Managerial Economics
Introduction
Managerial Economics:
1. Describes the economic forces that
shape the internal and external
environments of a business firm.
2. Prescribes rules for managerial
decision-making that furthers the
objective of the firm.
1
A Decision-Making Model
Objectives
Define the
problem
Alternative
Solutions
Social
constraints
Evaluation
Organizational
and input
constraints
Implement and
monitor the
decision
2
Objective of the Firm






Not market share
Not growth
Not revenue
Not empire building
Not name recognition
Not state-of-the-art technology
3
What’s the objective of the firm?



The objective of the firm is to maximize the
value of the firm.
Value of the firm is the true measure of
business success (of course, from a for-profit
perspective.)
Two questions:
1. How is the “value of the firm” defined and
measured?
2. How do managers go about adding value to
the firm?
4
Managerial Economics
Q1- What’s the value of the firm?
“The present value of the firm’s future net
earnings.”
1
2
n
V = [--------] + [ --------] + . . . + [ -------- ]
(1+r)1
(1+r)2
(1+r)n
t
=  [ ------- ] ,
(1+r)t
t = 1, 2, ... , N
5
Managerial Economics
Q2 - How should a manager go
about adding value?
A good map or a travel guide to the
“curious land of the Econ” should help.
6
Managerial Economics
A Useful Map
Profit = Total Rev - Total Cost
 = P . Qd - AC . Qs
7
Theories of Profits
(Why are profits necessary?)


Risk-Bearing Theory of Profit - Profits (normal
profits) are necessary to compensate for the risk
that entrepreneurs take with their capital and
efforts
Dynamic Equilibrium (Frictional) Theory Profits, especially extraordinary profits, are the
result of our economic system’s inability to adjust
instantaneously to unanticipated changes in
market conditions.
8
Theories of Profits



Monopoly Theory - Profits are the result of
some firm’s ability to dominate the market
Innovation Theory - Extraordinary profits
are the rewards for successful innovations
Managerial Efficiency Theory Extraordinary profits can result from
exceptionally managerial skills of wellmanaged firms.
9
Managerial Actions

Controllable factors (internal environment):






Productions
Technology
Marketing Mix
Employment Policies
Investment Strategies
Capital structure
10
Managerial Actions
Non-Controllable factors(external environment):





Level of Economic activities
Economic Regulations
Unions
Global Business conditions
BOP and Exchange rate changes
11
Terminology Issues




The Marginality analysis
Economic Profits
Accounting Profits
Cash flows
12
The Principle of Marginality
$
$1,000
MC
MB
1
2
3
4
Hospital Days
13
The Principle of Opportunity Cost



Costs are opportunities sacrificed. To be
precise, the opportunity cost of a choice or
decision is measured by the highest
valued alternative that will be given up.
Cost is not always the monetary expense
Cost is often implicit rather than explicit
14
Significance of the Opportunity
Cost Concept




Accounting profits = Net revenue –
Accounting costs (dollar costs of goods and
services)
Reported on the firms income statement
Economic profits = Net revenue –
Opportunities Costs
Economic profits and opportunity costs are
critical to decision making
15
More examples of useful concepts


The principal-agent or the agency
problems:
Moral hazard
16
What’s Managerial Economics?

Managerial economics is not a
separate management discipline
 Rather, it is a logical and useful tool
for framing and solving
management problems.
17
Outline for this Course
Microeconomics Way of Thinking
Consumers, Value
and Demand
Sellers, Production, Costs
Markets and Pricing
18
What will we learn?
 useful economic principles for sound economic
decision-making in a management context.
 the basics of the demand side of the market
and which factors influence the buyers’
behavior.
 the fundamentals of the market’s supply side laws of production and how these laws impact
a firm’s costs.
 how firms’ costs and buyers’ demand
together determine the firm’s price and net
profit.
19