CHAPTER 1: USING ECONOMICS TO SOLVE PROBLEMS
MANAGERIAL ECONOMICS (ECO1)
ELEMENTS OF A PROBLEM-SOLVING
PEDAGOGY (learning)
 Begin with a Business Problem -
puts the particular ahead of the
abstract and directly motivates the
material.
- require the use of analytical skills
of interest as solution tools.
 Using Economic Analysis to
Identify Profitable Decisions - to
use the rational actor paradigm to
identify problems or mistakes and
profitable solutions.
- know how to view each
underemployed asset into a
money-making opportunity
instead of spotting and
eliminating inefficiency.
 Find Ways to Implement Them -
when the inefficiency occurs within a
larger organization. The third
element of the pedagogy addresses
the problem of implementation.
- know how to design an
organization where employees
have enough information to
make profitable decisions, and
the incentive to do so.
Number 1 problem: Lack of information
A problem-solving algorithm uses these
questions:
1. Who is making the bad decision?
2. Do they have enough information to
make a good decision?
3. Do they have the incentive to do so?
Three potential solutions:
1. Let someone else make the decision,
someone with better information or
incentives;
2. Give more information to the current
decision maker; or
3. Change the current decision-maker’s
incentives.
 If people act rationally, optimally and
self-interestedly, then mistakes have
only one of two cases: either people
lack the information necessary to
make good decisions; or the
incentive to do so.
 Rational Actor Paradigm – used by
economist to predict behavior.
(Rational choice theory)
 Rational Choice Theory – assumes
that individuals are rational actors
using rational information to try
actively maximize their advantage in
any situation and therefore
consistently trying to minimize their
losses.
- The paradigm not only helps
economists to figure out why
people behave the way they do
but also suggests ways to
motivate them to change. You
have to change self-interest by
changing incentives to change
behavior.
Practical tips that will help you
develop problem-solving skills
1. Think about the problem from the
organization’s point of view.
- Avoid the temptation to think
about the problem from the
employee’s point of view
because you will miss the
fundamental problem of goal
alignment: how does the
organization give employees
enough information to make a
good decision and the incentive
to do so?
2. Think about the organizational design.
 Once you identify a bad decision,
avoid the temptation to solve the
problem by simply reversing the
CHAPTER 1: USING ECONOMICS TO SOLVE PROBLEMS
MANAGERIAL ECONOMICS (ECO1)
decision. Instead, think about why
the bad decision was made, and
how to make sure that similar
mistakes won’t be made in the
future.
3. What is the trade off?
 Every solution has costs as well as
benefits. Avoid the temptation to
think only about the benefits, as it
will make your analysis seem as if it
were done to justify a foregone
conclusion.
4. Don’t define the problem as the
lack of your solution.
 This kind of thinking may cause you
to miss the best solution. Instead,
define the problem as with some
other alternative as potential solution
to the problem.
5. Avoid jargon.
 Force yourself to spell out what you
mean in a simple language to help
your thinking and communication.
 Demand: higher the price, the lower
the quantity demanded, and vice
versa.
 Supply: higher the price, the higher
the quantity supplied, and vice
versa.
 Economics provides a
consequentialist defense of high
prices by comparing them to the
implied alternative. Economists
would show, using demand-supply
analysis, that if prices did not rise,
the consequence would be excess
demand. Without the ability to earn
additional profit during times of
scarcity, there will be less incentives
which would make the long run even
worse.
Spiderman Principle: with great power,
comes great responsibility.
The laws of capitalism allow
corporations to amass significant
power: in turn, society should demand a
high level of responsibility from
corporations.

ETHICS AND ECONOMICS

Ethics – rules of behavior based on ideas
about what is morally good and bad.

 Altruism, Affection, Personal Ethics

Economics – social science concerned
with man’s problem of issuing scarce
resources to satisfy unlimited wants.

 Rationality, Optimality
Deontology – study of moral obligation

 Act of moral abdication for

businesses to pretend they have no
choice but to charge as much as
they can based on supply and
demand (Joe Holt).
CHAPTER 1: USING ECONOMICS TO SOLVE PROBLEMS
MANAGERIAL ECONOMICS (ECO1)
CHAPTER 2: THE ONE LESSON OF BUSINESS
MANAGERIAL ECONOMICS (ECO1)
CAPITALISM AND WEALTH
 Wealth – created when assets move
from lower to higher – valued uses.
- The value for a good/service is
measured by an individual as the
amount of money he/she is
willing to pay.
 Voluntary transactions – create
wealth.
 Capitalism – private/corporate
ownership of capital goods.
- Used to produce and distribute
products in a free market
(gumagawa ng goods para
kumite)
- Create wealth (by following self-
interest)
 Buyer surplus – difference between
the buyer’s value minus the price
(ex. mas bibilin yung nakitang mas
mura (benefit)
 Seller surplus – difference between
the agreed on price and seller-s
value (ex. binawasan yung presyo
kasi may tubo pa rin)
 Total surplus/gains from grain –
the sum of buyer and seller surplus
(ex. di alam ng buyer and seller
yung value ng isa’t isa)
 Zero sum fallacy - capitalism who
think that if one person makes
money, someone else must be
losing it.
- Policy makers often invoke this
fallacy to justify limits on pay,
profitability, or prices, or even
trade itself. They are missing the
big idea, that the voluntary
nature of trade ensures that both
parties’ gain.
GOVERNMENT AND WEALTH
 The government plays a critical role
in the wealth creating process using
legal mechanisms that facilitate
voluntary transactions.
 Property rights- rights of an
individual /organizations to buy, sell,
and resell. (Money making
opportunity)
 Contracts – agreement on the
transactions made.
 Secure property rights are also
associated w/ measures of
environmental quality and human
well-being. If you give people
ownership to their property, they will
take care of it, invest in it and keep it
clean.
ECONOMICS AND BUSINESS
 Economics - social science
concerned w/ man’s problem of
issuing scarce resources to satisfy
unlimited wants.
- Can be used by business people
to spot money-making
opportunities (assets in lower-
valued uses)
 Efficiency – doing things well,
successfully producing a desired
(optimum) result.
- One of the most useful ideas
economics.
- An economy is efficient if all
assets are employed in their
highest-valued uses.
- Ex. the proposal of Bangko
Sentral ng Pilipinas to
microfinancing and lending
institutions to apply effective
interest rates on loans to
borrowers instead of straight
computation.
 One lesson of business: the art of
business consists of identifying
assets in low-valued uses and
devising ways to profitability move
them to higher-valued ones.
 Each underemployed asset
represents a potential wealth-
creating transaction. The art of
business is to identify these
transactions and find ways to
profitability consummate them.
 If the movement of assets to higher
valued uses creates a wealth, then
anything that impedes asset
movement destroys wealth.
Three impediments of wealth:
 Taxes – imposed by the
government.
 Subsidies – grants given by the
government or a private
organization.
 Price control – regulations that
allows trade only at certain
prices.
TWO TYPES:
- Price ceilings - which outlaw
trade at prices above the ceiling.
- Price floors - which outlaw
trade at prices below the floor.
*Black market – illegal, hindi nagbabayad
ng tax kaya mayaman*
CHAPTER 2: THE ONE LESSON OF BUSINESS
MANAGERIAL ECONOMICS (ECO1)
WEALTH CREATION IN
ORGANIZATIONS
 Companies can be thought of
collection of transactions, from
buying raw materials like capital and
labor to selling finished goods and
services. A successful company
move these assets to higher-valued
uses and thus making money for the
company.
CHAPTER 2: THE ONE LESSON OF BUSINESS
MANAGERIAL ECONOMICS (ECO1)
CHAPTER 3: BENEFITS, COSTS, AND DECISIONS
MANAGERIAL ECONOMICS (ECO1)
VARIABLE, FIXED, AND TOTAL
COSTS
 Fixed cost – cost that does not vary with the amount of output.
- Di pa nakakabenta may cost na agad.
 Variable cost – cost that change with output level
- Depende sa benta yung cost
 Total cost – sum of the total fixed cost and the total variable cost.
FORMULAS:
Total cost = Total fixed cost + total variable cost
Average fixed cost = Total fixed cost / Quantity
Average variable cost = total variable cost / quantity
Average total cost = total cost / quantity
Total revenue = price x quantity
Total profit = total revenue – total cost

ACCOUNTING VS. ECONOMIC PROFIT

 Revenue – total amount received by a company for goods or services sold.
 Profit – Difference between the revenue and cost.
EXPENSES INCLUDE:

 Cost paid to suppliers – payment disbursed to any supplier contract

 General operating expenses – costs of doing business
 Depreciation expenses – cost of an asset that has been depreciated for a single
period. Shows how much of the asset’s value has been used up.
 Interest payments – price pay to borrow money or cost charge to lend money
*These types of expenses are accounting costs (Explicit Cost)
CHAPTER 3: BENEFITS, COSTS, AND DECISIONS
MANAGERIAL ECONOMICS (ECO1)

 Implicit cost – cost that do not appear in the accounting statements

 Interest – the cost creditors charge for the use of their capital
OPPORTUNITY COST

 Cost of an alternative you gave up to earn profit from the other.

 It is the value of the best alternative that is foregone
SUNK COST FALLACY

 Sunk cost – cost that has already been incurred and cannot be recovered
 When making decisions, you should consider all costs and benefits that vary with the
consequence of a decision and only costs and benefits that vary with the consequence
of a decision.
 Sunk cost fallacy – means that you consider costs and benefits that do not vary with
the consequences of your decisions

HIDDEN COST FALLACY

 Occurs when you ignore the relevant costs, the costs that do vary with the
consequences of your decision.
CHAPTER 3: BENEFITS, COSTS, AND DECISIONS
MANAGERIAL ECONOMICS (ECO1)