managerial economics

SUB-DISCIPLINES WITHIN ECONOMICS

Managerial economics • the application of economic theory and methods

to business decision-making

Relationship with economic theory1 theory of the firm2 theory of consumer behaviour (demand)3 production and cost theory (supply)4 price theory5 market structure and competition theory

Relationship with business functions

• 1 production and operations• 2 marketing• 3 finance and accounting• 4 human resources

Relationship with decision sciences* numerical and algebraic analysis* optimization* statistical estimation and forecasting* analysis of risk and uncertainty* discounting and time-value-of-money techniques

PROFIT

Business profit

• Residual of sales revenue minus the explicit accounting costs of doing business

Economic profit Business profit minus the implicit costs of capital

and any other owner-provided inputs

Variability of Business Profits

Profit margin• Accounting net income divided by sales

Return on stockholders’ equity (ROE)Accounting net income divided by the book value

of total assets minus total liabilities

WHY DO PROFITS VARY AMONG FIRMS?

Frictional profit theoryAbnormal profits observed following unanticipated changes in demand or cost conditions

Monopoly profit theoryAbove-normal profits caused by barriers to entry that limit competition

WHY DO PROFITS VARY AMONG FIRMS?

Compensatory profit theory

Above-normal rates of return that reward efficiency

Innovation profit theoryAbove-normal profits that follow successful invention or modernization