Managerial Economics

Dr. Kishor Bhanushali

Faculty Member – Economics & Quantitative Methods
IBS - Ahmedabad
 Introduction: Fundamental
Problems of An Economic System:
Scarcity and Efficiency

The Three Problems of Economic Organization

Market command and mixed economies
The market mechanism
How markets solve three economic problems?
The invisible hands and perfect competition
The economic role of government
General and partial equilibrium
Nature and scope of managerial economics
 Economics
Economics is the study of how economic agents
or society choose to use scarce resources that
have alternative uses to satisfy wants which are
unlimited and of varying degrees of importance
Scarcity: the root of all economic problems
Problem of choice
Social Science
Decision making by the manager
Economics is Positive Sciences (what is ?)
Rational behavior
Economic activity (consumption, productions
and exchange)
 The central themes of
managerial economics
1. Identifying problems and
opportunities
2. Analyzing alternatives from which
choices can be made
3. Making choices that are best from
the standpoint of the firm or
organization
 It is certainly not true that all
managers must be managerial
economists, any more than it is true
that all managers should have
degree in management. However,
managers who understand the
economic dimensions of business
problems and apply economic
analysis to the specific problem they
encounter often choose more wisely
than those who do not
 Rationality?
Firm: maximize profit or sales
revenue (Productive capacity and
size of the market)
Consumer: Maximize profit (Size of
his budget)
Investor: maximize returns over
investment (level of acceptable risk)
Rational decision making process
1. Knowledge of all possible course of
action
2. Separate the course of action into
feasible and infeasible
3. Consequences of alternative feasible
courses of action
4. Rank alternatives in terms of priorities
5. Choose the course of action that
occupies the highest position in the order
of priority
Three fundamental questions
What goods and services to be
produced in what quantity?
How to produce those goods and
services? How the scarce resources
and optimally allocated?
How the goods and services so
produced are distributed among the
households?
Alternative economic systems
Market economy
Command economy
Mixed economy
 Market Economy
Demand decides the nature and quantity
of goods and services to be produced
Consumers are assumed to act in a
rational manner
Given the demand, firms decide the
production methods to maximize their
profits
Optimum allocation of scarce resources
Factor prices are determined by the
market
Invisible hands – Adam Smith
 Command Economy
Hierarchical organizational structure
Command decision making process
People carry out instruction given to them
Central planning authority to determine
resource allocation, production goal and
prices
State ownership of factors of production
Authoritarian methods to determine
resource use and prices
 Mixed Economy
Use of both market and command to co-
ordinate economic activities
Government control many resources and
criteria other than personal gains and business
profit are used to decide how resources will be
employed
Government as well as private business provide
goods and services
Government intervene in the market to control
prices and correct the shortcomings of a
system in which prices and the pursuit of
personal gains influence resource use and
income
 Role of Government
 Purchasing of labor services and other
productive resources
 Borrow funds from credit market
 Purchase output of business firms
 Contracts with business firms
 Tax on households and firms
 Provides national and social services
 Free public goods
 Social security measures
 Influence the market demand and prices
 Supply of goods and services
 MARGINALISM
Marginal output of labor
Marginal revenue
Marginal cost
Change in independent variable by single
unit
Chunk changes rather than unit changes –
Concept of instrumentalism (incremental
output, cost, benefits)
All marginal concepts are incremental but
all incremental concepts may not be
confined to marginal concepts alone.
 Opportunity Cost
The cost of particular alternative
chose is the cost of next best
alternative forgone
Opportunity cost is the highest
valued benefit that must be
sacrificed as a result of choosing
alternative
 Partial Equilibrium Analysis
 Determination of prices and quantity of a
commodity or a factor and working of its market
viewed in isolation of what happens to other
commodities and factors is called partial
equilibrium analysis
 Partial equilibrium analysis do not take in to
consideration the interrelationships or
interdependence between the prices of goods and
factors of production
 Each product and factor market is considered as
independent and self-contained for proper
explanation of the determination of price and
quantity of a commodity or factor
 Not useful when commodities and factor markets
are interrelated and interdependent
General Equilibrium Analysis
Used when markets for various
commodities and factors are
interrelated and interdependent
General equilibrium analysis
considers simultaneous equilibrium
of all the markets taking into account
all effects of changes in the price of
one market over the others
 Managerial Economics
 Managerial economics is an
application of the principles of
economic for the solution of business
problems
 Bridge between economics and
business practice
What is Managerial Economics?
Douglas - “Managerial economics is .. the
application of economic principles and
methodologies to the decision-making
process within the firm or organization.”
Pappas & Hirschey - “Managerial economics
applies economic theory and methods to
business and administrative decision-
making.”
Salvatore - “Managerial economics refers to
the application of economic theory and the
tools of analysis of decision science to
examine how an organisation can achieve
its objectives most effectively.”
 Managerial Economics
Managerial economics is the
science of directing scarce resources
to manage cost effectively. Wherever
resources are scarce, a manager can
make more effective decisions by
applying the discipline of managerial
economics. These may be decisions
with regard to customers, suppliers,
competitors, or the internal workings
of the organization.
 How it differ from…..
Microeconomics is the study of individual economic
behavior where resources are costly. It addresses
issues such as how consumers respond to changes in
prices and income and how businesses decide on
employment and sales. Microeconomics also extends
to such issues as how voters choose between political
parties and how governments should set taxes.
Managerial economics has a more limited scope – it is
the application of microeconomics to managerial
issues.
By contrast with microeconomics, the field of
macroeconomics focuses on aggregate economic
variables. Macroeconomics addresses such issues as
how a cut in interest rates will affect the inflation rate
and how a depreciation of the U.S. dollar will affect
unemployment, exports, and imports. While it is
certainly true that the whole economy is made up of
individual consumers and businesses, the study of
macroeconomics often considers economic aggregates
directly rather than as the aggregation of individual
consumers and businesses. This is the key distinction
between the fields of macroeconomics and
microeconomics.
Nature of Managerial Economics
Is essentially microeconomic in
nature
Is pragmatic (practical)
Belong to normative economics
(what ought to be)
Is conceptual in nature
Utilize some theories of
macroeconomics
Is problem solving in nature
Scope of Managerial Economics
Estimation of product demand
Analysis of product demand
Planning of production schedule
Deciding input combinations
Estimation of cost of production
Analysis of cost of product
Achieving economies of scale
Determination of price of product
Analysis of price of product
Analysis of market structure
Profit estimation and planning
Planning and control of capital structure
Managerial economics is applied
economics; it is the use of economics
theory and methodology to solve practical
decision problems.
A primary emphasis of managerial
economics is the application of economic
theory and methodology to the practice of
business decision making.
Secondary emphasis in managerial
economics is the study of how managerial
decisions are affected by the economic
environment.