MODULE 1: INTRODUCTION TO MANAGERIAL ECONOMICS
I.
EXPLAIN
Economics is a science that deals with efficient and effective allocation of scarce resources to satisfy unlimited needs
and wants. On the other hand, Management is defined as all the activities and tasks undertaken to achieve goals.
Planning, organizing, leading, and controlling are the four functions of management that management that male use
of or deal with resources to achieve certain goals, such as in a business setting.
Like households, business – no matter how big they are, still have limits in their resources. Hence, managerial economics
is a science that deals with the effective and efficient use of scarce resources in a business setting. It is simply using the
concepts of economics to manage a firm.
 Scarcity – means insufficiency relative to wants
 Have you ever done a small business as a child or a young adult? Have you observed someone do business?
Notice that people in business always have to keep track of their cash inflows and outflows. In every decision or
business proposal, budget is taken into consideration. In activities, the sufficiency and availability of manpower is
being considered. Why? It is because businesses, big or small, have limitations in resources. These resources are
classified as LAND, LABOR, CAPITAL AND ENTREPRENEURSHIP. These resources must be allocated well
because many are limited and aren’t renewable.
 Observe your parents and guardians as they budget the resources of the house. Household, firms and the
government all have to make allocation decisions because resources are limited and needs/wants can be unlimited.
This is what economics is all about. Economics is a social science that studies the efficient and effective
allocation of scarce resources to satisfy unlimited needs and wants of the people.
 2 Assumptions:
1. Rational – humans like to spend their income to satisfy satisfaction
2. Non-association – customers are not easily satisfied
 Economic Wants – tangible, goods and services
 Non-economic Want – non-tangible, psychological in nature
 Needs – food, clothing, water
Those in business always have to keep track of their cash inflows and outflows. In every decision or business proposal,
budget is taken into consideration. In activities, the sufficiency and availability of manpower is being considered. It is
because businesses, big or small, have limitations in resources. These resources are classified as LAND, LABOR,
CAPITAL, and ENTREPRENEURSHIP.
These resources must be allocated well because many are limited and aren’t renewable.
Goods that are used to produce other goods or services are called economic resources (and are also known as inputs or
factors of production).
1. Land – natural resources, the “free gifts of nature”
2. Labor – the contribution of human beings
3. Capital – plant and equipment, this differs from financial capital
4. Entrepreneurial Ability – ability to organize production
 Resource Payments
ECONOMIC RESOURCE
RESOURCE PAYMENT
Land
Rent
Labor
Wages
Capital
Interest
Entrepreneurial Ability
Profit
 Examples of resources:
ENTREPRENEUR/
LAND
LABOR
CAPITAL
ENTREPRENEURSHIP
1. Soil
1. Teacher
1. Equipment
1. Ms. Henry Sy
2. Trees
2. Farmer
2. Factory building
2. Mr. Manny Pangilinan
3. All animals
3. Doctor
3. Machinery
3. Mr. Injap Sia
4. Minerals
4. Construction worker
4. Mr. Manny Villar
II. EXPLORE
Page 1 of 6
MODULE 1: INTRODUCTION TO MANAGERIAL ECONOMICS
 In business, what do you think should a manager be concerned about?
 Pricing, finance, supply, production and advertisement are just some of the areas that managers must look into
as the firm tries to reach its goals. If we analyze it closer, each of this area is also a concern of other fields of
study.
 Marketing is also concerned with pricing, competition, demand and advertisement.
 Operations management deals with production and supply, as well.
 Furthermore, finance can be an entirely different discipline.
 As we see the connections, we conclude that indeed, economic concepts and principles can be applied in the different
aspects of life and business.
A. Two Major Branches of Economics
1. Microeconomics
- deals with decisions of individuals and firms in resource-allocation
- it is a broader concept as compared to Managerial Economics.
- It is the branch of economics that examines the functioning of individual industries and the behavior of
individual decision-making units – that is, business firms and households
Deals with:
a. Behavior of individual units – when consuming and how we choose what to buy
b. Markets – the interaction of consumers and producers
2. Macroeconomics
- looks at the behavior and performance of the economy as whole
- forms the foundation of managerial economics.
- It is the branch of economics that examines the economic behavior of aggregates – income, output,
employment, and so on – on a national scale
Deals with: Analysis of aggregate issues
a. Economic growth
b. Inflation
c. Unemployment
 The Linkage Between Micro and Macro-economics
Microeconomics is the foundation of macroeconomics is the foundation of macroeconomic analysis
 Simplifying Assumptions
 Ceteris Paribus – holding everything else constant
 Abstraction in economics/used to simplify reality
 The Ceteris Paribus Assumption: All other things being Equal – the assumption that nothing changes except
the factors being studied. It is used to isolate the effect of a change in one variable on another one by
assuming that all other variable do not change.
THE DIVERSE FIELDS OF ECONOMICS
Examples of microeconomic and macroeconomic concerns
Production
Prices
Income
Employment
MICROECONOMICS Production/Output in Price of Individual Distribution of
Employment by
Individual Industries Goods and
Income and
individual Business
and Businesses.
Services
Wealth
& Industries
 How much
 Price of
 Wages in the
 Jobs in the steel
steel?
medical care
auto industry
industry
 How many
 Price of
 Minimum
 Number of
officers?
gasoline
wages
employees in a
firm
 How many
 Food prices
 Executive
cars?
Salaries
 Apartment
rents
 Poverty
MACROECONOMICS National
Aggregate Price
National Income
Employment and
Production/Output
Level
unemployment in the
 Total wages
economy
and salaries
 Total Industrial
 Consumer
Output
prices
 Total number of
 Total
jobs
 Gross Domestic  Producer
corporate
Product
prices
profits
 Unemployment
rate
 Growth of
 Rate of
Output
Inflation
B. Managerial Economics
- is used by managers in addressing issues in a firm level, this means that this field of study is a sub-branch of
Microeconomics.
Page 2 of 6
MODULE 1: INTRODUCTION TO MANAGERIAL ECONOMICS
- deals with allocating the scarce resources in a manner that minimizes the cost.
- It is different from microeconomics and macroeconomics, it has a more narrow scope - it is actually solving
managerial issues using microeconomics.
- Wherever there are scarce resources, managerial economics ensures that managers make effective and efficient
decisions concerning customers, suppliers, competitors as well as within an organization
The fact of scarcity of resources gives rise to four fundamental questions:
1. What to produce?
2. How to produce?
3. How many to produce?
4. For whom to produce?
III. EXPLAIN
A. Seven important things to know AND UNDERSTAND about Managerial Economics
1. Managerial Economics can be defined as the blending of economic theory with business practices so as to ease
decision-making and future planning by management.
2. Managerial Economics assists the managers of a firm in a rational solution of obstacles faced in the firm’s
activities. It makes use of economic theory and concepts. It helps in formulating logical managerial decisions.
3. The key of Managerial Economics is the micro-economic theory of the firm. It lessens the gap between economics
in theory and economics in practice. Managerial Economics is a science dealing with effective use of scarce
resources. It guides the managers in taking decisions relating to the firm’s customers, competitors, suppliers as
well as relating to the internal functioning of a firm.
4. Managerial economics uses both Economic theoryas well as Econometrics for rational managerial decision
making. Econometrics is defined as use of statistical tools for assessing economic theories by empirically
measuring relationship between economic variables. It uses factual data for solution of economic problems
5. The study of Managerial Economics helps in enhancement of analytical skills, assists in rational configuration as
well as solution of problems. While microeconomics is the study of decisions made regarding the allocation of
resources and prices of goods and services, macroeconomics is the field of economics that studies the behavior
of the economy as a whole (i.e. entire industries and economies). Managerial Economics applies micro-economic
tools to make business decisions. It deals with a firm.
6. The use of Managerial Economics is not limited to profit-making firms and organizations. But it can also be used
to help in decision-making process of non-profit organizations (hospitals, educational institutions, etc). It enables
optimum utilization of scarce resources in such organizations as well as helps in achieving the goals in most
efficient manner. Managerial Economics is of great help in price analysis, production analysis, capital budgeting,
risk analysis and determination of demand.
7. Managerial Economics is associated with the economic theory which constitutes “Theory of Firm”. Theory of firm
states that the primary aim of the firm is to maximize wealth. Decision making in managerial economics generally
involves establishment of firm’s objectives, identification of problems involved in achievement of those objectives,
development of various alternative solutions, selection of best alternative and finally implementation of the
decision.
B. The role of managerial economist can be summarized as follows:
1. He studies the economic patterns at macro-level and analysis its significance to the specific firm he is working in.
Page 3 of 6
MODULE 1: INTRODUCTION TO MANAGERIAL ECONOMICS
2. He has to consistently examine the probabilities of transforming an ever-changing economic environment into
profitable business avenues.
3. He assists the business planning process of a firm.
4. He also carries cost-benefit analysis.
5. He assists the management in the decisions pertaining to internal functioning of a firm such as changes in price,
investment plans, type of goods /services to be produced, inputs to be used, techniques of production to be
employed, expansion/ contraction of firm, allocation of capital, location of new plants, quantity of output to be
produced, replacement of plant equipment, sales forecasting, inventory forecasting, etc.
6. In addition, a managerial economist has to analyze changes in macro- economic indicators such as national
income, population, business cycles, and their possible effect on the firm’s functioning.
7. He is also involved in advising the management on public relations, foreign exchange, and trade. He guides the
firm on the likely impact of changes in monetary and fiscal policy on the firm’s functioning.
8. He also makes an economic analysis of the firms in competition. He has to collect economic data and examine
all crucial information about the environment in which the firm operates.
9. The most significant function of a managerial economist is to conduct detailed research on industrial market.
10. In order to perform all these roles, a managerial economist has to conduct an elaborate statistical analysis.
11. He must be vigilant and must have ability to cope up with the pressures.
12. He also provides management with economic information such as tax rates, competitor’s price and product,
etc. They give their valuable advice to government authorities as well.
 Firms
- consider its resources when trying to reach its goals.
- is a collection of resources that is transformed into products demanded by consumers.
- Simply saying, it is a business. It is an entity that converts inputs (resources - land, labor, capital,
entrepreneurship) to outputs (products or services).
IV. ELABORATE
As managerial economists, we must be one with the firm in pursuing its goal. In most cases, the primary goal of a firm is
PROFIT MAXIMIZATION. Profit maximization is achieved when a firm produces at an output level where marginal
revenue is equal to marginal cost.
Aside from profit maximization, the other economic objectives that a firm may pursue are
1. Market Share
2. Profit Margin
3. Return On Investment
4. Technological Advancement
5. Customer Satisfaction
6. Shareholder Value
They may also pursue non-economic objectives such as:
1. Workplace Environment
2. Product Quality
3. Service To Community
A. PROFIT MAXIMIZATION HYPOTHESIS
Throughout the discussion, we will assume that the main goal of the firm is to maximize profit? Earning a profit is
different from maximizing profit. Maximizing profit involves identifying the best price and quantity (produced) to
get the highest profit as much as possible.
 Profit Maximization Rule Definition
The Profit Maximization Rule states that if a firm chooses to maximize its profits, it must choose that level of
output where Marginal Cost (MC) is equal to Marginal Revenue (MR) and the Marginal Cost curve is rising. In
other words, it must produce at a level where MC = MR.
 Profit Maximization Formula
The profit maximization rule formula is MC = MR
 Marginal Cost is the increase in cost by producing one more unit of the good.
 Marginal Revenue is the change in total revenue as a result of changing the rate of sales by one unit.
Marginal Revenue is also the slope of Total Revenue. This means that this is the amount to which we expect
the Total Revenue to change as the quantity being sold or demanded changes.
 Total Revenue (TR) = Price x Quantity Sold
 Profit = Total Revenue (TR) – Total Costs (TC) or
 Net Income = Sales – Expenses (Accounting term)
 Therefore, profit maximization occurs at the most significant gap or the biggest difference between the total
revenue and the total cost.
 Why is the output chosen at MC = MR?
Page 4 of 6
MODULE 1: INTRODUCTION TO MANAGERIAL ECONOMICS
 At A, Marginal Cost < Marginal Revenue, then for each additional unit produced, revenue will be higher than
the cost so that you will generate more.
 Why generate more? This is because you can still produce more while still having an additional cost that is
lower than the additional revenue. Sellers have this mindset that they will keep on producing or selling as
long the additional cost is lower than the additional benefit (Cost-Benefit analysis).
 At B, Marginal Cost > Marginal Revenue, then for each extra unit produced, the cost will be higher than
revenue so that you will create less.
 Thus, optimal quantity produced should be at MC = MR. You might ask why go for “Q’ to optimize profit when
the MR=MC. Why not go for A when MR is greater than MC?
 If we are to put values in this discussion, you will realize that even though point A allows the firm to enjoy
higher marginal (additional) revenue than its additional cost, the profit is still lower compared to when they
operate at point Q. This is the point of PROFIT MAXIMIZATION.
 Application of Marginal Cost = Marginal Revenue
The MC = MR rule is quite versatile so that firms can apply the rule to many other decisions.
For example, you can apply it to hours of operation. You decide to stay open as long as the added revenue from
the additional hour exceeds the cost of remaining open another hour.
It can also be applied to advertising. You should increase the number of times you run your TV commercial as
long as the added revenue from running it one more time outweighs the added cost of running it one more time.
B. Profit Maximization Example
In the early 1960s and before, airlines typically decided to fly additional routes by asking whether the extra revenue
from a flight (the Marginal Revenue) was higher than the per-flight cost of the flight.
In other words, they used the rule Marginal Revenue = Total Cost/quantity
Then Continental Airlines broke from the norm and started running flights even when the added revenues were below
average cost. The other airlines thought Continental was crazy – but Continental made huge profits.
Eventually, the other carriers followed suit. The per-flight cost consists of variable costs, including jet fuel and pilot
salaries, and those are very relevant to the decision about whether to run another flight.
However, the per-flight cost also includes expenditures like rental of terminal space, general and administrative costs,
and so on. These costs do not change with an increase in the number of flights, and therefore are irrelevant to that
decision.
C. Limitations of the Profit Maximization Rule (MC = MR)
Before we discuss the limitations, please remember that Profit is TR less TC and TR is Price X Quantity.
Further, changing the price can change the quantity being demanded, thus changing the TR, the MR and the profit.
(As early as now, please do know that Demand and Quantity Demanded are different.)
Limitations of MR=MC rule
1. Real World Data
In the real world, it is not so easy to know exactly your Marginal Revenue and Marginal Cost of the last products
sold. For example, it is difficult for firms to know the price elasticity of demand (degree of sensitivity of Demand
brought by a change in price) for their goods – which determines the MR.
2. Competition
The use of the profit maximization rule also depends on how other firms react. If you increase your price, and
other firms may follow, demand may be inelastic (not sensitive to the change in price). But, if you are the only
firm to increase the price, demand will be elastic (sensitive to the change in price).
3. Demand Factors
Page 5 of 6
MODULE 1: INTRODUCTION TO MANAGERIAL ECONOMICS
It is difficult to isolate the effect of changing the price on demand. Demand may change due to many other factors
apart from price.
4. Barriers to Entry
Increasing prices to maximize profits in the short run could encourage more firms to enter the market. Therefore,
firms may decide to make less than maximum profits and pursue a higher market share.
Page 6 of 6