Managerial Economics

JAYVEE VITUG MBA

⊸ Antalya Bilim University , Turkey : Bachelor of
Arts in Economics (June 14, 2017)
⊸ Ateneo de Zamboanga University: Master of
Business Administration (May 21, 2022)
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“The ultimate resource in economics development is

people. It is people , not capital or raw materials that
develop an economy”.
Peter Drucker
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Economics & Business and

Fundamentals of Managerial
Economics
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Objectives:
⊸ Summarize how goals, constraints, incentives, and market
rivalry affect economic decisions.
⊸ Distinguish economic versus accounting profits and costs.
⊸ Explain the role of profits in a market economy.
⊸ Learn that economics is about the allocation of scarce
resources
⊸ Examine some of the trade-offs that people face
⊸ Learn the meaning of opportunity cost
⊸ See how to use marginal reasoning when making decisions
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QUESTIONS !!!
⊸ How many ⊸ How will the ⊸ How can you
computers actions of ensure that
should you rival employees
produce, and computer work hard
at what price firms affect and produce
should you your quality
sell them? decisions? products?
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WHAT IS ECONOMICS?
⊸ Economics is the study of men
as they live, behave, move and
think in the ordinary business
of life.
⊸ RATIONAL
⊸ Economics, as a social science,
DECISION MAKING
studies human behaviour as a
relationship between numerous
wants and scarce means having
alternative uses
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SOME PRINCIPLES WE NEED TO

KNOW!!!
⊸ Decision Making ⊸ Rational People and
Involves Trade-Offs Businesses Think at
the Margin

⊸ The Cost of
Something Is What ⊸ People and
You Give Up to Get Businesses Respond
It to Incentives
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BUSINESS ECONOMICS OR MANAGERIAL
ECONOMICS?
📌Managerial Economics
The study of how to direct
scarce resources in the way that
most efficiently achieves a
managerial goal..
📌Business Economics
is a field in applied is fundamentally concerned with
economics which the art of economising, i.e.,
uses economic theory and making rational choices to yield
quantitative methods to maximum return out of minimum
analyze business resources and efforts, by making
enterprises and the factors the best selection among
contributing to the alternative courses of action.
diversity of organizational
structures and the
relationships of firms with
labour, capital and product
markets
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📌 is a specialised discipline of management studies which

deals with application of economic theory and techniques to
business management.
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Managerial Economics
⊸ incorporates elements of both micro and macroeconomics dealing with
management problems in arriving at optimal decisions.

⊸ helps the manager to understand the intricacies of the business problems which
make the problem-solving easier and quicker, arrive at correct and appropriate
decisions, improve the quality of such decisions, and so on.
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WHO IS A MANAGER?

direct the efforts of

others, including those are in charge of making
who delegate tasks other decisions, such as
within an organization product price or quality
such as a firm, a family,
or a club
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THE ECONOMICS OF EFFECTIVE

MANAGEMENT
📌 identify goals 📌 understand 📌 recognize the
and constraints incentives time value of
money.

📌 recognize the 📌 understand

nature and markets 📌 use marginal
importance of analysis
profits
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Identify Goals and Constraints

⊸ The first step in ⊸ If your goal is to ⊸ Constraints are an
making sound maximize your artifact of scarcity.
decisions is to have grade in this course
well-defined goals rather than
because achieving maximize your
different goals overall grade point
entails making average, your study
different decisions. habits will differ
accordingly.
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Recognize the Nature and Importance of

Profits
⊸ ACCOUNTING PROFIT
📌 The total amount of money taken in
from sales (total revenue, or price times
quantity sold) minus the dollar cost of
producing goods or services.
⊸ ECONOMIC PROFIT
📌 are the difference between the
total revenue and the total
opportunity cost of producing the
firm’s goods or services.

📌 show up on the firm’s income

📌 opportunity cost The explicit cost
statement and are typically reported to of a resource plus the implicit cost
the manager by the firm’s accounting of giving up its best alternative use.
department.
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EXAMPLE

👉Suppose you own a building in Zambonga City that you use to run a small coffee shop.
Food supplies are your only accounting costs. At the end of the year, your accountant informs
you that these costs were Php 20,000 and that your revenues were Php 100,000.

Accounting Profit ?

👉Suppose you could have work for somebody else and earn Php 30,000 and you could have
rented the building to someone else. If the rental value of the building is Php 100,000 per year.
Economic Profit ?
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ROLE OF PROFIT
the firm’s goal of maximizing profits is necessarily
bad for society?

👦 It is not out of the benevolence of the butcher, the

brewer, or the baker, that we expect our dinner, but
from their regard to their own interest.- Adam Smith
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Role of Profit
Profit a financial
gain, especially the
difference between
the amount earned 📌 Profits signal to resource
and the amount holders where resources are
spent in buying, most highly valued by
operating, or society
producing
something
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The Five Forces Framework and Industry
Profitability
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Five Forces Analysis

Entry
the ability of existing
firms to sustain profits
depends on how barriers
MILKTEA
to entry affect the ease
with which other firms
can enter the industry.
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Power of Input Suppliers

⊸ The concentration of
suppliers and the
availability of
substitute suppliers
are important factors
in determining
supplier power
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Power of Buyers
⊸ Similar to the case of
suppliers, industry profits
tend to be lower when
customers or buyers have
the power to negotiate
favorable terms for the
products or services
produced in the industry.
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Substitute and Complement

The level and sustainability of
industry profits also depend on the
price and value of interrelated
products and services. Porter’s
original five forces framework
emphasized that the presence of
close substitutes erodes industry
profitability.
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Industry Rivalry
⊸ how intense the current
competition is in the
marketplace, which is
determined by the number
of existing competitors and
what each competitor is
capable of doing
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Understand Incentives
⊸ Incentives plays an important role within the firm.
⊸ Incentives determine:
⊸ How resources are utilized.
⊸ How individuals work.
⊸ Managers must understand the role the incentives
play in the organization.
⊸ Constructing proper incentives will enhance
productivity and profitability.
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Understand Markets
👉Consumer –Producer Rivalry - Consumers attempt
to locate low prices, while producers attempt to
charge high prices.
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Understand Markets
👉Consumer – Consumer Rivalry -Scarcity of goods
reduces the negotiating power of consumers as they
compete for the right to those goods.
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Understand Markets
👉Producers- Producers Rivalry -Scarcity of
consumers causes producers to compete with one
another for the right to service customers.

👉 Government and Market - Discipline the market

process.
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The Time Value of Money

👉 The fact that Php 1 today is worth
more than Php1 received in the future.

👉 The opportunity cost of receiving the

Php1 in the future is the forgone
interest that could be earned were Php 1
received today.
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Present Value
The amount that would have to be
invested today at the prevailing interest
rate to generate the given future value.
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Present Value
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The present value of a future payment reflects the

difference between the future value (FV) and the
opportunity cost of waiting (OCW): PV = FV −
OCW.

If i=0, note PV=FV

As i increases, the higher the OCW and the lower

the PV.
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Present value of a stream of future amounts (FVt) received at the end of

each period for “n” periods:
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Net Prevent Value

The present value of the income stream generated by a project
minus the current cost of the project.

Suppose a manager can purchase a stream of future receipts (FVt)

by spending “Co” pesos today. The NPV of such decision is :
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⊸ If NPV>O accept
⊸ If NPV< O reject
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Example
⊸ The manager of Automated Products is
contemplating the purchase of a new machine that
will cost Php 300,000 and has a useful life of five
years. The machine will yield (year-end) cost
reductions to Automated Products of Php 50,000 in
year 1, Php 60,000 in year 2, Php 75,000 in year 3,
and Php 90,000 in years 4 and 5.
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What is the present value of the cost savings

of the machine if the interest rate is 8 percent?
Should the manager purchase the machine?

If yes, why?
If no, why?
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Marginal Analysis
- marginal analysis states that optimal
managerial decisions involve
comparing the marginal (or
incremental) benefits of a decision with
the marginal (or incremental) costs.
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CONTROL VARIABLES?
⊸ What is optimal amount of studying in
this course?
📌B(Q)- Total benefits in studying
📌Q- Benefits derived hours studying
📌C(Q)- Total cost of studying
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⊸ What are control variables in a firm?

Price
Output
Product quality
📌Question: How much of the control
variable should be used to maximize
net benefits?
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Suppose the objective of the manager is to maximize the net benefits N

( Q ) = B ( Q ) − C ( Q ) , ( Profit= Revenue- Cost)

⊸ Marginal benefit refers to the additional benefits that arise

by using an additional unit of the managerial control
variable
⊸ Marginal cost, on the other hand, is the additional cost
incurred by using an additional unit of the managerial
control variable
⊸ MNB(Q) = MB(Q) − MC(Q)
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⊸ To maximize net benefits, the manager should

increase the managerial control variable up to the
point where marginal benefits equal marginal
costs. This level of the managerial control
variable corresponds to the level at which
marginal net benefits are zero; nothing more can
be gained by further changes in that variable
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⊸ 0ptimal managerial decisions involve comparing the marginal (or

incremental) benefits of a decision with the marginal (or
incremental) costs.

⊸ let B(Q) denote the total benefits derived from Q units of some
variable that is within the manager’s control. This is a very general
idea: B(Q) may be the revenue a firm generates from producing Q
units of output.
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⊸ Marginal Benefit (MB) Change in total benefits arising

from a change in the control variable, Q.

⊸ Let C(Q) represent the total costs of the corresponding

level of Q
⊸ Marginal Cost (MC) Change in total costs arising from a
change in the control variable, Q
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marginal net benefits of Q—MNB(Q)—are the change in net

benefits that arise from a one-unit change in Q. (MNB ( Q )
= MB ( Q ) − MC ( Q )
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A CALCULUS ALTERNATIVE
Since the slope of a function is the derivative of that function, the preceding
principle means that the derivative of a given function is the marginal value of
that function. For example
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Figure the marginal benefits, marginal costs, and marginal net

benefits. At the level of Q where the marginal benefit curve
intersects the marginal cost curve, marginal net benefits are
zero. That level of Q maximizes net benefits
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THE CALCULUS OF MAXIMIZING NET

BENEFITS
The objective is to choose Q so as to maximize N ( Q
) = B ( Q ) − C ( Q ) The first-order condition for a
maximum is:
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⊸ is simply marginal costs. Thus, the first-order condition for a

maximum implies that

⊸ The second-order condition requires that the function N(Q) be

concave in Q or, in mathematical terms, that the second
derivative of the net benefit function be negative
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EXAMPLE
An engineering firm recently conducted a study to determine
its benefit and cost structure. The results of the study are as
follows:
B (Y) = 300Y − 6Y^2
C (Y) = 4Y^2
The manager has been asked to determine the maximum level
of net benefits and the level of Y that will yield that result.
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Example
Suppose B(Q) = 10Q − 2Q^2 and C(Q) = 2 + Q^2. What
value of the managerial control variable, Q, maximizes net
benefits?
Check for the second order.