BEC 30325: MANAGERIAL ECONOMICS

Session 01

Introduction to Managerial
Economics

Dr. Sumudu Perera

Session Outline
• Nature and scope of Managerial Economics
• Goals and Constraints of business
organizations
• The Theory of the firm
• The nature and importance of profit
• Economic Profit and Accounting Profit
• Quantitative techniques in Managerial
Economics
 Managerial Economics
• Managerial Economics is the integration
of economic theory with decision
science tools, so as to make decision
making effective and efficient.

• The application of economic theory and

the tools of decision science to examine
how an organization can achieve its
aims or objectives most efficiently.
Managerial Economics deals with:

“How decisions should be made by

managers to achieve the firm’s
goals-in particular, how to maximize
profit”
 Managerial Decision Problems

Economic theory Decision Sciences

Microeconomics Mathematical Economics
Macroeconomics Econometrics

MANAGERIAL ECONOMICS
Application of economic theory
and decision science tools to solve
managerial decision problems

OPTIMAL SOLUTIONS TO
MANAGERIAL DECISION PROBLEMS
Economics Vs. Managerial Economics
Economics
■ Study of economic theory
■ Belongs to positive
economics
■ Examine the human
behavior on using scarce
resources on unlimited
needs and wants
■ Limited Scope
Department of Business Economics, FMSC, USJP
Managerial Economics
■ Application of economic
theory
■ Belongs to normative
economics
■ Study the way of applying
economic theory for
decision making in firms
■ Wide scope
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Why is Managerial Economics Important?
• To estimate economic relationships
• To make decisions related to internal issues
• Effectively utilize resources (What/how
much/how/to whom, to produce)
• Pricing
• Face price and non-price competitions
• Maximizing sales, revenues, profits
• To identify the impact of external factors on
the firm
• To use theoretical concepts in economics to
actual behavior of firms
• A powerful “analytical engine”.
Department of Business Economics, FMSC, USJP 7
Theory of the Firm

 Combines and organizes resources for the purpose of producing goods

and/or services for sale.

 Internalizes transactions, reducing transactions costs.

 Primary goal is to maximize the wealth or value of the firm.

Example -Theory of the Firm

■ Mr. Smith, an entrepreneur decides to set up a company by recruiting people to work for
wages, by purchasing a property for the workplace machinery for the factory. He
believes that it is very much efficient and less costly to run a business through a firm,
rather than him doing everything alone.
■ He believes that a general contract agreed with laborers to perform a number of tasks
for specific wages and benefits is less costly than specific contacts for each task
undertaken.
■ He can also internalize many functions such as Finance, Marketing, IT, Research and
Development etc without giving those tasks to external parties.
Value of the Firm
The present value of all expected future profits

1 2 n n
t
PV     
(1  r ) (1  r )
1 2
(1  r ) n
t 1 (1  r ) t

n
t n
TRt  TCt
Value of Firm   
t 1 (1  r ) t
t 1 (1  r ) t
Alternative Theories

 Sales maximization
Adequate rate of profit
Management utility maximization
Principle-agent problem
Satisficing behavior
Definitions of Profit

 Business / Accounting Profit: Total revenue minus the explicit or accounting costs

of production.

 Economic Profit: Total revenue minus the explicit and implicit costs of production.

 Opportunity Cost: Implicit value of a resource in its best alternative use.

Example –Accounting vs Economic profit

■ Maya is in the final year of the University and she has lectures only during the evening.
Therefore she has free time to engage in an internship programme. She got the opportunity to
work at a bank which pays Rs. 12000 per month. If she is to undertake the internship she has
to incur extra travelling and food cost of Rs. 3000 per month. However Maya decides to bake
cakes at home and sell for private parties. She earns Rs. 25000 per month by making cakes.
The costs that she has to incur are given below;
– Ingredients Rs.4000
– Packaging Rs.500
– Electricity Rs.250
■ Find out the accounting profit and economic profit of carrying out the cake business.
Function of Profit

 Profit is a signal that guides the allocation of society’s resources.

 High profits in an industry are a signal that buyers want more of

what the industry produces.

 Low (or negative) profits in an industry are a signal that buyers

want less of what the industry produces.
 The Changing Environment of
Managerial Economics
 Globalization of Economic Activity
■ Goods and Services
■ Capital
■ Technology
■ Skilled Labor

 Technological Change
■ Telecommunications Advances
■ The Internet and the World Wide Web
Decision Science Tools
• Numerical analysis
• Statistical estimation
• Forecasting
• Game theory
• Optimization
• Simulation

Department of Business Economics, FMSC, USJP

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 Basic Training: Rules of Differentiation
■ Constant Function Rule: Y = f(X) =0
■ Power Function Rule: dY
 b  a X b 1
dX
dY dU dV
 
■ Sum-and-Differences Rule dX dX dX
dY dV dU
U V
■ Product Rule dX dX dX
■ Quotient Rule dY

V dU  dX  
 U dV
dX 
2
dX V

dY dY dU
■ Chain Rule  
dX dU dX

Department of Business Economics, FMSC, USJP 18