SESSION 1

INTRODUCTION TO
MANAGERIAL ECONOMICS
GRADING CRITERIA
Mid Term Examination 25%

End Term Examination 35 %

30%
Quizzes/Assignments

10%
Course Commitment

Total Marks 100

 WHAT AND WHY?
❑ The study of how various societies use scarce resources to produce commodities that are
valued by people, and design mechanisms to allocate them among different people

❑ Concerned with two “central truths”

1. Resources are scarce
2. One mechanism of producing and distributing commodities may be more
efficient and/or more equitable than another mechanism

❑ Scarcity of resources necessitates making choices, and different ways of organizing an

economy will provide different incentives to agents in making their choices

❑ Economics is all about recognizing trade-offs in decision-making, and

resolving such trade-offs in intelligent ways

“Economics is a study of mankind in the ordinary business of life” – Alfred

Marshall &
in both what matters is

CONSTRAINT OPTIMIZATION
MICROECONOMICS vs
MACROECONOMICS
• Microeconomics: the study of how households and firms
make decisions and how they interact in markets.

• How an individual maximises his welfare subject

to his budget constraint
• How firms optimize its production and cost structures
• How firms behave in monopoly or oligopoly

• Macroeconomics: the study of economy-wide phenomena,

including inflation, unemployment and growth

• Relationship between growth and inflation

• Why rates of interest are pushed up during recession
• What happens when Central Bank changes money
supply
• What happens if government runs a fiscal deficit etc.
 THEMES OF MICROECONOMICS
In economics, explanation and prediction are based on theories.
Theories are developed to explain observed phenomena, and • Economics is the only field in
which two people can get a
Theories and Models examining ideal states, in terms of a set of basic rules and
assumptions. Nobel Prize for saying exactly
the opposite thing
A model is an abstraction of real world of complexities with a
purpose of focusing on important matters. • Economics is the only field in
which two people can get a
Nobel Prize for saying the
opposite thing
positive analysis Explaining observed phenomena by
analyzing the relationships of cause and effect. • Economics is the only field in
Positive versus which two people can share a
Normative normative analysis Examining ideal states by asking the Nobel Prize for saying
Analysis questions of what ought to be. opposing things
TRADEOFFS

Workers must decide whether and when

to enter the workforce.
Consumers have limited
incomes, which can be spent Firms face limits in terms of the kinds of
Workers face trade-offs in their choice of
on a wide variety of goods products that they can produce, and the
employment.
and services, or saved for the They must sometimes decide how many resources available to produce them.
future. hours per week they wish to work,
thereby trading off labor for leisure.
 MANAGERIAL ECONOMICS
•Application of economic theory and methods to business decision-making

•The individual elements within the economy (consumers, firms and workers) as
rational agents with objectives that can be expressed as quantitative functions
(utilities and profits) that are to be optimized, subject to certain quantitative
constraints.

•Distinguishing between economic and accounting profits

• Accounting profits are the total amount of money taken in from sales (total revenue, or
price times quantity sold) minus the dollar cost of producing goods or services.
• Economic profits are the difference between the total revenue and the total opportunity
cost of producing the firm’s goods or services
• The opportunity cost of using a resource includes both the explicit (or accounting) cost of
the resource and the implicit cost of giving up the best alternative use of the resource
 UNDERSTANDING MARKETS
Markets
• a triadic relation between firms, their customers, and their suppliers
• boundary depends mainly on (a) the range of products related in consumption • Consumer–Producer rivalry
and/or production, and (b) geography [depends greatly on the eye of the beholder] o (Price negotiation)
• Market Structure composed of (i) demand structure, (ii) structure of input supply,
and (iii) industry structure – size distribution of firms in the industry • Consumer-consumer rivalry
• these three determine market power (e.g., power to affect prices vis-à-vis costs)
o (Doctrine of scarcity)
• Some markets are non-existent or incomplete

The essence of entrepreneurship is to identify such gaps and devise economically/socially • Producer–Producer rivalry
profitable ways of filling them o (Service competition)
Market definition is important for two reasons:
• Producer-Government rivalry
• A company must understand who its actual and potential competitors are for the
various products that it sells or might sell in the future. o (Discipline and regulation)
• Market definition can be important for public policy decisions.
 ROLE OF PRICES
Prices:
• convey information, affect resource allocation, and determine
incomes and profits
• new technological and institutional innovations (the internet,
electronic marketplaces in the rural economy, etc.) highlight the
benefits of information conveyed by prices

to compare prices over time and across space:

• Absolute vs. relative prices: comparing affordability of a product
relative to other goods, and across space (e.g., across currencies).
When two products are expressed in same currency, we have only
to take the ratio of their nominal prices; but when they are not, we
have to use the ‘real’ exchange rate (the purchasing power parity)
• Nominal vs. real prices: comparing affordability of a good over time
(controlling for inflation) - we have to ‘deflate’ nominal price by
appropriate ‘inflation index’
TIME VALUE OF MONEY
• The opportunity cost of receiving the $1 in the future is the forgone interest that could be earned were $1 received today. This opportunity cost
reflects the time value of money
• The present value (PV) of an amount received in the future is the amount that would have to be invested today at the prevailing interest rate to
generate the given future value
• The present value (PV) of a future value (FV) received n years in the future is

The basic idea of the present value of a future amount can be extended to a series of future payments.

• The net present value (NPV) of a project is simply the present value (PV) of the income
stream generated by the project minus the current cost (C0) of the project
• If the net present value of a project is positive, then the project is profitable because the
present value of the earnings from the project exceeds the current cost of the project
MARGINAL ANALYSIS
• Marginal analysis states that optimal managerial decisions involve comparing the marginal (or incremental) benefits of a
decision with the marginal (or incremental) costs
• The optimal amount of studying for this course is determined by comparing (1) the improvement in your grade that will
result from an additional hour of studying and (2) the additional costs of studying an additional hour.
• So long as the benefits of studying an additional hour exceed the costs of studying an additional hour, it is profitable to
continue to study.
• However, once an additional hour of studying adds more to costs than it does to benefits, you should stop studying
• Higher the level of scarcity of a resource, its marginal value is higher
• To maximize net benefits, the manager should increase the managerial control variable up to the point where marginal
benefits equal marginal costs.
• This level of the managerial control variable corresponds to the level at which marginal net benefits are zero; nothing
more can be gained by further changes in that variable.
• Managerial control variables can be discrete and continuous
• Discrete: Only integer values are possible, The manager must decide how many gallons of soft drink to produce (0, 1, 2,
and so on) - Marginal analysis through algebraic change
• Continuous: Fractional units are possible, Q is infinitely divisible (instead of allowing the firm to produce soft drinks only
in one-gallon containers) – Marginal analysis through usage of calculus