Managerial Economics 1.introduction To Managerial Economics

D ef in i ti o n an d M an ag eri al Is s ues
N at u re o f Man age rial E con o mi cs

Scope of Managerial Economics
Theory of Firm and Constraints
Managerial Economics
1.Introduction to Managerial Economics
Solomon K. (PhD)
Yardstick International College
April 2021
D ef in i ti o n an d M an ag eri al Is s ues
N at u re o f Man age rial E con o mi cs
Theory of Firm and Constraints
Table of Contents
• Introduction
1
• Definition and Managerial Issues
• Nature of Managerial Economics
• Scope of Managerial Economics
• Theory of Firm and Constraints
D e f i n i t i o n a n d M a n a g e r i a l I s s u es
N a t u r e of M a n a g e r i a l E c o n o m i c s
S c o p e of M a n a g e r i a l E c o n o m i c s
T h e o r y of F i r m a n d C o n s t r a i n t s
Definition and Managerial Issues

What is Economics?
• Economics is the study of how individuals and societies choose to utilize
scarce resources to satisfy virtually unlimited wants.
Scarcity choices Economics
• Scarcity describes the condition in which the availability of resources is

insufficient to satisfy the wants and needs of individuals and society.
 From the perspective of society as a whole, scarcity refers to the

limitations placed on the production of goods and services because
factors of production are finite.
 From the perspective of the individual, scarcity refers to the limitations

on the consumption of goods and services because of limited of personal
income and wealth.
What are these scarce productive resources?
• Productive resources, sometimes called factors of production or

productive inputs, are classified into one of four broad categories:
land, labor, capital, and entrepreneurial ability.
• Land generally refers to all natural resources including wildlife,

minerals, timber, water, air, oil and gas deposits, arable land, and
mountain scenery. The reward for land is called rent.
• Labor refers to the physical and intellectual abilities of people to

produce goods and services. The reward for labor is called wage.

What are these scarce productive resources?
• Capital refers to manufactured commodities that are used to produce

goods and services for final consumption. Machinery, office
buildings, equipment, warehouse space, tools, roads, bridges,
research and development, factories, and so forth are all a part of a
nation’s capital stock. The reward for capital is called interest.
• Entrepreneurial ability refers to the ability to recognize profitable

opportunities, and the willingness and ability to assume the risk
associated with marshaling and organizing land, labor, and capital to
produce the goods and services that are most in demand by
consumers. People who exhibit this ability are called entrepreneurs.
• The return to the entrepreneur is called profit.
Opportunity Cost
• The concepts of scarcity and choice are central to the discipline of
economics. It is important to understand, however, that in the face of
scarcity whenever the decision is made to follow one course of action, a
simultaneous decision is made to forgo some other course of action.
• When a high school graduate decides to attend college or university, a

simultaneous decision is made to forgo entering the work force and earning
an income.
• Scarcity necessitates trade-offs. That which is forgone whenever a choice is
made is referred to by economists as opportunity cost. That which is
sacrificed when a choice is made is the next best alternative.
• Definition: Opportunity cost is the highest valued alternative forgone

whenever a choice is made.

Macroeconomics versus Microeconomics
The field of economics is divided into two broad subfields:
macroeconomics and microeconomics.
Macroeconomics is the study of aggregate economic behavior.

Macroeconomists are concerned with such issues as gross domestic
product, national income, employment, inflation, national output, economic
growth, interest rates, and international trade.
In general, the topics covered in macroeconomics are concerned with the

economic environment within which firm managers operate. For the most
part, macroeconomics focuses on the variables over which the managerial
decision maker has little or no control but may be of considerable
importance in the making of economic decisions at the micro level of the
individual, firm, or industry.

• Microeconomics is the study of individual economic behavior.
Microeconomists are concerned with output and input markets,
product pricing, input utilization, production costs, market
structure, capital budgeting, profit maximization, production
technology, and so on.
• Microeconomics is the study of the behavior and interaction of

individual economic agents. These economic agents represent
individual firms, consumers, and governments.
• Microeconomics deals with such topics as profit maximization,

utility maximization, revenue or sales maximization, production
efficiency, market structure, capital budgeting, environmental
protection, and governmental regulation.

What is Managerial Economics?
• Managerial Economics is the applications of economics theory and
methodology to business decision-making.
• Managerial Economics is the analysis of major management decisions using

the tools of economics.
• Definition: Managerial economics is the synthesis of microeconomic theory

and quantitative methods to find optimal solutions to managerial decision-
making problems.
• The term ‘businesses applies to any situation where there is a transaction

between two or more parties.
• Integration of economic theory with business practice for the purpose of

facilitating decision making and forward planning by management.

Different kinds of Decisions that private and public managers face include:
 Determining prices and outputs to Maximize profits (Revenue and Cost)
 Competition between firms (Market structure)
 Public sector decisions (funding a public project)
 Regulatory Decision (cost benefit analysis )
 Decision making under uncertainty
• Decision-making involves several steps:
• Define the problem
• Determine the objective
• Explore alternatives
• Predict the Consequences
• Make a choice Perform sensitivity analysis
D e f i n i t i o n a n d M a n a g e r i a l I s sue s
Nature of Managerial Economics

A close interrelationship between management and
economics→ ME
Management:
Coordination
An activity or an ongoing process
An art of getting things done by other people.
Economics -two fundamental facts of life:
1 Basic problem 2 choice problem
(Firm)
Umlimited wants What to produce?
Limited resources How to produce?
Scarcity ME
For whom to
produce?
Hence, ME is economics applied to "problems of choice" and
allocation of scarce resources by the firms.
It is the study of allocation of resources available to a firm.

• Managerial Economics is related to economic theory and decision
sciences.
Relationship with economic theory
• The main branch of economic theory with which managerial
economics is related is microeconomics, which deals essentially with
how markets work and interactions between the various components
of the economy.
• In particular, the following aspects of microeconomic theory are
relevant:
 Theory of the firm
 Theory of consumer behavior (demand)
 Theory production and cost (supply)
 Price theory
 Market structure and competition theory
D e f i n i t i o n a n d M a n a g e r i a l Is s ue s
Economics Vs Managerial Economics

Characteristics of Managerial Economics
Economics Managerial Economics

Dealing both micro and macro aspects. Dealing only micro aspects.
Stating how markets work and what Stating what firms should
firms do in practice- descriptive do- prescriptive
Both positive and normative science. Only a normative science.
Deals with practical & theoretical aspects. Deals with practical aspects.
Study both the firm and individual. Study the problems of firm.
Wide scope. Narrow scope.
Economics Vs Managerial Economics
Relationship with decision sciences
provide the tools and techniques of analysis used in managerial

economics. The most important aspects are as follows:
 optimization
 statistical estimation and forecasting
 analysis of risk and uncertainty
 discounting and time-value-of-money techniques
D e f i n i t i o n a n d M a n a g e r i a l I s s ues
D e f i n i t i o n a n d M a n a g e r i a l I ss ue s
Theory of Firm and constraints

1. Time Value of Money :
• It states a birr (1ETB) received in the future is worth less
than a birr (1ETB) in hand today.
• It plays an important role in managerial economics.
• The opportunity cost of receiving the 1ETB in the future
is the forgone interest that could be earned were 1ETB
received today.
• This opportunity cost reflects the time value of
money.
• To properly account for the timing of receipts and
expenditures, the manager must understand present
value analysis.
Theory of Firm and constraints

2. Expected Value Maximization
Owner-managers maximize short-run profits.
Max π = TR − TC (1)
Primary goal is long-term expected value maximization.
Value of the Firm = Present Value of Expected Future
Profits
π1 π2 n
Σn t
= + + .... = t =1 (2)
π
(1 + i ) 1 (1 + i ) (1 + i ) (π1 + i )
2 +
n t
Constraints
Resource constraints.
Social constraints.
Variability of Business Profits
Where TR = Total Revenue, TC = Total Cost, π =

Profit,
i = interest rate, t = time.
Why do Profits vary among firms?
Theories used to explain profit variations are:
Frictional Theory of Economic Profits
Monopoly Theory of Economic Profits
Innovation Theory of Economic Profits
Compensatory Theory of Economic
Profits
Frictional Theory of Economic Profits
It states that markets are sometimes in disequilibrium because

of unanticipated changes in demand or supply (cost) shocks.
Unanticipated shocks produce positive or negative economic
profits for some firms.
The supply-side shocks may result from changes in production
technology or changes in resource prices.
On the demand-side shocks may result from the introduction
of new products and changing consumer preferences, such as
ATMs.
Monopoly Theory of Economic Profits
It is a further explanation of above-normal profits, which is an

extension of frictional profit theory.
It states that some firms are protected from competition by
high barriers to entry (such as patent rights, government
restrictions, economies of scale, etc), guaranteeing the firm
market power.
Monopoly power relates to the ability of a fir m or an industry
to raise the selling price of its product by restricting output.
The degree of a fir m ' s market power is usually related to the
level of competition.
D e f i n i t i o n a n d M a n a g e r i a l I s s ues
Innovation Theory of Economic Profits
• This theory states that, above average profits are the

rewards associated with being the first to introduce a
new product or technology.
• Examples:
• Microsoft Corporation has earned superior rates
of return because it successfully developed,
introduced, and marketed a superior image-
based approach to computer software
instructions.
• McDonald's Corporation in the fast-food
business.
Compensatory Theory of Economic Profits
It describes above-normal rates of return that reward firms for

extraordinary success in meeting customer needs, maintaining
efficient operations, and so forth.
It is reasonable to expect firms operating at above-average levels
of efficiency to earn above-normal rates of return than inefficient
firms.
Moreover, firms operating with above-average risk
environment should be compensated with above normal rates
of return for the uncertain environment.
Summary Questions
1. What is the concern of economics in general?

2. How is the concept of opportunity cost related with economics?
3. Macroeconomics Vs Microeconomics.
4. What is managerial economics? How is it helpful to managers?
5. Discuss the characteristics of ME.
6. Discuss the scope of ME.
7. A dollar received today will never be worth the same as a dollar
received tomorrow. Do you agree? If not, then why not?
8. What is the principal agent problem?
9. Differentiate B/N economic and accounting cost/profit
References
• Webster ,Thomas J. (2003)Managerial Economics: Theory

and Practice, Chapter 1.
• Thomas and Charles (2016). Managerial Economics:
Foundations of Business Analysis and Strategy, Chapter 1.
• Wilkinson (2005). Managerial Economics: A Problem
Based Approach, Chapter 1.
• Samuelson, William F. and Stephen G. Marks (2012)
Managerial Economics, 7th ed John Wiley & Sons, Inc., New
Jersey, Chapter 1.

Managerial Economics 1.introduction To Managerial Economics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Managerial Economics 1.introduction To Managerial Economics

Uploaded by

Copyright:

Available Formats

D ef in i ti o n an d M an ag eri al Is s ues

N at u re o f Man age rial E con o mi cs

Yardstick International College

• Nature of Managerial Economics

• Scope of Managerial Economics

• Theory of Firm and Constraints

Definition and Managerial Issues

Scarcity choices Economics

• Scarcity describes the condition in which the availability of resources is

 From the perspective of society as a whole, scarcity refers to the

 From the perspective of the individual, scarcity refers to the limitations

Definition and Managerial Issues

What are these scarce productive resources?

• Productive resources, sometimes called factors of production or

• Land generally refers to all natural resources including wildlife,

• Labor refers to the physical and intellectual abilities of people to

Definition and Managerial Issues

• Capital refers to manufactured commodities that are used to produce

• Entrepreneurial ability refers to the ability to recognize profitable

Definition and Managerial Issues

• When a high school graduate decides to attend college or university, a

• Definition: Opportunity cost is the highest valued alternative forgone

Definition and Managerial Issues

Macroeconomics is the study of aggregate economic behavior.

In general, the topics covered in macroeconomics are concerned with the

Definition and Managerial Issues

• Microeconomics is the study of the behavior and interaction of

• Microeconomics deals with such topics as profit maximization,

Definition and Managerial Issues

• Managerial Economics is the analysis of major management decisions using

• Definition: Managerial economics is the synthesis of microeconomic theory

• The term ‘businesses applies to any situation where there is a transaction

• Integration of economic theory with business practice for the purpose of

Definition and Managerial Issues

Nature of Managerial Economics

Definition and Managerial Issues

Economics Vs Managerial Economics

Economics Managerial Economics

Economics Vs Managerial Economics

Relationship with decision sciences

provide the tools and techniques of analysis used in managerial

Scope of Managerial Economics

Theory of Firm and constraints

Theory of Firm and constraints

Variability of Business Profits

Where TR = Total Revenue, TC = Total Cost, π =

Frictional Theory of Economic Profits

It states that markets are sometimes in disequilibrium because

Monopoly Theory of Economic Profits

It is a further explanation of above-normal profits, which is an

Innovation Theory of Economic Profits

• This theory states that, above average profits are the

Compensatory Theory of Economic Profits

It describes above-normal rates of return that reward firms for

1. What is the concern of economics in general?

• Webster ,Thomas J. (2003)Managerial Economics: Theory

You might also like