Chapter 1

1.1: The Fundamentals of Managerial Economics

Economics - the “Study of the allocation of scarce resources, among

alternative uses. (Rao)
 The social science that studies the behaviour of individuals, households,
nd organizations (called economic actors, players, or agents), when they
manage or use scarce resource, which have alternatives uses, to achieve
desired ends. (Wikipedia)
 A social science concerned with man’s problem of using scarce resources
to satisfy human wants. (Pagoso, et al)
 Study of how people use their scarce resources to satisfy their unlimited
wants;
 About making choices.
 The problem is that wants or desires are virtually unlimited while the
resources available to satisfy these wants are scarce. Economics studies
how people use their scarce resources in an attempt to satisfy their
unlimited wants.

Scarcity – occurs when the amount of people’s desire exceeds the amount
available at a price value.
 A resource scarce when it is not freely available or when its price exceeds
zero.
 Goods and services that are truly free are not the subject matter of
economics. Without scarcity, there would be no economic problems and
no need for prices.

 Resources are always scarce;
 They are not only scarce, but also have alternative uses.
 Optimum Allocation is requires;
  It is about making choices or decision making
 Allocation problems are faced by individuals, organizations, and nations.

Economics deals with:

o How an individual consumer allocates his scarce resources among
alternative uses?
 To get the maximum satisfaction
o How will an individual producer will attain its aim of least cost combination
of inputs to get a given quantities of output.
 To achieve efficiency
o How an individual firm/Industry attains equilibrium
 To attain profit maximizing level of output
 Maximize profit or minimize cost
 Maximize wealth or value
o How a country reach equilibrium
 To allocate limited resources in a way that desired goals are achieved.

Resources- the inputs or factors of production used to produce the goods and
services that human want.
 Labor- the physical and mental effort used to produce goods and services.
 Capital:
1. Physical Capital- Manufactured items (tools, buildings) used to
produce goods and services.
2. Human Capital- Knowledge and skills people acquire to increase
their labor productivity.
 Natural Resources- All “gifts of nature” used to produce goods and
services; which includes bodies of water, trees, oil reserves, minerals, and
animals;
- These can be renewable or exhaustible.
 Entrepreneurial Ability- Managerial and organizational skills needed to
start a firm. The talent, combined with the willingness to take risk of profit
 or loss.

 Labor, Capital, Natural Resources, and Entrepreneurial Ability- combined

to produce GOODS AND SERVICES.
 Good- A tangible product used to satisfy human wants.
 Service- An activity, or intangible product, used to satisfy human wants.

ECONOMIC DECISION MAKERS:

1. Households:
a) Consumers- demand goods and services.
b) Resource Owners- supply the resources.
2. Firms – demand goods and services; supply the resources.
3. Government- demand goods and services; supply the resources.
4. Rest of the World - demand goods and services; supply the resources.
5.
Market- a set of arrangements by which buyers and sellers carry out exchange of
mutually agreeable terms.
- bring together buyers and sellers
- determine price and quantity

1. Product Market- Market where goods and service are sold or exchanged.
2. Resource Market- Market where resource is brought or sold.

Circular Flow Model- diagram that traces the flow of resources, product income,
and revenue among economic decision makers;
- Shows the flow of the following among the economic decision makers:
 Resources
 Products
 Income
 Revenue
- Shows interaction between the household and firms.
Economics:
1. Microeconomics- The study of economic behaviour in particular markets:
a. Individual economic choices
b. Market coordinating the choices of the economic decision makers;
c. Individual pieces of the puzzle
2. Macroeconomics- The study of economic behaviour of entire economies;
a. Performances of the economy as a whole;
b. Big picture
3. Normative Economics- A normative economic statement concerns what
should be; it reflects an opinion and cannot be shown to be true or false by
reference to the facts.
- Normative economics statement- Opinion- “What should be”
4. Positive Economics- A positive economic statement concerns what is; it can be
supported or rejected by reference to facts,
- Positive Economics statements
- Assertion about economic reality
- Supported or rejected by evidence
- True or False
- “What is”

Application of Economics in Decision Making

Managerial Economics- Special branch of economics bridging the gap between
the abstract theory and managerial practice.
- “It is the application of economic analysis to business problems; it has the origin
of theoretical microeconomics.” By Howard Davies and Pun-Lee Lam

- “Integration of economic theory with business practice for the purpose of

facilitating decision-making and forward planning” by Milton H. Spencer

“”Price theory in the service of business executives is known as Managerial

economics” by Donald Stevenson Watson

Economics in general takes a “positive” and predictive approach not prescriptive

or “normative”
- Trying to explain “what is” not what “should be”
- the main objective is to understand how a market company works.

Not very concerned about the descriptive realism of assumption: “I assume ‘X’
does not mean “I believe X to be true”

Some real tension if the models are used for prescription

- Assume “perfect knowledge”: OK for model-building
- cannot say to a manager: “Behave AS IF you had perfect knowledge”

Managerial Economics- Adopt a general perspective, not a sample of one

- Simple models provide stepping stone to more complexitu
and realism;
- Thinking logically has a value itself and can expose sloppy
thinking.

- Assist in Decision Making

Why Study Managerial Economics?

 A powerful analytical engine
 A broader perspective on the firm.
 What is a firm?
 What are the firm’s overall objectives?
 What pressures drive the firms towards profit away from
profit?
 The basis for some of the more rigorous analysis of issues in Marketing
and Strategic Management.
