Economics

 Two major divisions

o Macroeconomics o Microeconomics

Managerial Economics
 Economics
 The science of making decisions in the
presence of scarce resources (Baye,2010)

o Resources – anything used to produce a good or service

o Scarcity – Implies the need for choice . If you decide to use
one, you have to give up another
 Microeconomics
Branch of economics that studies how
individuals and firms make decisions to allocate
limited resources………..in markets where goods
or services are being bought and sold (Chen, 2007).
o Markets – Defined by arrangement NOT “Place”
- Product (Buyers – individuals; Sellers – firms)
- Factor ( Buyers – firms; Sellers – individuals)
 Managers, Profits, and Markets
 Manager - A person who directs resources to
achieve a specific goal
o Direct/delegate tasks to people within an
organization
o Purchase inputs transformed into outputs
(including services)
o In charge of other decisions (such as, pricing and
quality)
 Managerial Economics
 study of how to direct scarce resources in the way
that most efficiently achieves a managerial goal
o Key to making sound decision is to understand what
information is needed (quality data is important)
 An effective manager must

 Identify goals and constraints

 Recognize the nature and importance of profits

 Understand incentives

 Understand markets

 Recognize the time value of money; and

 Use marginal analysis

 Identify goals and constraints
 The basic step in making sound decisions is have well-
defined goals. This is important because different goals
entails making different decisions.
 For illustration, if your goal is to maximize your grade in
managerial economics rather maximize your grade point
average (gpa), study habits will differ accordingly.
 In the above case, the decision maker faces a constraint –
time (limited to 24 hours)
 Recognize the nature and importance of profits

Economic versus Accounting profits

Explicit Costs i.e., Market supplied e.g Labor services, materials,
resources capital equipment
(monetary payments to resource owners)

+
e.g money provided to the
Implicit Costs i.e., Owner-supplied business by its owners, time,
resources (returns forgone by not labor services, land, building
taking the owners’ resources to market
=
Total Economic Costs i.e., Total opportunity
costs of types of resources

Economic profit = Total Revenue – Total economic costs

Total Revenue – Explicit costs – Implicit costs
Accounting profit = Total Revenue – Explicit costs
 Understand Incentives

 The ability to structure appropriate incentives within an organization

can make the difference between survival or failure in competition.
 Effective managers must have a grasp of incentive system capable of
inducing maximal effort from employees.
 Understand markets

 Ability of a manager to meet performance objective depend on

how product is affected by rivalry in the market.
 Consumer – producer rivalry ….. Both parties are trying to “rip
off” each other. Consumers will buy more if prices are low, while
producers tend to sell more when prices are high
 Consumer – consumer rivalry ….. When consumers try to
“outbid” each other due to scarcity of goods.
 Producer – Producer Rivalry ….. When producers compete to for
the right to provide service when customers are scarce. The firm
with the best quality at a lower price will get to provide the good
or service.
 Recognize the time value of money

 Decisions involving gap between the time when the costs of a

project are borne and the time benefits are received.
 In maximizing the value of the firm, use net present value
analysis
 Value of the firm (maximizing profit)= the present value of the
future of economic profits expected to be generated by the
firm
1 1 T T
t
(1  r )T 
t    .....  
(1  r ) (1  r ) 2 t 1 (1  r )
t

 t  economic profit
r  discount rate
T  no. of years in the life of a firm
 Value of the firm

What are these factors?

External Factors (outside manager’s control)

n
TR t  TCt Value
t1 (1  i)t Management Process of the
firm
Internal Factors (within manager’s control)
 Use marginal analysis

 Marginal Benefit
Additional satisfaction “utility” or value one derives from
an activity or product.

 Marginal Cost
Additional cost “expense” or sacrifice one incurred from
participating in an activity or purchasing a product.

Optimal decision involves comparing marginal (incremental)

benefits of a decision with marginal (incremental) costs.
 Marginal Benefit (MB)
• Change in total benefits arising from a
change in the control variable, Q:
MB = DB / DQ
• Marginal Benefit is the slope (calculus
derivative) of the total benefit curve
 Marginal Cost (MC)
• Change in total costs arising from a
change in the control variable, Q:
MC = DTC / DQ
• Marginal Cost is the slope (calculus
derivative) of the total cost curve
 Marginal Principle
To maximize net benefits MB = MC.
• MB > MC means the last unit of the control
variable increased benefits more than it
increased costs.
• MB < MC means the last unit of the control
variable increased costs more than it
increased benefits.
 Profit Maximization
• Using total curves
– maximising the difference between TR and TC
– the total profit curve

• Using marginal and average curves

– profit maximised where MR = MC
 Finding maximum profit using total curves
24 TC

20

16
TR, TC, TP (£)

12
TR

0
1 2 3 4 5 6 7 Quantity
-4

-8 TP
 Market Structures and Managerial Decision making
 Managers need a good grasp of how market forces shape the firm’s
ability to earn profit. Profit is the difference between Total Revenue
and Total Cost.
o Pricing is an aspect of managerial decision making [TR=P x Q]
o Structure of the market can help a manager to increase price
without losing quantity demanded [Any example?]

 Managers operating in competitive industries have no power to set

the price of the firm’s product.
o price is determined by demand and supply.
o firms are small and of equal size each firm in the industry makes up
a relatively small portion of total sales.
o produces a product that is identical to the output produced by
other firms in the industry.
 Price-Takers vs. Price-Setters
• Price-taking firm
– Cannot set price of its product
– Price is determined strictly by market forces of demand
& supply
• Price-setting firm
– Can set price of its product
– Has a degree of market power, which is ability to raise
price without losing all sales
 What is a Market?
• A market is any arrangement through which
buyers and sellers exchange goods and
services
• Markets reduce transaction costs
– Costs of making a transaction other than the price
of the good or service
– Transaction cost – ex. Think of ways to find a buyer
for your used car – knocking on doors until you
find a willing buyer.
 Market Structures and Managerial Decision making
 Market structure is a set of market characteristics that
determines the economic environment in which a firm
operates.
 Market characteristics that determine the economic
environment in which a firm operates
– Number & size of firms in market
– Degree of product differentiation
– Potential entrants - likelihood of new firms entering
market especially if existing firms are earning economic
profit
 Market structure (perfect competition, monopoly,
monopolistic competition & oligopoly).
 Recap, Competition in Markets

 In imperfectly competitive markets, individual buyers or sellers can

influence the price of the product
 In competitive markets, each buyer and seller takes the market price
as a given

How do they differ?

– Perfectly competitive markets have many small buyers and sellers
• Each is a small part of the market, and the product is
standardized

– Imperfectly competitive markets have just a few large buyers and

sellers
• the product of each seller is unique in some way
 Basic Economic Problems
• 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?
 The Three Basic Questions

Every society has some system or process that transforms its

scarce resources into useful goods and services. In doing so, it must
decide what gets produced, how it is produced, and to whom it is
distributed.

The primary resources that must be allocated are

land, labor, and capital.

Source: Case, Fair & Oster (2016, figure 2.1)

 Recap
See diagram on why economic problem exist
What ought to happen

What does happens

 Review of Mathematical Concepts Used in Managerial
Economics

 Rules for differentiating a function

 Constants – the derivative of a constant is always zero; e.g. if Y
is a constant:
dY
0
dX
Y = 3, Y does not vary as X changes.
The derivative or slope of any constant function is equal to zero.
Y Regardless of the value of x, the value of y will be constant.

X
0
 Examples:
1. If y = 10 , dy/dx = 0
2. If y = 1000, dy/dx = 0
3. If y = -10, dy/dx = 0
4. If Fixed cost = Php130,
d(FC)/dq = 0.
Fixed costs (e.g.,rent) do not change when your output (q)
changes.
 Power function
 The derivative of a power function such as
Y  aX n
Where a and n are constants, is equal to the exponent n
multiplied by a times the variable X raised to power n-1 power
= dY n 1
 na  X
dX

If y = 2x2 , dy/dx = 2 x 2 (x2-1) = 4x1 = 4x.

If y = x, dy/dx = 1 (since 1X1-1 = X0 , X0 = 1)
If y = X2 , dy/dx = 2x
If y = X3 , dy/dx = 3x2
If y = x-2 , dy/dx = -2x-3