestive
group with an estimated turnover of
1,10,000 crores by 2000.
 From being production-led to
being consumer and market-led;
being up in top three in every
segment.
Tata’s “Vision 2000” is a group. Why
not give someone else a chance to run
your business more efficiently if you
cannot do so? It makes better economic
as well as business sense. But then, the
ball is in the court of Tata’s. The what
and how to do is their prerogative.
The basic characteristics of
managerial economics can now be
enumerated as follows:
 It is concerned with “decision-making
of an economic nature.”
 It is “microeconomic” in character.
This is because the unit of study is a
firm. Managerial economics does not
deal with entire economy as a unit of
study.
 It largely uses that body of economic
concepts and principles, which is
known as “theory of the firm” or
“economics of firm.” In addition, it
also seeks to apply profit theory
which forms part of distribution
theories in economics.
 It is “goal oriented and prescriptive.”
 Managerial economics is both
“conceptual and metrical.” It includes
theory with measurement.
 Managerial economics belong to
normative economics rather than
positive economics.
 Macroeconomics is also useful to
managerial economics since it
provides an intelligent understanding
of the environment in which business
must operate. This understanding
enables a business executive to adjust
in the best possible manner with
external forces over which he has no
control but which plays a crucial role
in the well-being of his concern. The
important topics are: business cycles,
national income accounting and
economic policies of the government
like those relating to taxation, foreign
trade antimonopoly measures, labour
relations, etc.
Self-Instructional Material 38

Fig. 1.2. Significance of managerial economics.
Managerial economics should be
thought of as applied microeconomics,
which focuses on the behaviour of the
individual actors on the economic stage;
firms and individuals.
Fig. 1.3. Significance of managerial economics
in decision-making.
A decision is simply a selection
from two or more courses of action. The
essence of economic decision is the
solution to the economic problem. Once
one of the available alternative actions
is chosen, the economic problem is
solved. The act of choice signifying
solution of an economic problem is
economic decision- making. A manager
has to take several decisions in the
management of business. Decision-
making is a process and decision is the
product of that process. Managerial
economics is an evolutionary science; it
is a journey with continuing
understanding and application of
economic knowledge—theories, models,
concepts and categories in dealing with
the emerging business/managerial
situations and problems in a dynamic
economy. It serves as a link between
traditional economics and the decision-
making sciences for business decision-
making.
Managerial economics
accomplishes several objectives. First, it
presents those aspects of traditional
economics which are relevant for
business decision-making in real life.
For this purpose, it calls from economic
theory the concepts, principles and
techniques of analysis which have a
bearing on the decision-making process.
These are, therefore, adapted or
modified with a view to enable the
manager to take better decisions. Thus,
managerial economics accomplishes
the objectives of building a suitable kit
from traditional economics.
Secondly, it also incorporates
useful ideas from other disciplines such
as psychology, sociology, etc. if they are
found relevant for decision-making. In
fact, managerial economics take the aid
of other academic disciplines having a
bearing upon the business decisions of
managers in view of various explicit and
implicit constraints subject to which
resource allocation is to be optimized.
Self-Instructional Material 39
 Thirdly, managerial economics
help in reaching a variety of business
decisions in a complicated environment.
A few examples are:
What products and services
should be produced?
What inputs and production
techniques should be used?
How much output should be
produced and at what prices should it be
sold?
What are the best sizes and
locations of new plants?
When equipment should be
replaced?
Fourthly, managerial economics
makes a manager more competent
model builder. Thus, he can capture the
essential relationship which
characterizes a situation while leaving
out the cluttering details and peripheral
relationships.
Fifthly, at the level of the firm
where for various functional areas,
functional specialists or functional
department exists, e.g. finance,
marketing personnel, production, etc.
managerial economics serve as
integrating agent by coordinating the
different areas and bringing to bear on
the decisions of each department or
1.9. Role of a Managerial Economist in Business
specialist the implication pertaining to
other functional areas. It thus enables
business decision-making not in water
tight compartments but in an integrated
perspective, the significance of which
lies in the fact that the functional
departments or specialists often enjoy
considerable autonomy and achieve
conflicting goals.
Finally, managerial economics
take cognizance of the interaction
between the firm and society and
accomplishes the key role of business
as an agent in the attainment of social
and economic welfare. It has been
realized that business apart from its
obligations to shareholders, has certain
social obligations/constraints subject to
which business decisions are to be
taken. In doing so, it serves as an
instrument in further economic welfare
of the society through socially oriented
business.
To conclude, the usefulness of
managerial economics lies in borrowing
and adopting the tool kit from economic
theory, incorporating relevant ideas from
other disciplines to achieve better
business decisions, serving as a
catalytic agent in the course of decision-
making by different functional
departments/specialists at the firm level
and finally accomplishing a social
purpose through orienting business
decisions towards social obligations.
Self-Instructional Material 40
 Making decisions and processing
information are the two primary tasks of
managers. While we separate these two
tasks for analytical purposes, in reality
they are practically inseparable. That is
in order to make intelligent decisions,
managers must be able to obtain
process and use information. The
purpose of the economic theory is to
help managers know what information
should be obtained and how to process
and use the information. Managerial
economist has, therefore, gained an
increasing importance in business in
recent times. He can be very useful for
successful management.
The task of organizing and
processing information and the basic
theory can take two general forms.
 Task of making special decisions by
managers and
 General task of managers is to use
readily available information to
make a decision or carry out a
course of action that furthers the
goals of the organization.
Specific Decisions
There are several specific decisions
that managers have to take, e.g.,
whether or not to close down a branch
of a firm that has recently been
unprofitable; whether or not a store stay
open more hours a day; or whether to
pay for computing services rather than
install an in house computer. After
conducting a survey it has been found
that managerial economist perform the
following functions:
 Production scheduling
 Demand forecasting
 Market research
 Economic analysis of the industry
 Investment appraisal
 Security management analysis
 Advice on foreign exchange
management
 Advice on trade
 Pricing and the related decisions
 Analyzing and forecasting
environmental factors
General Tasks
Economic theory helps decision
makers know what information is
necessary to make intelligent decisions
to find the correct solutions to a problem
and to learn how to process and use
that information. After obtaining the
information or as much information as is
economically feasible to obtain, the
manager must analyze this information
and use it in correspondence with the
theoretical and statistical tools available
to make the best decision possible
under the prevailing circumstances. We
find that business is influenced by two
sets of decision factors:
(a) External factors (b) Internal
factors
Business is influenced not only by
what decisions are taken within the firm
Self-Instructional Material 41
but also by the general business
environment. The role of the managerial
economist is to understand these
external factors and to suggest policies
which the firm should follow to make the
best use of these external and internal
factors.
External Factors
 The most important external factor is
the general economic condition of the
economy, such as level and rate of
growth of national income, regional
income distribution, influence of
international factors on the domestic
economy, the business cycle, etc. The
managerial economist must obtain and
process information with regards to
these changes, advise the management
regarding their likely effects on the
operations of the firm and suggest
possible ways to further the
organization’s goals.
 Prospects of demand for the product:
Is there a change occurring in the
purchasing power of the public in
general or in some particular regions? Is
the change in purchasing power a result
of changes in population and migration
or is it due to changes in real income of
the people as a result of price level
changes? Are fashions, taste and
preferences undergoing any changes and
thus affecting the demand for the
product? A managerial economist tries
to find out their answers and advises the
firm accordingly.
 Input cost: The managerial economist
also tries to find out if there is anything
which is influencing the input cost of
the firm. For example, what about the
cost of labour in different regions and
for different operations? What about the
credit conditions in the market? Is there
going to be some changes in the
government credit policy? How different
inputs can be combined to minimize the
cost of production? And so on….
 The market conditions of raw material
and finished product is also a subject of
study by the managerial economist. He
has to understand the nature of the
market from which the firm is buying its
raw material and of the market where it
is selling its output. This understanding
helps the managerial economist to
recommend a pricing policy for
successful management of the firm.
 Managerial economist can also help in
the expansion of the firm’s share in the
market. He is to find out the
opportunities and the policies which help
in the expansion of the firm’s share in
local and internal markets. This he can
do by understanding the nature and trend
of demand.
 Managerial economics has to keep in
touch with the government’s economic
policies and the central bank’s monetary
policies, annual budgets of the
government, etc.
Internal Factors
The role of managerial economist
in internal management is as important
as his contribution towards the
management of external factors. He
helps in deciding about the production,
sales and inventory schedules of the
firm. He not only provides information
regarding their present level but also
forecasts their future trend.
Self-Instructional Material 42
 Perhaps a managerial economist
is used best to provide the pricing and
profit policies. As the present day firms
are often multi-product firms, a
successful managerial economist tries
to find for the firm the most profitable
output mix and the best price for its
various outputs, given the market
conditions.
The firm also needs the help of
managerial economist for its investment
decisions. For this, he needs to forecast
the return on the investment and the
cost that the firm incurs by taking up the
investment.
Thus, we find that managerial
economist has a very significant role to
play. He not only helps in the internal
management but also analyses the
external factors and also advises the
firm regarding their likely effects.
In short, the first role of a
manager is to recognize a problem or to
see a possible way to further the goal of
the organization and then to obtain and
process information in order to make a
decision or to reach a solution. His
second task is to use readily available
information to make a decision or carry
1.10. Responsibility of a Managerial Economist
As mentioned above managerial
economist has a role to play. Let us now
out a course of action that furthers the
goals of organization. Successful
managers know how to pick out the
useful information from the vast amount
of information they receive. In all these
roles of a manager, the knowledge of
managerial economics is extremely
helpful.
Though at one point of time or
other, managerial economist has to take
each one of the specific decisions
mentioned above, the decisions most
commonly undertaken are the analysis
of competing firms, sales forecasting
and market research. This is done in
order to keep the firm in a competitive
position vis-â-vis other firms in the
market. In addition, the managerial
economist also undertakes the job of
economic intelligence, which involves
obtaining and processing information
regarding the likely effects of changes in
government policies, tax rate structure,
exchange and tariff rates, etc. Though
the managerial economists in general
perform the above-mentioned functions,
the degree to which they participate in
overall management and the extent to
which they pursue these functions vary
from firm to firm.
find out what are his responsibilities
towards his job?
Self-Instructional Material 43
 The most important obligation of at the required time, he is bound to be a
a managerial economist is that his successful executive.
objectives coincide with that of the
business. Since in most of the cases the Here a couple of important points need
firms try to maximize profits on their be mentioned.
invested capital, the managerial
First, if the managerial economist
economist should also help in achieving
finds that due to some sudden and
this goal. So long as he maintains the
unaccounted factors, the presented
conviction and helps in enhancing the
forecast has undergone a change, it is
ability of the firm to maximize profits he
his duty to work out the new forecast
will be a successful managerial
and present it at the earliest possible
economist.
time. By drawing timely and prompt
The other most important attention to changes in forecasts he
responsibility of a managerial economist serves well both the management and
is to make forecasts as accurate as his own interest.
possible. We know that every decision,
Secondly, a managerial
a management takes normally has
economist’s caliber is generally judged
implications beyond the present, while;
by his ability to obtain necessary
future is rather uncertain. It is, therefore,
information quickly by personal contacts
necessary and obligatory for a
rather than by lengthy research from
managerial economist to make future
either the readily available sources or
forecast in such a manner that the risks
obscure reference sources. Though
involved in the uncertainties of future
thorough familiarity with reference
are minimized for the firm. He will have
sources and material is essential, yet it
to make these forecasts on the basis of
is even more important that he knows
data on the market conditions, the
from where to get the additional
general economic environment, the
information quickly. He must, therefore,
government policies, etc. For
personally know those individuals who
forecasting, he uses the techniques of
are specialists in the area of his
probability. A managerial economist is
concern. For this he needs to join
supposed to forecast the trends and
professional associations and take
shifts in the activities of importance to
active interest in them.
the firm be it sales, profits, demand,
cost, etc. Once such a forecast along Finally, the contribution of a
with its possible implications for the managerial economist will be adequate
firms is available, the management can only when he is a member of full status
follow a more orderly course of business in the business team. He must be ready
planning. If a managerial economist can to take up challenging tasks. Whenever
keep on providing successful forecasts some special assignments come to him,

Self-Instructional Material 44
he should be ready to undertake them
with full seriousness. It is for the
managerial economist himself that he
makes his services indispensable and
most sought after, both with the help of
his ability, training and experience as
well as his capacity to win continuing
support for himself and his professional
ideas. For the latter, a necessary
condition is that he can put even the
1.11. Summary
 For most purposes, economics can be
divided into two broad categories,
microeconomics and macroeconomics.
Macroeconomics as the name suggests is
the study of the overall economy and its
aggregates such as Gross National
Product, Inflation, Unemployment,
Exports, Imports, and Taxation Policy,
etc.
 Microeconomics deals with individual
actors in the economy such as firms and
individuals. Managerial economics can
be thought of as applied microeconomics
and its
 Managerial economics can be defined as
the study of how to direct scarce
resources in the way that most efficiently
achieves a managerial goal.
 A close relationship between
management and economics has led to
 Economic activity is the constant effort
to match ends to means because the
attainment of ends, the means and their
scarcities or to minimize the use of
resources, given the ends and their
most sophisticated ideas in the easiest
form in common language and in a
convincing manner.
In short, there is a growing
realization that they can significantly
contribute to the working and growth of
firms. However, a lot depend upon
managerial economists themselves as
to how they project themselves.
the development of managerial
economics. Management is the guidance,
leadership and control of the efforts of a
group of people towards some common
objectives.
 By reducing his sales, a monopolist can
drive up the price of his good his sales
will fall but his profits will rise.
 A business firm is an economic
organization, which is engaged in
transforming productive resources into
goods that are to be sold in the market. A
major part of managerial decisions
depend upon accurate estimates of
demand. A forecast of sales in future
aids the management in preparing
production employing resources. It will
help the management to strengthen its
market position and profit base
priorities. Decision-making by
management is truly economic in nature
because it involves choices among a set
of alternatives—alternative courses of
action.
Self-Instructional Material 45
 A decision is simply a selection from
two or more courses of action. The
essence of economic decision is the
solution to the economic problem.
 Economic theory helps decision makers
know what information is necessary to
make intelligent decisions to find the
correct solutions to a problem and to
learn how to process and use that
information.
 The most important obligation of a
managerial economist is that his
objectives coincide with that of the
business.
Self-Instructional Material 46