Economics and managerial

decision making

• Economics

The study of the behavior of human

beings in producing, distributing and
consuming material goods and
services in a world of scarce
Resources with alternate uses

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• Basic assumption in economics:
• Economic wants exceed productive
capacity.
• Limited resources and unlimited wants.
• Human wants are goods, services and
conditions of life individuals desire.

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 Definition of economics
• A social science that examines how individuals,
firms and society make optimal choices under
conditions of scarcity.
• It deals with the allocation of scarce resources
with alternative uses to satisfy unlimited human
wants.
• Basic assumption is that economic resources
are scarce and human wants are insatiable.
 Scarcity and Choice

• Resources are scarce

• Choices must be made (trade
off)
• Opportunity cost
• There’s no free lunch

LO1 1-4
 Review of economic terms
• Scarcity is the condition in which resources
are not available to satisfy all the needs and
wants of a specified group of people

• Opportunity cost is the amount (or

subjective value) that must be sacrificed in
choosing one activity over the next best
alternative

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 Purposeful Behavior

• Rational self-interest

Maximisation – profits or utility

Cost minimization

LO1 1-6
 Economic problem
• What to produce?
• How to produce?
• For whom to produce?
 Society’s Economizing Problem

Resources are inputs (factors) of

production which are scare : 4
Land : fertility of soil, climate, forest,
mineral resources.
•Gift of God, given by nature.
•Limited in supply. Fixed in supply.
•‘original and indestructible powers of
soil’
•Price is Rent.
LO4 1-8
Labor:
Physical and mental effort.
Includes entrepreneurial effort.
Skilled and unskilled labor.
Human capital.
Price is wage.
Capital
•Man made factor of production.
•Produced means of production. Used for
further production.
•Machinery, factories, equipment, tools,
inventories of finished and semi finished
goods, irrigation, transportation network,
communication networks.
•Money is not capital. Money only facilitates
exchange of goods and services. Does not
produce anything.
•Price is interest.
Entrepreneurial Ability
Brings the other factors of production
together. Takes initiative. Makes decisions.
The manager, the businessman.
Takes risk.
Innovates.
Price is profit.
 Theories, Principles, and Models

• The scientific method:

Observe Formulate a hypothesis Test the hypothesis

Accept, reject, or modify the hypothesis

Continue to test the hypothesis, if necessary

• Economic principles
• Generalizations
• Other-things-equal assumption
• Graphical expression

LO2 1-12
 Review of economic terms
• Microeconomics is the study of individual consumers
and producers in specific markets, especially:
• supply and demand
• pricing of output
• production process
• cost structure
• distribution of income

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 Review of economic terms
• Macroeconomics is the study of the
aggregate economy, especially:
• national output (GDP)
• unemployment
• inflation
• fiscal and monetary policies
• trade and finance among nations (balance
of payments)

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 Class activity
Indicate which statement applies to microeconomics or
macroeconomics?
•The unemployment rate in the US was 8% in 2012.
•RBI has decided to increase repo rate.
•Kotak Mahindra Bank has acquired ING Vysya Bank
•Pepsi announces for every one bottle purchased, you get one free.
•IMF revises upward China’s economic growth rate forecast for the
year 2017.
 Economics and managerial
decision making

The use of economic analysis to make

business decisions involving the best use
(allocation) of an organization’s scarce
resources

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 Economics and managerial
decision making
• Relationship to other business disciplines

Marketing: demand, price elasticity

Finance: capital budgeting, breakeven

analysis, opportunity cost, value added

Management science: linear

programming, regression analysis,
forecasting
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 Economics and managerial
decision making
• Relationship to other business disciplines

Strategy: types of competition,

structure-conduct-performance
analysis

Managerial accounting: relevant

cost, breakeven analysis, incremental
cost analysis, opportunity cost
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 Economics and managerial
decision making
• Questions that managers must answer:

– What are the economic conditions in our

particular market?
• market structure?
• supply and demand?
• technology?

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 Economics and managerial
decision making
• Questions that managers must answer:

– What are the economic conditions in our

particular market?
• government regulations?
• international dimensions?
• future conditions?
• macroeconomic factors?

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 Economics and managerial
decision making
• Questions that managers must answer:

– Should our firm be in this business?

• if so, at what price?
• and at what output level?

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 Economics and managerial
decision making
• Questions that managers must answer:

– How can we maintain a competitive

advantage over other firms?
• cost-leader?
• product differentiation?
• market niche?
• outsourcing, alliances, mergers?
• international perspective?
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 Economics and managerial
decision making
• Questions that managers must answer:

– What are the risks involved?

• shifts in demand/supply conditions?
• technological changes?
• the effect of competition?
• changing interest rates and inflation rates?

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 Economics and managerial
decision making
• Questions that managers must answer:

– What are the risks involved?

• exchange rates (for companies in
international trade)?
• political risk (for firms with foreign
operations)?

Risk is the chance that actual future

outcomes will differ from those expected
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 Economics of a business
• The economics of a business refers to the
key factors that affect the firm’s ability to earn
an acceptable rate of return on its owners’
investment

The most important of these factors are

– competition
– technology
– customers
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 Economics of a business
• Change: the four-stage model

– Stage I (the ‘good old days’)

• market dominance
• high profit margin
• cost plus pricing

… changes in technology, competition,

customers force firm into Stage II ..
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 Economics of a business
• Change: the four-stage model

– Stage II (crisis)
• cost management
• downsizing
• restructuring

… ‘re-engineering’ to deal with changes and

move firm into Stage III ..
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 Economics of a business
• Change: the four-stage model

– Stage III (reform)

• revenue management
• cost cutting has limited benefit

… focus on ‘top-line’ growth ..

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 Economics of a business
• Change: the four-stage model

– Stage IV (recovery)
• revenue plus

… revenue grows profitably

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 Economics of a business
• Example: Avon

• well established company, in stage I

until late 1970s
• found itself in Stage II during 1980s
• since mid 1990s, entered stage III
• expanded into emerging markets and
updated its image

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 Economics of a business
• Example: Sears, Kmart

• Wal-Mart effect
• Sears pushed down to number three
in late 1980s … repositioned itself as
a clothing store
• Kmart filed for bankruptcy in 2002 …
plan to acquire Sears

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 Economics of a business
• Example: Kodak

• struggled to transition from

chemical-based film to digital
imaging
• responded by developing strong cash
flows in new product range

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 Review of economic terms
• Allocation decisions must be made
because of scarcity. Three choices:

What should be produced?

How should it be produced?

For whom should be produced?

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 Review of economic terms
• Economic decisions of the Firm

What - begin or stop providing

goods/services (production)
How - hiring, staffing, capital budgeting
(resourcing)
For whom – target the customers most
likely to purchase (marketing)
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 Review of economic terms

• Entrepreneurship is the willingness to

take certain risks in the pursuit of goals

• Management is the ability to organize

resources and administer tasks to achieve
objectives

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 Global application

• Example: Western Union

• began over 100 years ago

• huge changes in technology
• to survive, the company branched
out

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 Global application

• Example: VNU

• Dutch publishing company

• transformed itself into a global
provider of marketing and media
information

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 Economic systems
• Set of institutional arrangements
• Coordinating mechanism
• Differences in systems exist by:
• Who owns the factors of production
• What method is used to motivate,
coordinate, and direct economic activity
 Command economy
• Known as socialism or communism
• Government ownership
• Decisions made by a central planning
board.
• USSR, Libya, Myanmar, and Iran.
 Market economy
• Known as capitalism
• Private ownership of resources
• Decisions based on markets
• The United States, Australia, Switzerland, and the
U.K.

• Neoclassical economics