Topic 1 – Introduction to Managerial
Economics
Business Economics
Business Economics
Topic 1:
Introduction to Managerial Economics
© NCC Education Limited
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Scope and Coverage
This topic will cover:
• Subject matter and approach of
business/managerial economics
• Role of models in busmanagerial economics
• Maximising models of firm objectives
• Non maximising/behavioural models of firm
objectives
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Learning Objectives
By the end of this topic, students will be able to:
• Understand the relevance and value of economic
theory to business decision making
• Appreciate a range of theories concerning business
objectives
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Topic 1 – Introduction to Managerial
Economics
Definition of Managerial
Economics
Business Economics
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• Managerial economics can be defined as:
• The application of economic analysis to business
problem solving at the level of the firm
• Managerial economics combines economic theory
and managerial practice
Development of Managerial
Economics
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Managerial economics as a science is relatively
new, emerging in the USA in the 1950s. It deals
with those situations that can be incorporated into
economic models.
Use of Models in Managerial
Economics
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• As you will know from your previous study in economics,
model (or theory) building is central to economics
• Generally, model building occurs via the following stages:
– Establishing a set of assumptions
– Theoretical analysis/logical deduction - where the
logical implications of the above assumptions are
followed
– Predictions are made based upon the above analysis
– Predictions are tested against real world data
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Topic 1 – Introduction to Managerial
Economics
Business Economics
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Use of Models in Helping to Make
Better Decisions
• Basic economic theory is designed to fit together to
explain the workings of the economy as a whole
• It is not initially designed to assist decision-making
• The distinction introduced in your previous studies
is relevant here:
– Positive economic theory
– Normative economic theory
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Positive Economics
• Positive economics deals with ‘what is’.
• It takes a neutralist view, even if products sold
could be morally questionable.
• Good positive economic theory will generate
accurate predictions about firms’ behaviour, as it
draws patterns from the past to predict the future
• Its assumptions may be unrealistic, perhaps
because they are designed to simplify reality
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Normative Economics
Managerial economics is more associated with
normative economics as it is concerned with what
decisions should be made.
It involves making value judgements about the
attractiveness of different strategies.
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Topic 1 – Introduction to Managerial
Economics
Business Economics
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The Relevance of Economic
Theory to Business Decisions
• It can offer a different perspective on an issue
• It can demonstrate and encourage clear, logical
reasoning
• Simple positive models may lead the way to more
complex, more realistic models, which may have
greater application to decision-making
• Theory may provide an agenda of relevant issues
to consider and analyse rather than providing
obvious decision-making rules
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Firms’ Objectives
• Theories about firms’ objectives can be grouped
into theories about:
• Goals that are maximised
-Profit maximisation
-Sales revenue maximisation
-Constrained sales revenue maximisation
-Growth maximisation
• Non maximising goals
-Satisficing
-Coalitions’/stakeholders’ objectives
-Contingency theory
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Profit Maximisation - 1
• This theory is based upon two assumptions:
- A firm’s owners are in control of day-to-day decision
making
- Those owners always desire more profit than less
• As you will have seen in previous study, profit is maximised
at an output where marginal cost (MC) equals marginal
revenue (MR).
• Managers are not assumed to know MR and MC at all
levels of output
• They may have a detailed knowledge of MC and MR or they
may find other ways of finding these points
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Topic 1 – Introduction to Managerial
Economics
Business Economics
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Profit Maximisation - 2
• The dominant organisational form in many countries is
the public limited company (PLC) undermines the first
assumption of the previous slide
• PLCs are owned by shareholders, but run by
professional managers.
• Managers may have different objectives from
shareholders
• They are able to pursue these because of the lack of
involvement of shareholders
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Sales Revenue Maximisation
• Baumol - firms run by professional managers are
likely to seek to maximise sales revenue rather
than profit:
– Top managers’ salaries and other perks are more
dependent on sales revenue than profit
• Williamson - similar view:
– Sales revenue is the best source of resources to
fund staff and projects which can increase
managerial satisfaction
Constrained Sales Revenue
Maximisation
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• Sales revenue maximisation will typically occur
substantially above the level of output at which
profit would be maximised.
• Shareholders may require at least a certain level of
profit (out of which they would receive dividends)
and so sales revenue can only be maximised
subject to this constraint.
• This possibility was recognised by both Baumol
and Williamson.
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Topic 1 – Introduction to Managerial
Economics
Business Economics
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Growth Maximisation - 1
• Marris took the view that, rather than shareholder
and management interests being opposed, both
would be served by growth:
– Managers seek growth in sales (see previous
slides)
– Shareholders seek growth in the value of the
company and hence their shares
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Growth Maximisation - 2
• Marris proposed a major objective that both
managers and shareholders could pursue, which
would maximise both the value of a firm’s sales and
its capital value
• However, he saw this as constrained by the need
to distribute a reasonable proportion of profit as
dividends to shareholders, i.e. a need to maintain a
low ratio between retained and distributed profits
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Satisficing
• So far we have assumed that a firm seeks to
maximise a single goal, desired by either its owners
or its managers, sometimes subject to some form
of constraint.
• However, Simon suggested that decision makers
may not have sufficiently precise information to
maximise anything, and may instead set
themselves minimum levels of achievement
• i.e. they satisfice rather than maximise.
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Topic 1 – Introduction to Managerial
Economics
Business Economics
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Behavioural Theories
• Rather than companies pursuing dominant goals,
such as maximising profit or sales, behavioural
theories see a company as made up of a number of
groups, each of whom may have different goals
• Hence a company’s goals may emerge as a
compromise between competing groups’ goals
• The trade-offs required between different groups’
goals is a second reason for companies to adopt
goals expressed in terms of satisficing, rather than
maximising behaviour
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Contingency Theory
• This suggests that successful companies seek to
match their internal activities and processes to their
environments.
• As the environment is subject to continuous
change, companies are likely to have to adjust their
goals as their environment changes, which makes
pursuit of a single maximising goal impossible.
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References
• Davies, H. & Lam, P-L. (2001). Managerial
Economics, Financial Times Prentice Hall, 3rd
edition, pages 1-5.
• Griffiths, A. & Wall, S. (2010). Applied Economics,
Financial Times Prentice Hall, 11th edition, pages
46-50
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Topic 1 – Introduction to Managerial
Economics
Business Economics
Topic 1 - Introduction to Managerial
Economics
Any Questions?
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