Managerial Economics
 What is it?
– Applied microeconomic theory
– A systematic way of analyzing business
decisions
– Although focus is on “for profit” firms, tools
are relevant for “not for profit” firms also
Chapter 1-1
Defining Profit
 Profit is the difference between a firm’s
revenues and costs.
 However, economic costs requires some
clarification since it differs from accounting
costs.
 Economic Costs = Explicit Costs + Normal
Profit(which is an implicit or implied costs)
Chapter 1-2
The Two Types of Economic
Costs
 Explicit costs reflect payments made to
resource owners external to the firm for the
use of their land, labor services, or capital.
 Implicit costs(Normal profit) reflect an
implicit payment(no explicit dollar flow)
made to the firm’s owner(s) for the use of
their services.
Chapter 1-3
Accounting Profit
 Accounting Profit is the difference between
total revenue and explicit cost.
Chapter 1-4
Maximizing Profit
 Throughout the course the basic goal of the
firm is assumed to be the Maximization of
Profit within a single period.
 However, this is generally consistent with
maximizing the Value of the Firm over time
as long as decisions made in one period
have no impact on revenues and costs in
other periods.
Chapter 1-5
Value Maximization
The value of the firm, V, is the present
value of expected future profits (p) or
cash flows, discounted at the
shareholders required rate of return, r,
ignoring taxes.
T

t 1
t
(1  rt )
Chapter 1-6
Separation of Ownership &
Control
 When the owner and manager(decision-
maker) are one and the same person – there
is no problem in modeling firm behavior.
What is good for the owner is also good for
the manager and there is no conflict of
interest.
 However, when owner and manager are two
distinct individuals, there is a potential
conflict of interest.
Chapter 1-7
Corporate Structure
 In corporations there is this separation of
ownership and control.
 Ownership rests with the shareholders often
called the Principals.
 Control rests with the managers often called
the Agents.
 Thus, the potential conflict we refer to is
often called the Principal Agent Problem
Chapter 1-8
Chapter 1-9