ECO491 MANAGERIAL ECONOMICS NOTES FOR STUDENTS WEEK

1-2-3-4

WEEK 1

INTRODUCTION

WEEK 2

 What Is Managerial Economics?

Economics is the study of choice related to the allocation of scarce resources.So

Managerial Economics is a subfield of economics that places special emphasis
on the choice aspect in the definition. The purpose of managerial economics is
to provide economic terminology and reasoning for theimprovement of
managerial decisions

 The Economic Way of Thinking

Economists study choices that scarcity requires us to make. This fact is not what
distinguishes economics from other social sciences; all social scientists are
interested in choices. An anthropologist might study the choices of ancient
peoples; a political scientist might study the choices of legislatures; a psychologist
might study how people choose a mate; a sociologist might study the factors that
have led to a rise in single-parent households. Economists study such questions
as well. What is it about the study of choices by economists that makes economics
different from these other social sciences? Features distinguish the economic
approach to choice from the approaches taken in other social sciences:
1.Economists give special emphasis to the role of opportunity costs in their
analysis of choices. 2.Economists assume that individuals make choices that seek
to maximize the value of some objective, and that they define their objectives in
terms of their own self-interest. 3.Individuals maximize by deciding whether to
do a little more or a little less of something. Economists argue that individuals pay
attention to the consequences of small changes in the levels of the activities they
pursue.The emphasis economists place on opportunity cost, the idea that people
make choices that maximize the value of objectives that serve their selfinterest,
and a focus on the effects of small changes are ideas of great power. They
constitute the core of economic thinking.

 Microeconomics and Macroeconomics

Microeconomics is the branch of economics that focuses on the choices made by

individual decision making units in the economy typically consumers and firms
and the impacts those choices have on individual markets. Macroeconomics is
the branch of economics that focuses on the impact of choices on the total, or
aggregate, level of economic activity.

Economics is a social science that examines how people choose among the
alternatives available to them. It is social because it involves people and their
behavior. It is a science because it uses, as much as possible, a scientific
approach in its investigation of choices.

 Scarcity

Our resources are limited. At any one time, we have only so much resources. But
our wants, our desires for the things that we can produce with those resources, are
unlimited. If our resources were also unlimited, we could say yes to each of our
wants or needs—and there would be no economics. Because our resources are
limited, we cannot say yes to everything. To say yes to one thing requires that we
say no to another. Whether we like it or not, we must make choices. Our unlimited
wants are continually colliding with the limits of our resources, forcing us to pick
some activities and to reject others. Scarcity is the condition of having to choose
among alternatives. A scarce good is one for which the choice of one alternative
requires that another be given up

 Scarcity and the Fundamental Economic Questions

The choices we confront as a result of scarcity raise three sets of issues. Every
economy must answer the following questions:

1.What should be produced?

Using the economy’s scarce resources to produce one thing requires giving up
another. Producing better education, for example, may require cutting back on
other services, such as health care. A decision to preserve a wilderness area
requires giving up other uses of the land. Every society must decide what it will
produce with its scarce resources.

2.How should goods and services be produced?

There are all sorts of choices to be made in determining how goods and services
should be produced. Should a firm employ a few skilled or a lot of unskilled
workers? Should it produce in its own country orshould it use foreign plants?
Should manufacturing firms use new or recycled raw materials to make their
products?

3.For whom should goods and services be produced?

If a good or service is produced, a decision must be made about who will get it.
A decision to have one person or group receive a good or service usually means
it will not be available to someone else..Every economy must determine what
should be produced, how it should be produced, and for whom it should be
produced.
  Ceterİs Parİbus

Ceteris paribus, literally "holding other things constant," is a Latin phrase that is
commonly translated into English as "all else being equal." A dominant
assumption in mainstream economic thinking, it acts as a shorthand indication of
the effect of one economic variable on another, provided all other variables In
economics, " is important in determining causation. It helps isolate multiple
independent variables affecting a dependent variable.

 Models in Economics

All scientific thought involves simplifications of reality. The real world is far too
complex for the human mind or the most powerful computer to consider.
Scientists use models instead. Amodel is a set of simplifying assumptions about
some aspect of the real world. Models are always based on assumed conditions
that are simpler than those of the real world, assumptions that are necessarily false.
A model of the real world cannot be the real world. Economists often use graphs
to represent economic models. Models in economics also help us to generate
hypotheses about the real World.

WEEK 3

 FACTORS OF PRODUCTION

Choices concerning what goods and services to produce are choices about an
economy’s use of its factors of production, the resources available to it for the
production of goods and services.

The factors of production are resources that are the building blocks of the
economy; they are what people use to produce goods and services. Economists
divide the factors of production into four categories: , labor, capital,natural
resources and entrepreneurship.

Labor is the human effort that can be applied to the production of goods and
services. People who are employed or would like to be are considered part of the
labor available to the economy.

Capital is a factor of production that has been produced for use in the production
of other goods and services. Office buildings, machinery, and tools are examples
of capital.

Natural resources are the resources of nature that can be used for the production
of goods and services.In the next three sections, we will take a closer look at the
factors of production we use to produce the goods and services we consume.

The three basic building blocks of labor, capital, and natural resources may be
used in different ways to produce different goods and services, but they still lie at
the core of production. We will then look at the roles played by technology and
entrepreneurs in putting these factors of production to work.

 Labor

Labor is human effort that can be applied to production. People who work to repair
tires, pilot airplanes, teach children, or enforce laws are all part of the economy’s
labor. People who would like to work but have not found employment who are
unemployed are also considered part of the labor available to the economy.In
some contexts, it is useful to distinguish two forms of labor. The first is the human
equivalent of a natural resource. It is the natural ability an untrained, uneducated
person brings to a particular production process. But most workers bring far more.
The skills a worker has as a result of education, training, or experience that can
be used in production are called humancapital.
Students who are attending a college or university are acquiring human capital.
Workers who are gaining skills through experience or through training are
acquiring human capital. Children who are learning to read are acquiring human
capital.The amount of labor available to an economy can be increased in two
ways. One is to increase the total quantity of labor, either by increasing the number
of people available to work or by increasing the average number of hours of work
per week. The other is to increase the amount of human capital possessed by
workers

 Capital

Think of capital as the machinery, tools and buildings humans use

to produce goods and services. Some common examples of capital include
hammers, forklifts, conveyer belts, computers.Also transportation equipment,
such as cars and trucks, is capital. Facilities such as roads, bridges, ports, and
airports are capital. Buildings, too, are capital; they help us to produce goods and
services. Capital does not consist solely of physical objects. The score for a new
symphony is capital because it will be used to produce concerts. Computer
software used by business firms or government agencies to produce goods and
services is capital. Capital may thus include physical goods and intellectual
discoveries.

Any resource can be considered as capital if it satisfies two criteria:

1.The resource must have been produced.

2.The resource can be used to produce other goods and services.

One thing that is not considered capital is money. A firm cannot use money
directly to produce other goods, so money does not satisfy the second criterion for
capital. Firms can, however, use money to acquire capital. Money is a form of
financial capital. Financial capital includes money and other “paper” assets (such
as stocks and bonds) that represent claims on future payments. These financial
assets are not capital, but they can be used directly or indirectly to purchase factors
of production or goods and services.

 Natural Resources

There are two essential characteristics of natural resources. The first is that they
are found in nature that no human effort has been used to make or alter them. The
second is that they can be used for the production of goods and services. That
requires knowledge; we must know how to use the things we find in nature before
they become resources.

The natural resources available to us can be expanded in three ways. One is the
discovery of new natural resources, such as the discovery of a deposit of ore
containing titanium. The second is the discovery of new uses for resources, as
happened when new techniques allowed oil to be put to productive use or sand to
be used in manufacturing computer chips. The third is the discovery of new ways
to extract natural resources in order to use them. New methods of discovering and
mapping oil deposits have increased the world’s supply of this important natural
resource.

 Technology and the Entrepreneur

Goods and services are produced using the factors of production available to the
economy. Two things play an important role in putting these factors of production
to work. The first is technology, the knowledge that can be applied to the
production of goods and services. The second is an individual who plays a key
role in a market economy: the entrepreneur. An entrepreneur is a person who,
operating within the context of a market economy, seeks to earn profits by finding
new ways to organize factors of production. In non-market economies the role of
the entrepreneur is played by bureaucrats and other decision makers who respond
to incentives other than profit to guide their choices about resource allocation
decisions.The interplay of entrepreneurs and technology affects all our lives.

THE PRODUCTION POSSIBILITIES CURVE

Also known as the productıon possıbılıtıes frontier. The production possibilities

frontier shows all combinations of goods and services that it’s possible to
produce in this economy, given its resource endowment – that is, the amount of
capital, labor, and raw materials available – and given its technology – that is, its
know-how for transforming raw materials into final goods and services. The
production possibilities frontier will show you the maximum amount of one
good that the economy can produce, given the amount of other goods that it’s
already producing, and given its resource and technological constraints

 The Production Possibilities Frontier (PPF) is a graph that shows all the
different combinations of output of two goods that can be produced using
available resources and technology. The PPF captures the concepts of
scarcity, choice, and tradeoffs.

 The shape of the PPF depends on whether there are increasing,

decreasing, or constant costs.

 Points that lie on the PPF illustrate combinations of output that are
productively efficient. We cannot determine which points are
allocatively efficient without knowing preferences.

 The slope of the PPF indicates the opportunity cost of producing one good
versus the other good, and the opportunity cost can be compared to the
 opportunity costs of another producer to determine comparative
advantage.

between X and Y, shows us how, in order to increase the output X, the quantity
of Y must decrease. In fact, the marginal rate of transformation measures the
tradeoff of producing more X in terms of Y.

This frontier determines the maximum output (of both X and Y) that can be
obtained given the technology. Production at point A will produce more quantity
of Y and less of X than production at point B. However, both are technically
efficient, since they maximize the output. For example, production at point C is
technically inefficient because, at any point on the PPF, more combined output
is produced using given the technology. Also, point D is unattainable given the
technology, being this is the reason why it is outside the PPF.

The Production Possibilities Frontier and Social Choices

Because society has limited resources (e.g., labor, land, capital, raw materials) at
any point in time, there is a limit to the quantities of goods and services it can
produce. Suppose a society desires two products, healthcare and education. This
situation is illustrated by the production possibilities frontier in this graph.

This production possibilities frontier shows a tradeoff between devoting social

resources to healthcare and devoting them to education. At A all resources go to
healthcare and at B, most go to healthcare. At D most resources go to education,
and at F, all go to education.

In the graph, healthcare is shown on the vertical axis and education is shown on
the horizontal axis. If the society were to allocate all of its resources to healthcare,
it could produce at point A. But it would not have any resources to produce
education. If it were to allocate all of its resources to education, it could produce
at point F. Alternatively, the society could choose to produce any combination of
healthcare and education shown on the production possibilities frontier. In effect,
the production possibilities frontier plays the same role for society as the budget
constraint plays for its introducer.. Society can choose any combination of the two
goods on or inside the PPF. But it does not have enough resources to produce
outside the PPF.

Most important, the production possibilities frontier clearly shows the tradeoff
between healthcare and education. Suppose society has chosen to operate at point
B, and it is considering producing more education. Because the PPF is downward
sloping from left to right, the only way society can obtain more education is by
giving up some healthcare. That is the tradeoff society faces. Suppose it considers
moving from point B to point C.

Productive Efficiency and Allocative Efficiency

Productive efficiency means that, given the available inputs and technology, it is
impossible to produce more of one good without decreasing the quantity that is
produced of another good

Allocative efficiency means that the particular mix of goods a society produces
represents the combination that society most desires . allocative efficiency means
producers supply the quantity of each product that consumers demand. Only one
of the productively efficient choices will be the allocatively efficient choice for
society as a whole

WEEK 4

THE BUDGET CONSTRAINT

A budget constraint represents all the combinations of goods and services that a
consumer may purchase given current prices within his or her given income.
The budget constraints presented, showing individual choices about what
quantities of goods to consume, were all straight lines. The reason for these
straight lines was that the slope of the budget constraint was determined by the
relative prices of the two goods in the consumption budget constraint.

In economics, a budget constraint represents all the combinations of goods and

services that a consumer may purchase given current prices within his or her given
income.

Individual choice

Consumer behaviour is a maximization problem. It means making the most of our

limited resources to maximize our utility. As consumers are insatiable, and utility
functions grow with quantity, the only thing that limits our consumption is our own
budget

OPPORTUNITY COST

If doing one thing requires giving up another, then the expected benefits of the
alternatives we face will affect the ones we choose. Economists argue that an
understanding of opportunity cost is crucial to the examination of choices. As the set
of available alternatives changes, we expect that the choices individuals make will
Change.
Opportunity costs represent the benefits an individual, investor or business misses out
on when choosing one alternative over another. this is an economics term that refers
to the value of what you have to give up in order to choose something else
BUSINESS FIRMS AND BUSINESS DECISIONS

Business firms are a combination of manpower, financial, and physical resources

which help in making managerial decisions. Societies can be classified into two main
categories - production and consumption

Firms are the economic entities and are on the production side, whereas consumers
are on the consumption side. The performances of firms get analyzed in the framework
of an economic model. The economic model of a firm is called the theory of the firm.
Business decisions include many vital decisions like whether a firm should undertake
research and development program, should a company launch a new product, etc.
Business decisions made by the managers are very important for the success and
failure of a firm. Complexity in the business world continuously grows making the role
of a manager or a decision maker of an organisation more challenging! The impact of
goods production, marketing, and technological changes highly contribute to the
complexity of the business environment.

The Concept of Decision Making

These decisions:

Are expressed mostly in quantifiable terms (such as production plants ,how many
products produce or investing plants .how much Money do the company have to spent
in expnditure values..money)..these are all quantifiable terms

Affect more people: organisations effect so how many people working in the same
direction to accomplish the same goal with the business itself. So decisions a fact a lot
of people who works on it

Any business decision Result in consumption of more resources: when we

compare the individual decisions with business decisions we can see that business
decisions require more resources such as workforce also capital which are factors of
production.

Decision making process must be conducted with an analytical and systamatic

approach .The process must ve formal and trackable so that others can participate
easily any part of it.

In a business you have superiors who supervise your decisions and actions based on
these decisions

Also you have subordinates who take order from you and work based on your
decisions
To make them or to convince them to do these orders, decisions must be formal and
trackable

The concept of decision-making is to choose the most appropriate alternative

among the available alternatives

A good decision:

 Takes into account all of the possible alternatives of actions . These must be
listed from the most preferred one to least preferred one

 Includes the info about the factors and results of these alternatives : you got the
outcomes of the alternatives so you should choose the best option among those
alternatives

 Must be logical. (chooses the best action possible)

Steps for Decision Making

1. Define the Problem

What is the problem and how does it influence managerial objectives are the main
questions. Decisions are usually made in the firm’s planning process. Managerial
decisions are at times not very well defined and thus are sometimes source of a
problem. While identifying the problem, you should keep in mind that the definition of
the problem shouldn’t be too broad or vague; it must be specific and precise.

If the definition of the problem is vague or unclear, it would lead you to make vague
decisions. Therefore, problem identification must be clearly defined which would help
you to achieve your goals.

2. Gather Relevant Information

After identifying the problem, now you’ve reached the second stage where you should
start collecting relevant information. You should gather information both from internal
and external sources. By internal sources, I mean the company’s record.
External sources, on the other hand, comprised of case studies, research reports by
paid consultant or external journals.

At this stage, it might be a possibility that you would be overcrowded with information
which can be overwhelming. Therefore, you should diligently screen all the information
with facts and statistic which is only relevant and applicable to your situation.

3. Identify the Alternatives

The problem is identified and you have collected the relevant information. Now, you
should come up with more than one alternative or option at least to choose from.

For instance, if you or your company wants more post engagements on social media,
then you should have options like changing social media strategy, paid social media
advertisement or both

4. Determine the Objective

The goal of an organization or decision maker is very important. In practice, there may
be many problems while setting the objectives of a firm related to profit maximization
and benefit cost analysis.

Are the future benefits worth the present capital? Should a firm make an investment
for higher profits for over 8 to 10 years? These are the questions asked before
determining the objectives of a firm

5. Discover the Alternatives

For a sound decision framework, there are many questions which are needed to be
answered such as: What are the alternatives? What factors are under the decision
maker’s control? What variables constrain the choice of options? The manager needs
to carefully formulate all such questions in order to weigh the attractive alternatives. By
going through all the stages from problem identification, information collecting, creating
an alternative to weighing the evident; now you fully aware of the situation of your
company and what decision is best under the circumstance
6. Forecast the Consequences

Forecasting or predicting the consequences of each alternative should be considered.

Conditions could change by applying each alternative action so it is crucial to decide
which alternative action to use when outcomes are uncertain.

7. Make a Choice

Once all the analysis is completed, the preferred course of action is selected. This step
of the process is said to occupy the lion’s share in analysis. In this step, the objectives
and outcomes are directly quantifiable. It all depends on how the decision maker puts
the problem, how he formalizes the objectives, considers the appropriate alternatives,
and finds out the most preferable course of action

8. Review Your Decision

After going through all the stages of the decision-making process; now you should take
a look back at your decision. Then ask yourself does it answer the problem which you
defined at the first stage? Does it help you to meet your goals?

If the answer is yes, then move forward and make a note for future references. If the
answer is no, then remember we learn from our mistakes and repeat the whole
process.

Characteristics of Effective Decisions

 Longer life span. (longer life time)

 Doesn’t create a conflict of interest.

 assists decision-makers to get and achieve what they are looking for.

 It involves both internal and external factors

Challenges to Decision Making

1. Information Overload

At first, you don’t have any information about the problem, but when you start receiving
information from different sources, and then it becomes very different to manage
information. What to choose and what to leave; drawing the right standards for the
selection of information is very important at this stage. Choosing the right information
would lead you to the right decision, vice versa. Also gathering information about the
factors and results can be difficult costly or impossible that makes your decision
process harder.

2. Uncertainty

Factors and results may be measurable but they does not certainly occur.

3. Scarce source

Implementation of a decision can be constraint by the availability of sources. if you

don't have enough sources then you can't implement the actions based on the
decisiones that you made. so you must consider the possibilities the capabilities of
your organization when you're making decision. It must be feasible

4. Misleading the Problem

Diagnosis of the exact problem is the most important part of the decision making
process; because diagnosing the precise pinpoint would provide you a strong basis to
work on

5. Psychological factors

Fear an anxiety maybe hurdle making the best decision in line with the purpose

6. Overconfidence in the Outcome

There’s another problem that decision-makers made when they know that they have
the right decision. Instead of being precautious and keep looking for the contingency
plan (emergency plan) like if that doesn’t work, then what should be the next game
plan? They become so overconfident over their result that they completely avoid the
contingent factor. Even the smallest mistake in the result would put them at the first
step again, they have to do things over and over again.

7. Number of alternatives

Nowadays new products come to the market also new services so the way handling
things are changing.Lack of creativity and vision may lead to miss the alternatives with
greater potential. If you overlook the alternative that is most beneficial for your business
and you ignore it than you cannot make the best decision because best decision will
be out of your list

8.Cost of making errors

Reversing back or aborting the actions taken by a decision maybe so difficult or costly

Consider you have a production plant with a 1000 product capacity per day . No you
decided to produce 1001 product per day. so you need another production plan which
is possible with another 1000 product capacity with that current production plan for that
additional 1 unit. but this time there would be over capacity for 2000 products for that
certain business. So that would be a bad decision. You need to make a decision
correctly be cause you won't find chance to reverse that decision back