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Managerial Economics
Managerial Economics
Managerial Economics
BSA 301
The subject is much more fun when you have the passion to invest your time and effort reading the
materials given. My first review is about the speaker in the video given to us by our teacher, a
review on his video content and how he delivers each topic. Then the second would be all about the
content of the videos.
First, the speaker on the video I watched is very knowledgeable about the topic. The way he
discusses the content/topic is very comprehensive although I often encountered few lines or words
he spoken that is not clear to me but I find way for that which is I repeat and repeat the video until I
get what he wanted to deliver about the topic. The video discussion is very complete about
managerial economic.
FIRST SECTION:
INTRODUCTION TO MANAGERIAL ECONOMICS:
Managerial economics is a discipline which deals with the application of economic theory to
business management. It deals with the use of economic concepts and principles of business decision
making. Formerly it was known as “Business Economics” but the term has now been discarded in
favor of Managerial Economics.
Managerial Economics may be defined as the study of economic theories, logic and methodology
which are generally applied to seek solution to the practical problems of business. Managerial
Economics is thus constituted of that part of economic knowledge or economic theories which is
used as a tool of analyzing business problems for rational business decisions. Managerial Economics
is often called as Business Economics or Economic for Firms.
The primary function of management executive in a business organization is decision making and
forward planning.
Decision making and forward planning go hand in hand with each other. Decision making
means the process of selecting one action from two or more alternative courses of action.
Forward planning means establishing plans for the future to carry out the decision so taken.
The problem of choice arises because resources at the disposal of a business unit (land, labor,
capital, and managerial capacity) are limited and the firm has to make the most profitable use
of these resources.
The decision making function is that of the business executive, he takes the decision which
will ensure the most efficient means of attaining a desired objective, say profit maximization.
After taking the decision about the particular output, pricing, capital, raw-materials and
power etc., are prepared. Forward planning and decision-making thus go on at the same time.
A business manager’s task is made difficult by the uncertainty which surrounds business
decision-making. Nobody can predict the future course of business conditions. He prepares
the best possible plans for the future depending on past experience and future outlook and yet
he has to go on revising his plans in the light of new experience to minimize the failure.
Managers are thus engaged in a continuous process of decision-making through an uncertain
future and the overall problem confronting them is one of adjusting to uncertainty.
In fulfilling the function of decision-making in an uncertainty framework, economic theory
can be, pressed into service with considerable advantage as it deals with a number of
concepts and principles which can be used to solve or at least throw some light upon the
problems of business management. E.g. are profit, demand, cost, pricing, production,
competition, business cycles, national income etc. The way economic analysis can be used
towards solving business problems, constitutes the subject-matter of Managerial Economics.
Thus, in brief we can say that Managerial Economics is both a science and an art.
The scope of managerial economics is not yet clearly laid out because it is a developing science.
Even then the following fields may be said to generally fall under Managerial Economics:
Recently, managerial economists have started making increased use of Operation Research
methods like Linear programming, inventory models, Games theory, queuing up theory etc.,
have also come to be regarded as part of Managerial Economics.
Conclusion: The various aspects outlined above represent the major uncertainties which a
business firm has to reckon with, viz., demand uncertainty, cost uncertainty, price uncertainty,
profit uncertainty, and capital uncertainty. We can, therefore, conclude that the subject-matter of
Managerial Economics consists of applying economic principles and concepts towards adjusting
with various uncertainties faced by a business firm.
What is Supply
Supply is a fundamental economic concept that describes the total amount of a specific good or
service that is available to consumers. Supply can relate to the amount available at a specific price
or the amount available across a range of prices if displayed on a graph. This relates closely to
the demand for a good or service at a specific price; all else being equal, the supply provided by
producers will rise if the price rises because all firms look to maximize profits.
Demand
is the quantity of good and services that customers are willing and able to purchase during a
specified period under a given set of economic conditions. The period here could be an hour, a
day, a month, or a year. The conditions to be considered include the price of good, consumer’s
income, the price of the related goods, consumer’s preferences, advertising expenditures and so
on. The amount of the product that the customers are willing to buy, or the demand, depends on
these factors. There are two types of demand. The first of these is called direct demand. This
model of demand analysis individual demand for goods and services that directly satisfy
consumers desires. The prime determinant of direct demand is the utility gained by consumption
of goods and services. Consumers budget, product characteristics, individuals preferences are all
important determinants of direct demand. The other type of demand is called derived demand.
Derived demand is the demand resulting from the need to provide the final goods and services to
the consumers. Intermediate goods, office machines are examples of derived demand. An other
good example is mortgage credit. Mortgage credit demand is not demanded directly, but derived
from the demand for housing.
Market demand function The market demand function for a product is a function showing the
relation between the quantity demanded and the factors affecting the quantity of demand. A
demand function for the good X can be expressed as follows: Quantity of product X demanded =
Qx = f (the price of X, prices of related goods, expectations of price changes, income,
preferences, advertising expenditures and so on. ) For use in managerial decision making, the
relation between quantity of demand and each demand determining variable must be specified.
Demand Curve The demand function specifies the relation between the quantity demanded and
all factors that determine demand. But the demand curve expresses the relation between the price
of a product and the quantity demanded, holding constant all the other factors affecting demand.
The law of supply and demand, one of the most basic economic laws, ties into almost all
economic principles in some way. In practice, supply and demand pull against each other until
the market finds an equilibrium price. However, multiple factors can affect both supply and
demand, causing them to increase or decrease in various ways. It was extensively studied
by Murray N. Rothbard.
The law of demand states that, if all other factors remain equal, the higher the price of a good,
the less people will demand that good. In other words, the higher the price, the lower the quantity
demanded. The amount of a good that buyers purchase at a higher price is less because as the
price of a good goes up, so does the opportunity cost of buying that good. As a result, people will
naturally avoid buying a product that will force them to forgo the consumption of something else
they value more. The chart below shows that the curve is a downward slope.
Like the law of demand, the law of supply demonstrates the quantities that will be sold at a
certain price. But unlike the law of demand, the supply relationship shows an upward slope. This
means that the higher the price, the higher the quantity supplied. Producers supply more at a
higher price because selling a higher quantity at a higher price increases revenue.
Unlike the demand relationship, however, the supply relationship is a factor of time. Time is
important to supply because suppliers must, but cannot always, react quickly to a change in
demand or price. So it is important to try and determine whether a price change that is caused by
demand will be temporary or permanent.
Let's say there's a sudden increase in the demand and price for umbrellas in an unexpected rainy
season; suppliers may simply accommodate demand by using their production equipment more
intensively. If, however, there is a climate change, and the population will need umbrellas year-
round, the change in demand and price will be expected to be long term; suppliers will have to
change their equipment and production facilities in order to meet the long-term levels of demand.
Regression analysis is the oldest, and probably, most widely used multivariate technique in the
social sciences. Unlike the preceding methods, regression is an example of dependence analysis
in which the variables are not treated symmetrically. In regression analysis, the object is to
obtain a prediction of one variable, given the values of the others. To accommodate this change
of viewpoint, a different terminology and notation are used. The variable being predicted is
usually denoted by y and the predictor variables by x with subscripts added to distinguish one
from another. In linear multiple regression, we look for a linear combination of the predictors
(often called regressor variables). For example, in educational research, we might be interested in
the extent to which school performance could be predicted by home circumstances, age, or
performance on a previous occasion. In practice, regression models are estimated by least
squares using appropriate software. Important practical matters concern the best selection of the
best regressor variables, testing the significance of their coefficients, and setting confidence
limits to the predictions.
CONCLUSION: It is worth pointing out that regression analysis always involves the use of
historical data in order to understand the relationship between two or more variables. Those who
use regression analysis assume that whatever relationship existed in the past will continue to
exist in the present or the future. Some observers refer to this as the issue of the lag between the
past and the present and the future. Nonetheless, regression analysis is a popular forecasting and
estimating technique. Although many users might find the mathematics involved quite difficult,
the technique itself is relatively easy to use, especially when a model or template has previously
been developed.
However, users who do not understand the underlying mathematics should obtain some
assistance in the interpretation of the results.
A market is the area where buyers and sellers contact each other and exchange goods and services.
Market structure is said to be the characteristics of the market. Market structures are basically the
number of firms in the market that produce identical goods and services. Market structure influences
the behavior of firms to a great extent. The market structure affects the supply of different
commodities in the market.
When the competition is high there is a high supply of commodity as different companies try to
dominate the markets and it also creates barriers to entry for the companies that intend to join that
market. A monopoly market has the biggest level of barriers to entry while the perfectly competitive
market has zero percent level of barriers to entry. Firms are more efficient in a competitive market
than in a monopoly structure.
Perfect Competition
Perfect competition is a situation prevailing in a market in which buyers and sellers are so numerous
and well informed that all elements of monopoly are absent and the market price of a commodity is
beyond the control of individual buyers and sellers
With many firms and a homogeneous product under perfect competition no individual firm is in a
position to influence the price of the product that means price elasticity of demand for a single firm
will be infinite.
Pricing Decisions
Market price is determined by the equilibrium between demand and supply in a market period or
very short run. The market period is a period in which the maximum that can be supplied is limited
by the existing stock. The market period is so short that more cannot be produced in response to
increased demand. The firms can sell only what they have already produced. This market period
may be an hour, a day or a few days or even a few weeks depending upon the nature of the product.
In the case of perishable commodity like fish, the supply is limited by the available quantity on that
day. It cannot be stored for the next market period and therefore the whole of it must be sold away
on the same day whatever the price may be.
In case of non-perishable but reproducible goods, some of the goods can be preserved or kept back
from the market and carried over to the next market period. There will then be two critical price
levels.
The first, if price is very high the seller will be prepared to sell the whole stock. The second level is
set by a low price at which the seller would not sell any amount in the present market period, but
will hold back the whole stock for some better time. The price below which the seller will refuse to
sell is called the Reserve Price.
SECTION V: THE PRODUCTION PROCESS AND COST
Technology summarizes the feasible means of converting raw inputs into an output. Most production
processes involve capital (machinery) and labor (people).
Increasing marginal returns – Range of input usage over which marginal product increases. E.g. in
the first hours you study for an exam you can concentrate very well and you increase your
knowledge rapidly.
Decreasing (diminishing) marginal returns – Range of input usage over which marginal product
declines. E.g. the longer you study the less you remember but still you gain more knowledge. You
increase total knowledge, but at a decreasing rate. Marginal product declines but it is still positive.
Negative marginal returns – Range of input usage over which marginal product is negative. E.g. if
you study too long you get tired and too much information is in your head in too little time. You get
confused and reduce the total knowledge.
Phases of Marginal Returns – When there is an increase in the use of input, Marginal product
changes from increasing to decreasing and further to negative.
It describes the maximum possible output that can be produced with given inputs. In case of labor,
the manager has to think of an incentive system to ensure that employees are working at full
potential.
The manager has to determine how many units of input are needed to maximize total output. When a
manager decides on how many employees that his/her firm needs to employ, he/she has to consider
marginal returns. The value marginal product describes the value of the output produced by the last
unit of an input.
Profit-Maximizing Input Usage – To maximize profits, a manager should use inputs at levels at
which the marginal benefit equals the marginal cost. More specifically, when the cost of each
additional unit of labor is w, the manager should continue to employ labor up to the point where in
the range of the diminishing marginal product. E.g. it is profitable to hire additional units of labor as
long as his/her contribution (value marginal product) is greater than his/her hiring costs.
Algebraic Forms of Production Functions
Optimal Input Substitution – To minimize the cost of producing a given level of output, the firm
should use less of an input and more of other inputs when that input’s price rises.
For given input prices, different isoquants will entail different production costs, even allowing for
optimal substitution between capital and labor. The higher isoquants will imply higher costs of
production, even assuming the firm uses the cost-minimizing input mix.
Fixed costs (FC) – Costs that do not change with changes in output; include the costs of fixed inputs
used in production.
Variable costs (VC) – Costs that change with changes in output; include the costs of inputs that vary
with output.
Short-run cost function – A function that defines the minimum possible cost of producing each
level of output when variable factors are employed in the cost-minimizing fashion. Mathematically it
is the sum of fixed and variable costs. TC = FC+VC
Average fixed cost (AFC) – Fixed costs divided by the number of units of output. Average fixed
cost decrease as output increases.
Long-run average cost curve (LRAC) – A curve that defines the minimum average cost of
producing alternative levels of output, allowing for optimal selection of both fixed and variable
factors of production. The long-run average cost curve lies below every point on the short-run
average cost curves.
Economies of scale – Exist whenever long-run average costs decline as output is increased.
Diagrammatically, it is in the section of LRAC with negative slope.
Diseconomies of scale – After a certain point, the optimal production quantity Q*, further increases
in output lead to an increase in average costs. Long run average costs rise as output is increased.
Diagrammatically, it is in the section of LRAC with positive slope
Constant returns to scale – Exist when long-run average costs remain constant as output is
increased. A firm produces at different levels of output at the same minimum average cost.
Economic costs – The costs perceived of producing a certain product, while the opportunity to
produce another product is forgone.
Multi-product cost function – A function that defines the cost of producing given levels of two or
more types of outputs assuming all inputs are used efficiently.
Dynamic consideration
If the firm manage to maintain its monopoly, then the profit will be π = [(1+i)/i] π m
If entry occurs, then the profit will be π = πm + πd/i
If the incumbent uses limit pricing, the profit will be π = [(1+i)/i] π l
Limit pricing is profitable if
Network externalities
Direct - The direct value enjoyed by the user of a network because others also use the network. A
two-way network linking n user provides n (n - 1) potential connection services. If one new user
joins the network, all existing users benefit by 2n
Indirect - The indirect value enjoyed by the user of a network because of complementarities
between size of a network and the availability of complementary products or services
Note, however, negative externalities such as bottleneck can occur if the network grows up to the
point where the infrastructure cannot handle anymore.
SUMMARY:
Let’s Have A Look At The Importance Of Managerial Economics:
Helps in evaluating managerial policies – There are certain operational policies of company
which yield no return or are not at all important in altering certain market conditions. It calls for
timely evaluation of these policies so that there can be solutions for budding obstacles in the way
of business decision-making. Managerial economics plays an active role in the evaluation and
assessment of certain managerial policies.
Computing the economic relationship – There are certain business aspects like income, profit,
acquisitions, loss, demand elasticity etc. The relationship and accord among these factors are
estimated with the help of managerial economics.
Makes business planning much easier – The managerial economics is immense significant and
essential in planning an appropriate prospect in order to achieve rewarding results and
operations. This business planning plays an important role in connecting the tools of production
and systems of operation. Through these benefits we can easily apprehend the importance of
managerial economics.
Helps in managing the cost – Managerial economics offer a helping hand when it comes to
deciding the correct and appropriate way for operating a business. All these decisions and
arbitrations are possible when there is an active role and exercise of managerial economics which
automatically affects the decisions related to cost control.
Systemization of business activities – There are several business activities that needs to be
coordinated and managed in a systematic manner. Managerial economics helps in coordination
of activities related to business.
Resolves problem related to business taxation – Managerial economics proves to be the giant
problem solving tool in various types of issues related to taxation in the business.
Helps in computing firm’s efficiency – Managerial economics helps the business managers to
measure the ability and efficiency of the firm.
We all must agree to the fact that decision making is a crucial aspect of management. The
management and decision-making are indivisible part of any firm. Managerial economics is quite
proficient in serving different and dynamic objectives to the managers. The prime objective of
managerial economics is to enhance the decision making process. Managerial economics
supports in analyzing all the decisions and forecasts related to business.