INTRODUCTION
NATURE AND SCOPE OF MANAGERIAL
ECONOMICS

 Definition of Managerial Economics
•
Application of economic tools and techniques to business and
administrative decision-making; another term for the title of this
course, namely economic analysis for agribusiness and
management.
•
Helps decision-makers recognize how economic forces affect
organizations and describes the economic consequences of
managerial behavior. How? By linking economic concepts and
quantitative methods to develop tools for managerial decisionmaking.
•
Simply put, managerial economics uses economic concepts and
quantitative methods to solve managerial problems.
•
We place emphasis on the practical application of economic
analysis to managerial decision problems; the primary virtue of
managerial economics lies in its usefulness.
ECONOMIC CONCEPTS

 Economic concepts:
 influence which products to produce, which costs to
consider, and the prices to charge;
 necessitates the collection, organization, and analysis
of information.
 Emphasis is placed on microeconomic topics, although
macroeconomic relations have implications for
managerial decision-making as well.
Economic decision-making requires the
following:

1) Optimization techniques (calculus-based and linear
programming)
2) Statistical relations
3) Demand analysis and estimation (through
regression)
4) Forces of demand and supply
5) Forecasting of firm activities (sales, production,
demand, prices)
6) Risk analysis
FIRMS

 Firms are useful for producing and distributing
goods and services
 Motivation for firms:
 profit maximization or expected value maximization;
free enterprise depends upon profits and the profit
motive
 Expected value of maximization:
 optimization of profits in light of uncertainty and time
value of money.
VALUE OF THE FIRM


…
TRt  TCt
Value of firm  
t
(
1

i
)
t 1
n
+
EXAMPLE: VALUE OF THE FIRM

 Suppose that Chevron Corporation makes
projections of profits (expected profits) over the next
five years:

2011
= $18,690 million

2012
= $15,560 million

2013
= $14,935 million

2014
= $20,125 million

2015
= $24,585 million
EXAMPLE, CONT.

 Let the discount rate be equal to three percent.
Calculate the value of Chevron Corporation today.
 Value of the firm ( in millions)
=
$18,690
1+.03 1
+
$15,650
1+.03 2
+
$14,935
1+.03 3
+
$20,125
1+.03 4
+
$24,585
1+.03 5
 Value of the firm discounted back to the present
85,653
= $_____________
million
EXPECTED VALUE MAXIMIZATION

 Expected value maximization relates to the various
functional departments of the firm; also illustrates
the value of forecasting
 TR:
marketing department, primary responsibility
for promotion and sales
 TC:
production department, primary
responsibility for costs
 i:
finance department, primary responsibility
for the acquisition of capital and hence the
discount factor i.
TOTAL REVENUE AND TOTAL COSTS

 The determination of TR and TC is a non-trivial and
often complex task.
 𝜋𝑡 = 𝑇𝑅𝑡 − 𝑇𝐶𝑡
 Suppose that a firm produces only one product.
 TRt = PtQt-1 requires the notion of a demand function
 TCt = fixed costst + variable costst
 Variable costs are a function of Q ⇒ TCt = f(Qt)
 Even more complex situation if a firm produces
more than one product.
FIRM FACES CONSTRAINTS

 Skilled labor
 Raw materials
 Energy
 Specialized machinery
 Warehouse space
 Amount of investment funds available for a particular
project or activity
 Legal /contractual restrictions
 Consequently, optimization techniques with constraints
are important in decision-making
 Linear programming
 Calculus-based optimization
PROFIT MEASUREMENT
 Business Profit:

 = TR – TC
 the residual of sales revenue minus the explicit costs of
doing business.
 Economic Profit:
 = business profit minus the implicit costs of capital
and any other owner-provided inputs
 reflects the opportunity cost for the effort of the
owner-entrepreneur.
PROFIT MEASUREMENT

 Opportunity Costs:
 Owner-provided inputs are a notable part of business
profits, especially among small businesses.
 Profit Margin:
 = business profit (net income)/sales,
 Expressed as a percent
EXAMPLE: PROFIT MARGIN

 In 2007, the sales revenue of the American Express
Company was $27,136 million. The Business
profit or
b
net income for this firm was $3,729 million. What
was the profit margin for the American Express
Company?
Profit Margin =
$3,729 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
$27,136 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
∗ 100 = 13.7%
EQUITY

 Return on Equity(ROE)
 business profit (net income)/equity
 Expressed as a percent
 Equity
 total assets – total liabilities = net worth=equity
EXAMPLE: ROE

 In 2007, the net income for Microsoft Corporation
was $11,909 million. The equity (or net worth) of this
firm was $36,708 million. What is the ROE for
Microsoft Corporation?
ROE =
$11,909 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
$36,708 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
∗ 100 = 32.4%