Managerial Economics
Dr. Hasnain Naqvi
Assistant Professor
Department of Management Sciences
COMSATS Institute of Information Technology
Islamabad Campus
Islamabad, 44000
Introduction, Basic Principles and
Methodology
The central themes of Managerial
Economics:
1. Identify problems and opportunities
2. Analyzing alternatives from which choices
can be made
3. Making choices that are best from the
standpoint of the firm or organization
• Not true that all managers must be
managerial economists
• But managers who understand the
economic dimensions of business
problems and apply economic analysis to
specific problems often choose more
wisely than those who do not.
Some Economic Principles of
Managers
1.Role of manager is to make decisions. Firms
come in all sizes but no firm has unlimited
resources so managers must decide how
resources are employed
2. Decisions are always among alternatives.
3. Decision alternatives always have costs
and benefits
Opportunity cost = next best alternative
foregone.
Marginal or incremental approach
4. Anticipated objective of management is to
increase the firm’s value
• Maximize shareholder’s wealth
• Negative impact = principal-agent problem
5. Firm’s value is measured by its expected
profits
Time value of money, discount rates
6. The firm must minimize cost for each level
of production
7. The firm’s growth depends on rational
investment decisions
Capital budgeting decisions
8. Successful firms deal rationally and
ethically with laws and regulations
Macroeconomics & Microeconomics
• Economists generally divide their discipline into
two main branches:
• Macroeconomics is the study of the aggregate
economy.
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National Income Analysis (GDP)
Unemployment
Inflation
Fiscal and Monetary policy
Trade and Financial relationships among nations
• Microeconomics is the study of individual
consumers and producers in specific markets.
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Supply and demand
Pricing of output
Production processes
Cost structure
Distribution of income and output
Microeconomics is the basis of managerial economics
• Methodology, data and application
Methodology- is a branch of philosophy that
deals with how knowledge is obtained.
How can you know that you are managing
efficiently and effectively?
You need some theory to do some analysis.
Without theory, there can be no good
analysis
Microeconomics (probably more than other
disciplines) provides the methodology for
managerial economics
Managerial Economics is about both
methodology and data
You need data to plug into some model to do
some analysis.
This gives you the information to manage
Managerial Economics lends empirical content to
the study of effective management
Review of Economic Terms
• Resources are factors of production or inputs.
– Examples:
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Land
Labor
Capital
Entrepreneurship
• Managerial Economics
– The study of how to direct scarce resources in
the way that most efficiently achieves a
managerial goal.
• Managerial economics is the use of economic
analysis to make business decisions involving
the best use (allocation) of an organization’s
scarce resources.
• Relationship to other business disciplines
– Marketing: Demand, Price Elasticity
– Finance: Capital Budgeting, Break-Even Analysis,
Opportunity Cost, Economic Value Added
– Management Science: Linear Programming,
Regression Analysis, Forecasting
– Strategy: Types of Competition, Structure-ConductPerformance Analysis
– Managerial Accounting: Relevant Cost, Break-Even
Analysis, Incremental Cost Analysis, Opportunity Cost
• Questions that managers must answer:
– What are the economic conditions in a particular
market?
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Market Structure?
Supply and Demand Conditions?
Technology?
Government Regulations?
International Dimensions?
Future Conditions?
Macroeconomic Factors?
• Questions that managers must answer:
– Should our firm be in this business?
– If so, what price and output levels achieve our
goals?
• Questions that managers must answer:
– How can we maintain a competitive advantage over
our competitors?
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Cost-leader?
Product Differentiation?
Market Niche?
Outsourcing, alliances, mergers,
acquisitions?
International Dimensions?
• Questions that managers must answer:
– What are the risks involved?
• Risk is the chance or possibility that actual
future outcomes will differ from those
expected today.
• Types of risk
– Changes in demand and supply conditions
– Technological changes and the effect of
competition
– Changes in interest rates and inflation rates
– Exchange rates for companies engaged in
international trade
– Political risk for companies with foreign
operations
• Because of scarcity, an allocation decision must
be made. The allocation decision is comprised of
three separate choices:
– What and how many goods and services should be
produced?
– How should these goods and services be produced?
– For whom should these goods and services be
produced?
• Economic Decisions for the Firm
– What: The product decision – begin or stop
providing goods and/or services.
– How: The hiring, staffing, procurement, and
capital budgeting decisions.
– For whom: The market segmentation decision
– targeting the customers most likely to
purchase.
• Three processes to answer what, how, and
for whom
– Market Process: use of supply, demand, and
material incentives
– Command Process: use of government or
central authority, usually indirect
– Traditional Process: use of customs and
traditions
• Profits are a signal to resource holders
where resources are most valued by
society
• So what factors impact sustainability of
industry profitability?
• Porter’s 5-forces framework discusses 5
categories of forces that impacts
profitability
1. Entry
2. Power of input sellers
3. Power of buyers
4. Industry rivalry
5. Substitutes and Complements
Entry:
Heightens competition
Reduces margin of existing firms
Ability to sustain profits depends on the
barriers to entry: cost, regulations,
networking, etc.
Profits are higher where entry is low
Power of input suppliers:
Do input suppliers have power to negotiate
favorable input prices?
Less power if
a. inputs are standardized,
b. not highly concentrated
c. alternative inputs available
Profits are high when suppliers power is low
Power of buyers:
High buyer power if
a. buyers can negotiate favorable terms for
the good/service
b. Buyer concentration is high
c. Cost of switching to other products is low
d. perfect information leading to less costly
buyer search
Industry rivalry:
Rivalry tends to be less intense
a. in concentrated industries
b. high product differentiation
c. high consumer switching cost
Profits are low where industry rivalry is
intense
Substitutes and complements:
Profitability is eroded when there are close
substitutes
Government policies (restrictions e.g. import
restriction on drugs from Canada to US)
can affect the availability of substitutes.
The Five Forces Framework
Entry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale
Entry
Power of
Input Suppliers
Power of
Buyers
Supplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints
Sustainabl
e Industry
Profits
Industry Rivalry
Concentration
Price, Quantity, Quality, or
Service Competition
Degree of Differentiation
Network Effects
Reputation
Switching Costs
Government Restraints
Switching Costs
Timing of Decisions
Information
Government Restraints
Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints
Substitutes & Complements
Price/Value of Surrogate Products
or Services
Price/Value of Complementary
Products or Services
Network Effects
Government
Restraints
Market Interactions
• Consumer-Producer Rivalry
– Consumers attempt to locate low prices, while
producers attempt to charge high prices.
• Consumer-Consumer Rivalry
– Scarcity of goods reduces the negotiating
power of consumers as they compete for the
right to those goods.
• Producer-Producer Rivalry
– Scarcity of consumers causes producers to
compete with one another for the right to
service customers.
• The Role of Government
– Disciplines the market process.
Overview of Lectures
Lecture 1: Demand
Lecture 2: Supply
Lecture 4: Quantitative Demand Analysis
Lecture 5: The Theory of Individual Behavior
Lecture 6:Demand Estimation & Forecasting
Lecture 7: Production
Lecture 8: Cost of Production
Lecture 9: Organizing Production
Lecture 10: Perfect Competition
Lecture 11:The Firm’s Decisions in Perfect
Competition
Lecture 12:Monopoly
Lecture 13:Price Discrimination
Lecture 14:Monopolistic Competition
Lecture 15: Oligopoly
Lecture 16: Oligopoly Games
Lecture 17: Labor and Capital Market
Lecture 18: Capital Market
Lecture 19: Economic Equations and Their
Solutions
Lecture 20: Economics Applications of
Derivatives
Lecture 21: ECONOMIC APPLICATION OF
DERIVATIVES – A
Lecture 22: ECONOMIC APPLICATION OF
DERIVATIVES - A
Lecture 23: ECONOMIC APPLICATION OF
MAXIMA AND MINIMA-A
Lecture24: MAXIMIZATION OR
MINIMIZATION (OTIMIZATION) OF
MULTI-VARIABLE FUNCTIONS OR TWO
OR MORE VARIABLE
Lecture 25: CONSTRAINED OPTIMIZATION
Lecture 26: CONSTRAINT OPTIMIZATION –
A
Lecture 27: Correlation & Regression
Lecture 28: Measuring a Nation’s Income
Lecture 29: Money
Lecture 30: Monetary Policy
Lecture 31: Fiscal Policy and NI Determination