Managerial Economics

MBA ZC 416

Sidharth Mishra
BITS Pilani Associate Professor, Department of Management
sidharth.mishra@pilani.bits-pilani.ac.in
Pilani Campus
 BITS Pilani
Pilani|Dubai|Goa|Hyderabad

Managerial Economics
Introduction - Part 1
Agenda

• Introductions

• Flipped classroom

• Course objectives

• Textbooks/ Resources

• Evaluation scheme

• Overview of Managerial Economics

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Instructor

Sidharth Mishra
• BE (NIT, Rourkela), PGDM (IIM,Ahmedabad)
• 25 years in the corporate sector in the consumer and the start up sector with
tenures in leading companies like LG, Samsung and HCL.
• Associate Professor (Department of Management), BITS, Pilani since
November, 2018.
• sidharth.mishra@pilani.bits-pilani.ac.in

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Textbook/ Resources

T1 “Managerial Economics” Truett and Truett by John Wiley and

Sons, 4th Edition, 2004
 

R1 Managerial economics by Keat and Young, Pearson, 7th Edition, 2018

R2 Samuelson & Nordhus, "Economics", Tata McGraw-Hill Edition, 16th

edition, , 1998
R3 Petersen, Lewis and Jain, “Managerial Economics”, Pearson Education, ,
2006.
R4 Hirschey, “Economics for Managers”, Thompson, , 2006

R5 Suma Damodaran, "Managerial Economics", Press, 2006

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Evaluation Scheme

No Name Type Duration Weight

EC-1 Quiz-I Online - 10%

Quiz-II Online - 10%

Assignment Online - 5%

EC-2 Mid-Semester Test Closed Book 2 hours 30%

EC-3 Comprehensive Exam Open Book 3 hours 45%

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Introduction

Fundamental Questions
– What is Managerial Economics?
– Why Managerial Economics?
– What kind of issues does it help
address?
– How can it help managers to make
better decisions?
Managerial Economics (MBAZC416)
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
 Fundamental economic problems
• Three questions that managers face:
– What to produce?
– How to produce?
– How to distribute?
• Scarcity of resources
• How does economics answer these questions?

Managerial Economics (MBAZC416)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Imagine

• Imagine a car manufacturer producing only one model of car (Model T) priced at
US 10,000 at which they were able to find 5000 customers.
• For selling additional volumes they have to start giving freebies (additional
warranty, 0% finance, free services)
• For selling more they have to initiate price-cuts. After the given volume they would
be able to sell by lowering price.
• At the same time their costs would also change (material cost would go down
because of bulk discounts, service and repair costs would go up etc.). There would
be an ideal level of production where they would be able to make maximum profit.
• How many Model Ts should I produce? Should I develop new models with my spare
resources?
• The concept applies equally well to your neighborhood burgher joint or dosa seller.

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Managerial economics
Definition
Managerial Economics: the
application of economic theory and
methods to business decision-making.

Business: Any situation where there is a

transaction between two or more
parties
Managerial Economics (MBAZC416)
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Managerial Economics: How is it useful?
• While economics attempts to describe how the
economy works, managerial economics deals with its
impact on businesses and how managers can handle
them for the benefit of their firms as well as the
society.
• It prescribes rules for improving managerial decisions
• It helps managers recognize how economic forces
affect organizations
• It links economic concepts with quantitative methods
to develop vital tools for managerial decision making

Managerial Economics (MBAZC416)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Relationship with economic theory
• Microeconomics
– Focuses on individual consumers and firms
– Theory of the firm
– Theory of consumer behaviour (demand)
– Production and cost theory (supply)
– Price theory
– Market structure and competition theory
• Macroeconomics
– Aggregate variables such as GDP, GNP,
Unemployment, Inflation, etc.
Managerial Economics (MBAZC416)
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Managerial Economics: a Tool for
Improving Management Decision Making

Managerial Economics (MBAZC416) BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
What is the best “choice”
• Understand the economic environment in which firms operate
– We will be exploring several case studies throughout the course
• Consider alternatives
• Make optimal choices to maximize
 Profit
 Market share
 Managerial interests
 Brand Value, Check the competition
 Government influence
 National interests
 Providing employment, Inflation under check.
 Social and environmental benefits

Managerial Economics (MBAZC416)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Economic systems

• Traditional Economy
• People centric
• Little division of labor
• Limited Resources
• Little Surpluses and Little wastages
• RURAL ECONOMY
• Command Economy
• Dominant central authority (Government) takes production decisions
• Many Resources
• Works well under enlightened leadership
• Rigid, slow to change and hence prone to crises.
• COMMUNIST SOCIETY

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Economic systems

• Market Economy
• Little Government regulation
• Regulation through supply and demand
• Growth Oriented
• Unequal distribution of economic power
• Prone to recessions
• CAPITALISM
• Mixed System
• Combines the characteristics of market and command economies
• Most industries are private while public services (law and order, health, education etc.) are under government
control.
• Economy is REGULATED (not controlled) by the Government
• Challenges of right balance between the Government and market forces.
• GLOBAL NORM (Most countries in the world follow this system)

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Market Environment

Monopoly
• One dominant player (Indian Railways)
• No substitute
• High Barriers of entry
• Seller is price maker (seller decides the price)
• Firm can charge any price to its customer without giving any notice.
Oligopoly
• A few sellers but many buyers (Steel Companies, Oil companies, Ecommerce)
• High Entry Barrier
• Firms set price collectively (cartelization)

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Market Environment

Monopolistic competition
• Many sellers who offer similar but not substitute products (products are
differentiated)
• Low Entry Barriers
• Firms are price makers
• Overall business decision of one company does not affect the competition
• Restaurants
Monopsony
Many sellers, but one or only a few buyers
Armament industry, Tobacco farmers

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Market Environment

Perfect Competition
• Many firms produce identical products
• Sellers and buyers have all relevant information to make rational decisions
about the product being bought or sold.
• Many buyers are available to buy a product and many sellers to sell a
product.
• Firms can enter and exit the market without any restrictions.
• The neighborhood vegetable vendor.

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Characteristics of perfect competition
markets
• Firms are price takers. They have to take (accept) the market price. Else they
would lose customers.
• The price is decided by supply and demand.
• A firm in a perfect competition market would be small to the point its output
would not affect the overall supply or impact the prevailing price.
• In the long run, perfect competition firms would react to profits by increasing
production and losses by decreasing it.
• In the long run equilibrium conditions would prevail (here firms are not
increasing decreasing supply) when the firms are making zero profits or
losses.

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Factors of Production

• Land
• Labor
• Capital
• Entrepreneurs

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The Decision-Making Process

Managerial Economics (MBAZC416)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
 Summary
• Managerial Economics helps business leaders and policy
makers to make optimal decisions
• Leverages economic analysis for concepts such as
demand, cost, production, profit and competition
• Bridges the gap between theory and practice
• Provides tool sets to make optimal decisions

Managerial Economics (MBAZC416)

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Application of concepts using Case Studies

• Multinational production and pricing

– How does Ford or GM decide where to produce its cars
(multinational factory locations) and where to sell
(multinational markets)
• Market Entry
– How do major bookstores decide where to set up shop,
assess demand and profitability, assess and react to threats
from online stores
• R & D Decisions
– How does a pharma company decide whether to invest in
traditional biochemistry based research or to pursue
biogenetic approaches (such as gene splicing)
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Positive and Normative economics
• This is also referred to as is/ought distinction
• Positive statements
– Factual statements
– It can be verified by empirical study or logic
– Based on a study of 500 firms, it can be inferred that private owned
enterprises are more profitable than state owned ones.
• Normative statements
– Value judgements
– It can’t be verified by empirical study or logic
– We should focus on growth through state owned companies ar private
firms lead to concentration of wealth which is detrimental to democracy.

• Relevance of the distinction to the study of managerial economics

Managerial Economics (MBAZC416)
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Behavioural Economics

The study of psychology as it relates to the economic decision making

processes of individuals and institutions.
Rational Choice Theory
When individuals are presented with various choices under condition of scarcity
they choose the option that maximizes their individual satisfaction.
It assumes that human beings are capable of rational decisions.
Behavioural Economics explains that is not often the case. Individuals often get
swayed by extraneous factors to make “irrational” decisions.
A man struggling with weight problems should avoid sugar-rich food. The same
person would get swayed by a television ad and consume carbonated soft
drinks.

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Opportunity costs
• Scarcity and choice are central to the
economics discipline
• In the face of scarcity, we make many
decisions
• Follow one course of action and forgo some
other course of action

Opportunity cost is the highest valued

alternative forgone whenever a choice is made

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Illustration Opportunity Cost

1. Ram chose to start a business ignoring two job offers. The first one would
have offered a salary of Rs. 100,000 per month. The figure for the second
one is Rs. 150,000 per month. What is his opportunity cost of starting the
business?
Answer: Rs. 150,000 per month
2. Dr. Usha started her clinic for which she had to vacate a part of her
residential premise from which she was getting a rent of Rs. 20000 per
month. She also chose to quit her job at a local hospital where she was
getting a salary of Rs. 100,000 per month. What is her opportunity cost?
Ans:

Opportunity cost is the highest valued alternative forgone

whenever a choice is made

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Definitions of Profit
• Business or 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.
FUNDAMENTAL EQUATION OF BUSINESS: PROFIT = REVENUE - COST

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 Explicit and Implicit Costs

Basis Explicit Cost Implicit Cost

Definition The cost that involves The cost that does not
outflow of cash due to use involve any cash outlay.
of one or more factors of (Opportunity Cost)
production (Land, Labour,
Capital)
Nature Out of pocket expense Imputed (projected) costs
Occurrence Actual Implied
Recording and Reporting Yes No
Impact Objective Subjective
Example Salaries, Rent, Return on owner’s capital,
Advertisement, Bank Cost of owner’s work, Rent
Interest of owner’s premises

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Illustration

At the end of the year, Dr. Usha found that she has made a revenue of Rs. 10 Lakh. Her
expenses on electricity, consumable and the salary of one assistant is Rs. 6 lakh. What her
accounting profit / loss? What is her economic profit or loss?
Ans: Revenue =
Explicit Cost =
Implicit (Opportunity) Cost = Rent + Salary = 20000*12+100000*12 = 14.4 L
Accounting Profit = Revenue – Explicit Cost = 10L – 6L = 4L
Economic Profit = Revenue – Implicit cost-Explicit Cost = 10L – 14.4L – 6L = -10.4L

Dr. Usha started her clinic for which she had to vacate a part of
her residential premise from which she was getting a rent of Rs.
20000 per month. She also chose to quit her job at a local
hospital where she was getting a salary of Rs. 100,000 per
month. What is her opportunity cost?

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Theories of Profit
• Risk-Bearing Theories of Profit
– Firms make profit because they take risks.
• Frictional Theory of Profit
– Firms make profit because the perfect competition equilibrium is never reached.

• Monopoly Theory of Profit

– Firms make profit when they enjoy monopoly.
• Innovation Theory of Profit
– Firms make profit when they innovate on products or costs.
• Managerial Efficiency Theory of Profit
– Firms make profit by managing their businesses well, eliminating wastages etc.

Managerial Economics (MBAZC416)

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Social 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.

Managerial Economics (MBAZC416)

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 1. Making decisions
• The role of the managers is to make
decisions
– Business firms come in all sizes
– No firm has unlimited resources
– Short-run and long-run decisions
• Managerial Economics: How to make
decisions that make sense for the
operation of the firm

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 2. Decisions are among alternatives
• Choices are always among alternatives 
• Example-buying a new computer
• A job can be done by many, but some may
be better at it than others-cost differs

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BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
 3. Decision alternatives have costs and benefits

• Working Vs. Pursuing further studies

• What we consider when making our decisions?
• Benefits: benefit gained from studying – enhanced knowledge
and capabilities, which lead to better career opportunities in the
future
• Cost - cost of giving up short term promotions and increments
• Choosing to study- additional benefit gained from further
studies exceeds the additional cost
• Opportunity cost
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 4. Objective of management is to increase the firm’s value

• Profit is the difference between TR (Total Revenue) and TC (Total Cost)

• Different types of organizations/ firms
– Proprietorship Firms
• Sole proprietorship
– One owner
• Partnership Firms
– More than one owner
– Joint Stock Firms
• Private Limited Firms
– Shares are in private hands and not publicly traded.
• Public Limited Firms
– Shares are registered at stock exchanges and available for public trading

• Problem - Managers attempt to maximize own interest while shareholders increase own
benefit
• Principal –agent problem

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5. The firm’s value is measured by its expected profit

• Example: consider two companies using different

production process
• Which one would be the better company?
• This can be easily evaluated based on excepted profits
• Present value of the expected future profit stream

Managerial Economics (MBAZC416)

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6. Firm’s sales revenue depends on
demand for its product

• Some goods are highly price sensitive while other goods

are less price sensitive
• Demand for a product is a function of a number of factors
in addition to price

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7. Firm must minimize cost for each level of output

• Total Profit (TP) = Total Revenue (TP) – Total Cost (TC)

• Important factors:
– Technology of production
– Input prices
– Factors of production
– Different levels of technologies

Managerial Economics (MBAZC416)

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8. Firm must develop a strategy consistent with its market

• We will study the various market structures and the

appropriate strategy for each of these situations
• Selling identical products
• Differentiated products
• Example - airline industry, software industry, etc.

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 Value of the Firm

The present value of all expected future profits

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

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

Managerial Economics (MBAZC416)

42
9. Firm’s growth depends on rational investment

• Decision to invest in new plant or equipment or develop a

new product
• The process of evaluating new investments of the firm-
capital project analysis or capital budgetting
• Capital project - calculating the expected stream of
benefits it will produce for the firm

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10. Successful firms deal rationally and
ethically with laws and regulations

• Various business laws and regulations

• Case of Enron or closer hope the collapse of Satyam
highlight the consequences of unethical behaviour

Managerial Economics (MBAZC416)

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Course Objectives

No Course Objectives
CO1 Gain insights into the scientific and analytical methods, techniques
and tools of economics.

CO2 Gain basic understanding of the underlying concepts and building

blocks related to managerial Economics.

CO3 Understand the application of these concepts in business and

economic policy using suitable examples, case studies, simulation,
etc.

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Expectations

• Replay prerecorded digital content before class

• Attend all “live” classes else replay recordings

• Review the relevant chapters from textbook before and after

class

• Do the homework and assignments in a timely manner

• Make sure you have access to laptop/ computer with Excel;

we will need it for experiential learning components in
subsequent classes. (Excel 2007 or later versions preferred.)

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Flipped Classroom

• Replay recorded lectures

• Review relevant study materials/ pre-class assignments
Week before • Case study (if applicable)
class

• Review important and advanced/ difficult concepts

• Active Learning - Application/ Problem solving
In “Live” • Experiential learning – Excel modelling, Case study discussion,
Class Simulation

• Active learning - problem solving

• Discussion forums
After Class • Peer learning

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Seven Habits of Successful Students

1. Concise Thinker
2. Problem Solver
3. Focus
4. Ability to correlate
1. Across subjects (economics to finance, physics to chemistry)
2. Real Life
5. Discipline
6. Enjoy
7. Inspiration

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