BEC 30325: MANAGERIAL ECONOMICS

INTRODUCTION TO MANAGERIAL ECONOMICS

Session 01

Dr. Sumudu Perera

• Nature and scope of Managerial Economics

• Goals and Constraints of business organizations

• The Theory of the firm

• The nature and importance of profit

• Economic Profit and Accounting Profit

• Quantitative techniques in Managerial Economics

Session Outline

Managerial Economics• Managerial Economics is the integration of

economic theory with decision science tools, so as to make decision making effective and

efficient.

• The application of economic theory and the tools of decision science to examine how an

organization can achieve its aims or objectives most efficiently.

Managerial Economics deals with:

“How decisions should be made by managers to achieve the firm’s goals-in particular, how to maximize profit”

Managerial Decision Problems

Economic theoryMicroeconomicsMacroeconomics

Decision SciencesMathematical Economics

Econometrics

MANAGERIAL ECONOMICSApplication of economic theory

and decision science tools to solvemanagerial decision problems

OPTIMAL SOLUTIONS TOMANAGERIAL DECISION PROBLEMS

ECONOMICS VS. MANAGERIAL ECONOMICS

ECONOMICS

• Study of economic theory

• Belongs to positive economics

• Examine the human behavior on using scarce resources on unlimited needs and wants

• Limited Scope

MANAGERIAL ECONOMICS

• Application of economic theory

• Belongs to normative economics

• Study the way of applying economic theory for

decision making in firms

• Wide scope

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Why is Managerial Economics Important?• To estimate economic relationships

• To make decisions related to internal issues• Effectively utilize resources (What/how much/how/to whom, to

produce)• Pricing• Face price and non-price competitions • Maximizing sales, revenues, profits

• To identify the impact of external factors on the firm• To use theoretical concepts in economics to actual behavior of firms• A powerful “analytical engine”.

THEORY OF THE FIRM

Combines and organizes resources for the purpose of producing goods

and/or services for sale.

Internalizes transactions, reducing transactions costs.

Primary goal is to maximize the wealth or value of the firm.

EXAMPLE -THEORY OF THE FIRM

• Mr. Smith, an entrepreneur decides to set up a company by recruiting people to work for wages, by purchasing a property for the workplace machinery for the factory. He believes that it is very much efficient and less costly to run a business through a firm, rather than him doing everything alone.

• He believes that a general contract agreed with laborers to perform a number of tasks for specific wages and benefits is less costly than specific contacts for each task undertaken.

• He can also internalize many functions such as Finance, Marketing, IT, Research and Development etc without giving those tasks to external parties.

VALUE OF THE FIRM

The present value of all expected future profits

1 21 2

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ALTERNATIVE THEORIES

Sales maximization

Adequate rate of profit

Management utility maximization

Principle-agent problem

Satisficing behavior

DEFINITIONS OF PROFIT

Business / Accounting Profit: Total revenue minus the explicit or accounting costs

of production.

Economic Profit: Total revenue minus the explicit and implicit costs of production.

Opportunity Cost: Implicit value of a resource in its best alternative use.

EXAMPLE –ACCOUNTING VS ECONOMIC PROFIT

• Maya is in the final year of the University and she has lectures only during the evening. Therefore she has free time to engage in an internship programme. She got the opportunity to work at a bank which pays Rs. 12000 per month. If she is to undertake the internship she has to incur extra travelling and food cost of Rs. 3000 per month. However Maya decides to bake cakes at home and sell for private parties. She earns Rs. 25000 per month by making cakes. The costs that she has to incur are given below;

• Ingredients Rs.4000• Packaging Rs.500• Electricity Rs.250

• Find out the accounting profit and economic profit of carrying out the cake business.

FUNCTION OF PROFIT

Profit is a signal that guides the allocation of society’s resources.

High profits in an industry are a signal that buyers want more of

what the industry produces.

Low (or negative) profits in an industry are a signal that buyers

want less of what the industry produces.

THE CHANGING ENVIRONMENT OF MANAGERIAL ECONOMICS

Globalization of Economic Activity• Goods and Services

• Capital

• Technology

• Skilled Labor

Technological Change• Telecommunications Advances

• The Internet and the World Wide Web

• Numerical analysis• Statistical estimation• Forecasting• Game theory• Optimization• Simulation

Decision Science Tools

Department of Business Economics, FMSC, USJP

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BASIC TRAINING: RULES OF DIFFERENTIATION

• Constant Function Rule: Y = f(X) =0

• Power Function Rule:

• Sum-and-Differences Rule

• Product Rule

1bdYb aX

dX

dY dU dV

dX dX dX

dY dV dUU V

dX dX dX

• Quotient Rule

• Chain Rule

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dY dY dU

dX dU dX

2

dU dVV UdY dX dXdX V