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Thinking Like an
Economist
Every field of study has its own
terminology

Economics
Opportunity Elasticity
Supply
cost
Consumer
Comparative
Surplus
advantage
Demand
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Economics trains you to. . . .

 Think in terms of alternatives.

 Evaluate the cost of individual and
social choices.
 Examine and understand how certain
events and issues are related.

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Definition

According to Lionel Robbins,

“Economics is a science which Studies
human behavior as a relationship
between ends and scarce means which
has alternative uses”

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 Economics
MICROECONOMICS MACROECONOMIC
Which deals in small, Which deals in total,
individuals, particular, aggregates, whole area.
specific area. Example--
Example-- • National Income
• Consumer • Population
• Producer • Poverty
• Firm • Unemployment
• Industry

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Managerial Economics

Economics Management

Managerial
Economics

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Features
Applied branch of economics
Normative science
Theory of Firm and Profit
Microeconomics

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 Scope
1. Demand Analysis and forecasting
2. Production Function
3. Cost Analysis
4. Inventory Management
5. Advertising
6. Price system
7. Cost – Benefit Analysis
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Importance

Decisions of business are to be

taken under the conditions of
Uncertainty and Risk.

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 Business Decision Making
problems

Decision Sciences
Economic Theory Optimisation Techniques
Microeconomics Differential Calculus
Macroeconomics Statistical Estimation,
Linear Programming,
Game Theory

Managerial Economics: Use of Economic Theory and

Techniques of decision Sciences for solving Business
Decision Problems

Optimal Solution to Business Decision Problem

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Three Choice Problems of an Economy
Unlimited Human Limited Resources
Wants

Scarcity

What to How to For whom

Produce? Produce? To Produce?

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Basic Problems Of Economics

What to produce?
How to Produce?
For whom to Produce?

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 Objectives of Firm
1. Profit Maximisation
2. Sales Maximisation.
Firms often seek to increase their market
share – even if it means less profit.
This could occur for various reasons:
3. Growth Maximisation.
4. Long Run Profit Maximisation.
5. Social/ Environmental concerns.
6. Co-operatives

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 FIVE SECTORS OF THE ECONOMY
Households supply factors of production to firms for
Households which they receive INCOME. They spend that income on
CONSUMPTION goods and services

Firms PRODUCE goods and services and pay wages,

profits etc to households. Firms also INVEST in plant
Firms
and equipment

Government Governments TAX and spend (GOVT EXPENDITURE)

EXPENDITURE

$$$$$
Banks Households deposit their SAVING with banks and
Banks lend firms money to INVEST
Rest
of IMPORTS and EXPORTS
World

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 The Circular Flow of Income and Expenditure
2 Sector Model: Households and Firms
Firms produce
goods and
Households
services. The
value of income
Income Consumption Expend
must always be $100
$100
equal to the value
of production.
This is a National Firms
Accounting
INDENTITY
This is a fully sealed circular flow - there are no leakages
from, or injections into the flow of income and expenditure
between firms and households

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 The Circular Flow of Income and Expenditure
3 Sector Model: Households, Firms & Banks

Households

Income Consumption
Consumption Saving
$80$100
Expend $20
$100

Firms
Assume households
Investment
save 20% of their $20
disposable income.

This is a functional
$$$$$
Banks

relationship Income (Y) = C + I

Income (Y) = 80 + 20 = 100

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 The Circular Flow of Income and Expenditure
4 Sector Model: Households, Firms, Banks & Government

Disposable
Government Income $60 Households

Income Consumption
Consumption
Consumption Saving
Saving
Taxes $80
Expend $20
$100 $48$100 $12
$40

Govt Expend Firms

$40
Investment
Investment
$20
$12

Income (Y) = C + I + G $$$$$

Banks

Income (Y) = 48 + 12 + 40 = 100

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 The Circular Flow of Income and Expenditure
5 Sector Model: Households, Firms, Banks, Government& Rest of World
Closed (Domestic) Economy
Disposable
Government Income $60 Households

Income Consumption Saving

Saving
Taxes $80
Expend $20
$100 $48$100 $12
$40

Govt Firms
Expend
$40 Investment
Investment
$20
$12

$$$$$
Banks

Rest
Exports
of Imports
World

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Profit Maximization of Firm

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 Any business decision by a firm will
increase its profits if the following
conditions prevail:

1. It brings about increase in total revenue more

than increase in costs.
2. It causes increase in revenue, costs remaining
unchanged.
3. It reduces cost more than it reduces revenue.
4. It reduces costs, revenue remaining the same.

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 Theories of Firms

1. Profit-Maximizing Theories 
2. Other Optimizing Theories
3. Rational (Non-Optimizing) Theories.

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 Maximization & Optimization

Finding an alternative with the

most cost effective or
highest achievable performance under the
given constraints, by maximizing
desired factors and minimizing undesired ones.
In comparison, maximization means trying to
attain the highest or maximum result or outcome
without regard to cost or expense.

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 Satisficing

Aiming to achieve only
satisfactory results because the
satisfactory position is familiar, hassle-free,
and secure, whereas aiming for the best-
achievable result would call for costs, effort,
and incurring of risks.

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 Opportunity Cost

A benefit, profit, or value of something that must be given

up to acquire or achieve something else. Since
every resource (land, money, time, etc.) can be put to
alternative uses, every action, choice, or decision has
an associated opportunity cost.

Opportunity costs are fundamental costs in economics, and

are used in computing cost benefit analysis of a project.
Such costs, however, are not recorded in the account
books but are recognized in decision making by computing
the cash outlays and their resulting profit or loss.

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 Behavior Theory
The behavioral theory of the firm first
appeared in the 1963 in book “A Behavioral
Theory of the Firm” by Richard M. Cyert and
James G. March

It attempts to predict behaviour with respect to

price, output and resource allocation decisions..

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 Organization Goal

1. Production Goal
2. Inventory Goal
3. Sales Goal
4. Market-Share Goal
5. Profit Goal

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 Marris’ Growth
Maximisation Model

Robin Marris in his book The Economic Theory of

‘Managerial’ Capitalism (1964) has developed a
dynamic balanced growth maximising model of the
firm.

Marris developed a balanced growth model in which

the manager chooses a constant growth rate at which
the firm’s sales, profits, assets, etc. grow.

More growth can be preferred by Manager but can

create an imbalance in favor of shareholders’
interest.
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 Marris’ Growth
Maximisation Model

GS- Growth Supply

GD – Growth Demand
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 Assumptions:

1. It assumes a given price structure.

2. Production costs are given.
3. There is no oligopolistic interdependence.
4. Factor prices are constant.
5. Finns are assumed to grow through
diversification.
6. All major variables such as profits, sales
and costs are assumed to increase at the same
rate.

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 Baumol's static and dynamic model
Boumal's model highlights that the primary objective of a
firm is to maximize its sales rather than profit
maximization. It states that the goal of a firm is
maximization of sales revenue subject to a minimum profit
constraint. Prof. Boumal has developed two models –

1)Static Model
2)Dynamic Model

A model that is either fixed (static) or a model that

can change at any time (dynamic).

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 Static Model
1. The model is applicable to a particular
time period and the model does not
operate at different periods of time.
2. The firm aims at maximizing its sales
revenue subject to a minimum profit
constraint.
3. The demand curve of the firm slope
downwards from left to right.
4. The average cost curve of the firm is U-
shaped one
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 Dynamic Model
This model explains how changes in
advertisement expenditure, a major
determinant of demand, would affect the sales
revenue of a firm under severe competitions.
Few assumptions of this model are –

1.Higher advertisement expenditure would

certainly increase sales of a firm.
2.Market price remains constant.
3.Demand and cost curves of the firm are
conventional in nature.
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Williamson’s Managerial Discretionary Theory
Oliver E. Williamson hypothesised (1964) that profit
maximization would not be the objective of the managers of a
joint stock organisation.

The managers can use their ‘discretion’ to frame and execute

policies which would maximise their own utilities rather than
maximising the shareholders’ utilities. This is essentially the
principal–agent problem. This could however threaten their job
security, if a minimum level of profit is not attained by the firm
to distribute among the shareholders. The Theory assumes that
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Imperfect competition in the markets.
Divorce of ownership and management.
A minimum profit constraint exists for the firms to be able to
pay dividends to their share holders.
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Williamson’s Managerial Discretionary Theory

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First Chapter

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 Factors of production

Land, Labour, Capital,

Enterprises

Producing
Sale

Sectors in the Economy

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 L,L,C,E
Factors of production

Household Firm

Production
R,W,I,P
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 Ex IM – 3 L
Timber – 2 L

Accounting Profit – 3 L
Economic Profit – 1 L

AP > EP

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Cost,
Price
,
Reve
nue

Output/D/S
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 TM – C -8L
TM – R -12 L
P =4L

R –C -8L
R – R – 15 L
R = 7L

AP = 7L
EP = 7L-4L = 3L

AP>EP
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