Queen College

Postgraduate Studies

Course Title:
Managerial Economics
By
Fekadu Tesgera (PhD)

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 Unit 1

Introduction to Managerial
Economics

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1.1. Definition of Managerial Economics

 Economics is a social science that study of efficient

allocation of resources in order to attain the
maximum fulfilment of unlimited human wants or
needs.
◦ Because all decisions are essentially about the
allocation of scarce resources, economics is in fact
the study of decision making and problem solving in
general.

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Cont’d
 As the subject matter of economics get started to
expand its branches, the use of economic concepts
and application economic tools have got a
paramount importance.

 A close interrelationship between management and

economics had led to the development of managerial
economics.

 The nature and scope of the science of economics have

dramatically grown and it has become very wide and
vast.

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Cont’d

◦ Managerial Economics is the application of economic

theory to decisions made by managers and firms.

◦ It is generally defined as the study of economic theories,

logic and tools of economic analysis, used in the process
of business decision making.

◦ It involves the understanding and use of economic

theories and techniques of economic analysis in
analyzing and solving business problems. Eg four basic
economic questions. the ff diagram explains it well.
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 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 SOLUTION TO
MANAGERIAL DECISION PROBLEMS

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Cont’d

Economic principles contribute significantly

towards the performance of managerial duties
as well as responsibilities(apply economic
rules for decision making).
Taking appropriate business decisions
requires a good understanding of the
technical and environmental conditions
under which business decisions are taken

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Cont’d
 Managers with some working knowledge of
economics can perform their functions more
effectively and efficiently than those without
such knowledge.
 Application of economic theories and logic to
explain and analyze these technical conditions
and business environment can contribute
significantly to the rational decision-making
process.

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1.2. Why managerial Economics
 Managerial Economics as a course required for effective
resource management was put in place due to the
following developments in the global business
environment:
a. Growing complexity of business decision-making
processes.
b. Increasing need for the use of economic logic,
concept, theories, and tools of economic analysis in
the process of decision-making.
c. Rapid increases in the demand for professionally
trained managerial manpower.

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 Cont’d
 These developments have made it necessary that
every manager aspiring for good leadership and
achievement of organizational objectives be
equipped with relevant economic principles and
applications.
 Unfortunately, a gap has been observed in this
respect among today’s managers.
 It is therefore the aim of this course to bridge such
gap.

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1.3. Nature of Managerial Economics

 Since economics provides analytical tools and

techniques that managers need to achieve
goals of the organization they manage. A
working knowledge of economics is essential
for managers.

 In a nutshell, three major contributions of

economic theory to business economics have
been enumerated:

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Cont’d
1. Building of analytical models that help to recognize the
structure of managerial problems, eliminate the minor
details that can obstruct decision making, and help to
concentrate on the main problem area.
2. Making available a set of analytical methods for business
analyses thereby, enhancing the analytical capabilities of
the business analyst.
3. Clarification of the various concepts used in business
analysis, enabling the managers avoid conceptual pitfalls.

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Cont’d
 Managerial Economics is micro-economics in
nature.
 Contribution of Quantitative Techniques to
Managerial Economics
 Mathematical Economics and Econometrics are
utilised to construct and estimate decision models
useful in determining the optimal behaviour of a
firm.
 Various optimisation techniques, such as
linear programming, in the study of
behaviour of a firm.

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1.4. Economics tools for Managerial Decision-making

1. The Fundamental concept

a. Marginal and Incremental Principle
b. Equi–Marginal Principle
c. Opportunity Cost Principle
d. Time Perspective Principle
e. Discounting Principle

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Marginal and Incremental costs

 Marginal cost refers to the cost incurred on the

production of another or one more unit.

 It implies additional cost incurred to produce an

additional unit of output It has nothing to do with
fixed cost and is always associated with variable cost.

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Cont’d
 Fixed costs are those costs which do not vary with
either expansion or contraction in output.
 They remain constant irrespective of the level
of output. They are positive even if there is no
production. They are also called as supplementary or
over head costs.
 Variable costs are those costs which directly and
proportionately increase or decrease with the level
of output produced. They are also called as prime
costs or direct costs.

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Actual costs and Opportunity Costs

 Actual costs: They are the actual expenses

incurred for producing or acquiring a
commodity or service by a firm.

 Opportunity cost of a good or service is

measured in terms of revenue which could
have been earned by employing that good or
service in some other alternative uses.
 Opportunity cost is the highest valued alternative
forgone whenever a choice is made.

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Accounting costs and economic costs.

 Accounting costs are those costs which

are already incurred on the production of
a particular commodity.
 It includes only the acquisition costs. They are the
actual costs involved in the making of a commodity.
 Economic costs are those costs that are to
be incurred by an entrepreneur on various
alternative programs.
 It involves the application of opportunity costs in
decision making.

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Discounting Principle
 The process of reducing future values
to their present values is often
referred to as discounting.

 For this reason, the interest rate used

in present value calculations is often
referred to as the discount rate

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1.5. Scarcity and Decision Making

 Scarcity can be defined as a condition in which

resources are not available in adequate amounts to
satisfy all the needs and wants of a specified group
of people.
 The concepts of scarcity and choice are central to the
discipline of economics.
 These concepts are used to explain the behavior
of both producers and consumers.
 Scarcity necessitates trade-offs. That which is
forgone whenever a
 choice is made is referred to by economists as
opportunity cost. That which is sacrificed when a
choice is made is the next best alternative.
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1.6. Scope of Managerial / Business
Economics

 The scope of managerial economics refers to its

area of study. Managerial economics comprises
both micro and macroeconomics aspects of
economics. However it is thought as applied
microeconomics.
 Scope of Managerial Economics is wider than
the scope of business Economics

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 The scope covers two areas of decision making (A)
operational or internal issues and (B) Environmental or
external issues.

 A) Operational problems: are of internal nature. These

problems include all those problems which arise within
the business organization and fall within the control of
management. Some of the basic internal issues include:

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(i) choice of business and the nature of product
(what to produce);
(ii) choice of size of the firm (how much to produce);
(iii) choice of technology (choosing the factor
combination);
(iv) choice of price (product pricing);
(v) how to promote sales;
(vi) how to face price competition;
(vii) how to decide on new investments;
(viii) how to manage profit and capital; and,
(ix) how to manage inventory.

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-
This can be done via
 Demand analysis and Forecasting
 Theory of Production and cost
 Theory of Exchange or Price Theory
 Profit Analysis
 Theory Capital budgeting

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Cont’d
B. Environmental or external issues
It refers to the general business environment in
which the firm operates
 Types of economic system in the country.
 The general trend in production,
employment, income, prices, savings and
investments

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 Trends in the working of financial institutions
like banks, financial corporations, insurance
companies etc..
 Magnitude and trends in foreign trade.
 Trends in labour and capital market.
 Government economic policies viz., industrial policy,
monitory policies, fiscal policy, price policy etc…
• Social organizations, such as trade unions, consumers’
cooperatives, and producer unions.

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Cont;d
• The political environment.
• The degree of openness of the economy.
 Managerial economics is particularly concerned
with those economic factors that form the
business climate.
 In macroeconomic terms, managerial
economics focus on business cycles, economic
growth, and content and logic of some relevant
government activities and policies which form
the business environment.

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1.7. Managerial economics as a tool for Deci M and forward
planning

• Decision making is an integral part of modern

management.
• Decision making is the process of selecting one
action from two or more alternative course of
actions.
• Managers of business organizations are constantly
faced with wide variety of decisions in different areas
which could probably have variety of alternative
solutions.

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 -
Decision making processes involve five main phases,
including:
Phase One: Determining and defining the objective to be
achieved.
Phase Two: Collection and analysis of information on
economic, social, political, and technological
environment.
Phase Three: Inventing, developing and analyzing
possible course of action
Phase Four: Selecting a particular course of action from
available alternatives.
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Cont’d
Phase five:The implementation and monitoring of
the selected alternative.
 Note that phase two and three are the most
crucial in business decision-making.
 They put the manager’s analytical ability to
test and help in determining the
appropriateness and validity of decisions in the
modern business environment.

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Cont’d
 Personal intelligence, experience, intuition and
business insight of the manager need to be
supplemented with quantitative analysis of
business data on market conditions and
business environment
 It is in fact, in this area of decision-making that
economic theories and tools of economic
analysis make the greatest contribution in
business.

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1.8. Characteristics of Managerial Economics

 Managerial economics is Micro economic in

character.
 It is Normative economics
 Pragmatic: It is purely practical oriented
 Uses theory of firm
 Takes the help of macroeconomics
 Aims at helping the management
 It is a scientific art
 Prescriptive rather than descriptive

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1.9. Functions and Responsibilities of managerial economist

 A managerial economist can play an important

role by assisting the management to solve the
difficult problems.
 Managerial economists have to study external
and internal factors influencing the business
while taking the decisions.
 It answers the following questions

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Cont’d…
1. Is competition likely to increase or decrease?
2. What are the population shifts and their
influence in purchasing power?
3. Will the price of raw materials increase or
decrease? Etc...
4. Managerial economist can also help the
management in taking decisions regarding
internal operation of the firm.
 Following are the important specific functions of
managerial economist;

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 Sales forecasting.
 Market research.
 Production scheduling
 Economic analysis of competing industry.
 Investment appraisal.
 Advise on foreign exchange management.
 Advice on trade.
 Environmental forecasting.
 Economic analysis of agriculture
Salesforecasting
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 The responsibilities of managerial
economists are the following;
 To bring reasonable profit to the company.
 To make accurate forecast.
 To establish and maintain contact with
individual and data sources.
 To keep the management informed of all the
possible economic trends.
 To prepare speeches for business executives.
 To participate in public debates
• To earn full status in the business team.

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Circular flow
 It is representation of the organization of the economy.
 Decisions are made by households and firms.
 Households and firms interact in the markets for
 goods and services (where households are buyers
and firms are sellers) and
 in the markets for the factors of production (where
firms are buyers and households are sellers).
 The outer set of arrows shows the flow of dollars, and the
inner set of arrows shows the corresponding flow of goods
and services.

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THE CIRCULAR FLOW

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