Managerial Economics

Justyna Sokołowska - Woźniak

Department of Economics WSB-NLU, 022C

Manager's decisions and Elasticity

Materials based on:
Chapter 1 and 2 of the book: Managerial Economics, William F. Samuelson & Stephen G.
Marks, JOHN WILEY & SONS, INC.
Chapter 2 of the book: Economics, J. Sloman and:
http://wps.pearsoned.co.uk/ema_uk_he_sloman_economics_6/41/10678/2733799.cw/index.html
 Questions for today 2

• What is Economics about? – revision

• What is managerial economics and why should
you study it?
• Examples of managerial decisions
• Six steps to decision making
• How does managerial economics helps in
decision making?
 Manager's decisions 3

semestr zimowy
2008/2009
 Economics as a science 4

• Economics
A social science that studies how individuals, governments, firms
and nations make choices on allocating scarce resources to
satisfy their unlimited wants. Economics can generally be broken
down into: macroeconomics, which concentrates on the
behaviour of the aggregate economy (concerned with the
economy as a whole); and microeconomics, which focuses
on individual consumers.
http://www.investopedia.com/terms/e/economics.asp#axzz1penmCXgm
 WHAT DO ECONOMISTS STUDY? 5

Resources are scarce so choices have to be made.

• rational economic decision making - choices that involve

weighing up the benefits and cost of any activity
(benefits against its opportunity costs)
 WHAT DO ECONOMISTS STUDY? 6

Resources are scarce so choices have to be made.

• Choice involves sacrifice - with every choice, an alternative is forgone—money
or time spent on one thing can’t be spent on another.

The real cost of an item is thus its opportunity cost: what you must give up in
order to get it.

Opportunity cost - the cost of any activity measured in terms of the best
alternative forgone (sacrifice made to do something - it is the best thing that
could have been done as an alternative)
 WHAT DO ECONOMISTS STUDY? 7

Resources are scarce so choices have to be made.

• Marginal analysis - the key to deciding “how much” to do of any activity involve
trade-offs at the margin: comparing the costs and benefits of doing a little bit
more of an activity versus a little bit less. The study of such decisions is known
as marginal analysis, plays a central role in economics because the formula of
doing things until the marginal benefit no longer exceeds the marginal cost is
the key to deciding “how much” to do of any activity.

weighing up marginal costs with marginal benefits:

• marginal costs - the additional cost of doing a little bit more

• marginal benefits – the additional benefits of doing a little bit more

• MB > MC  do more

• MC > MB  do less
 WHAT DO ECONOMISTS STUDY? 8

• Scarcity: the central economic problem

• defining scarcity – the excess of human wants over
what can actually be produced
human wants are unlimited
resources (factors of production) are limited
 Economics as a science 9

• Managerial Economics
• is the analysis of major management decisions using the tools
of economics.
• is the study of how managers can apply economic principles
and analyses as well as quantitative tools in making an effective
business and managerial decisions involving the best use
(allocation) of the organizations scarce resources to achieve
their objectives.

„The crucial step in tackling almost all important

business and government decisions begins with a
single question: What is the alternative”
ANONYMOUS
 Manager's decisions 10

• Economic Concepts
• Framework for Decisions
• Theory of Consumer Behaviour
• Theory of the Firm
• Theory of Market Structure and Pricing
• Management Decision Problems
• Product Price and Output
• Make or Buy
• Production Technique
• Advertising Media and Intensity
• Investment and Financing
 Manager's decisions 11

• Examples of Managerial Decisions

• How to use economic theory to set prices that
maximize profits.
• How to use economic theory to choose the cost-
minimizing production technique for a given scale of
output.
• How to use economic theory to select the “optimal”
location for a new restaurant, grocery store, etc.
• How to use economic theory to forecast near-term
demand for goods and services.
Source: C. Brown, Managerial economics
 Manager's decisions
12
The Basic Steps in Decision Making

The process of decision making can be

broken down into six basic steps:
1. Defining the problem
2. Determining the objectives
3. Examine the options for selection
(exploring the alternatives)
4. Predicting the consequences (Models)
deterministic models - take the predicted outcome as certain
probabilistic models - identify a range of possible outcomes
with probabilities attached
5. Making the choice (choosing the optimal
variant)
6. Performing the sensitivity analysis
how an optimal decision is affected if key economic facts or
conditions vary
 PRIVATE AND PUBLIC DECISIONS: AN ECONOMIC VIEW 13

• How firms behave and what objectives they

pursue
• The main principle of theory of the firm is that
management strives to maximize the firm’s profits.
• The most general theory of the firm states that
management’s primary goal is to maximize the value of
the firm (the present value of its expected future
profits).
• How decisions are done in the public sector
• government programs and projects are evaluated on the
basis of net social benefit - the difference between
total benefits and costs of all kinds. Benefit-cost
analysis is the main economic tool for determining the
dollar magnitudes of benefits and costs
 PRIVATE AND PUBLIC DECISIONS: AN ECONOMIC VIEW 14

• How firms behave and what objectives they

pursue
• Management strives to maximize the firm’s profits.
• Management’s primary goal is to maximize the value
of the firm
• Three other decision models should be noted:
• The model of satisficing behaviour- firm may seek to
achieve acceptable levels of performance with respect to
multiple objectives
• The firm attempts to maximize total sales subject to
achieving an acceptable level of profit.
• The social responsibility of business - other management
goals may include taking actions that contribute to the
welfare of society, are in the interests of stakeholders
(its workers, customers, neighbors).
 Manager's decisions 15

• Rational producer behaviour:

when a firm weighs up the cost and benefits of
alternative courses of action and then seeks to
maximise its net benefits
• Profits and the aims of the firm:
- traditional theories of the firm – the analysis of
pricing and output decision of the firm under
various market conditions, assuming that the firm
wishes to maximise profits
- and alternative theories of the firm – theories of
the firm based on the assumption that firms have
aims other than profit maximisation
 Manager's decisions 16

Maximizing company’s value - maximising

profit
Maximizing profits—but over what time
horizon?
• We get around this problem by assuming
that managers seek to maximize the
present value of the firm by maximising
profits in each time period
 Manager's decisions 17

Maximizing profit (company value)

• Output and input
production (output) depends on the amount of
resources (inputs) and how they are used
• Profits = Revenues – Costs:
• earning more from sale of goods than they cost to
produce:
TP = TR - TC
• Marginal analysis
MR = MC
 Manager's decisions
18
The Basic Steps in Decision Making

Suppose a soft-drink firm is grappling with the

decision about whether or not to introduce to the
market a new carbonated beverage with 25
percent real fruit juice. How might it use the six
decision steps to guide its course of action?
 Questions 19

semestr zimowy
2008/2009
 Wyższa Szkoła Biznesu
National-Louis University

ul. Zielona 27
33-300 Nowy Sącz

sokolowj@wsb-nlu.edu.pl