ABM 112 – MANAGERIAL

ECONOMICS
by
BERNADETH S. MANZANO

Note:

• Students are required to answer and perform the task.

• Do not forget to indicate your name, section and date submitted.
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 No. and Title Lesson MODULE 1 Introduction to Economics and the Scope of Managerial
Economics
No. and Title LESSON 1 Introduction to Economics

1. Define key economic concepts and the feature of the

Learning Outcomes economic perspective.
2. Describe the role of economic theory in economics and business.

Time Frame The lesson will take you about an hour to complete.

Introduction
As you begin your studies, you are probably asking, why is it important to study economics?
Many consider studying economics because they need to know the language of the market.
Others hope to make money. Some simply wants to understand the laws of demand and supply.
But what really is economics?
The purpose of this lesson is to elaborate this definition and introduce the subject matter of
economics.

Activity
Pause for a moment and consider a typical day in your life, then answer the following.

1. How do you choose what to wear for the day?

2. How did you decide on the snacks to buy from your favorite store?

3. How did you go about in deciding what degree to take up in college?

Analysis
✔What do you think has influenced your choice on what to wear? What about on the snacks to
buy and eat?
✔How do your constraints impose the way you choose?
✔Based on the activity above, define economics and discuss the limits we face as we make
choices.

Abstraction
What is a manager? Manager is a person who directs resources to achieve a stated goal. He or
she is responsible for its own actions as well as for the actions of individuals, machines, and
other inputs under the manager’s control.
What is economics? Economics is the study of proper allocation of scarce resources to satisfy
unlimited human wants and needs.
Behind this definition are key economic ideas: human wants and needs are insatiable, yet
resources are limited and scarce. Thus, economics is the study of how we make choices among
the alternative uses of our resources.
The definition of economics also embodies some key concepts:
Resources. These are inputs that are either produced or natural that are necessary in the
production of goods and services that satisfy human wants and needs. These resources, often
referred as factors of production, are classified into four broad categories:
▪ Land – generally refers to as natural resources, is anything that nature offers. These gifts
of nature include land itself that is used for farming, the renewable and nonrenewable
energy resources that we use on a daily basis, and other environmental resources, such as
the water we drink and the air we breathe.
▪ Labor – refers to the time a person spends to produce goods and services. This includes
persons working in a factory, on a farm, in schools, and offices.
▪ Capital – refers to physical resources that are produced in order to produce yet other
goods and services. This includes machineries, buildings, roads, distribution facilities,
furniture, computers, and other equipment.
▪ Entrepreneurial ability – refers to a person or enterprise who brings together land, labor,
and capital to produce goods and services that satisfy human wants and needs. This is a
specialized form of labor.
Wants and needs. The two differ in terms of their impact to survival. To satisfy a need is
essential in order to survive. Primarily, these needs are your basic needs: food, shelter, and
clothing. Want, on the other, is something you desire that may not be necessary for survival.
Note, however, that these differences are general in nature. For example, you need food in order
to survive, however, you need not to eat a beef steak in order to survive. You need shelter to
survive, but you do not
need to live in a condominium to survive. You need clothing to survive, but you do not need to
wear designer clothes to live.
It is important to emphasize that the primary concern of economics is the satisfaction of human
wants and needs among the many uses of resources.
Scarcity. This is a critical quality of a resource. This simply means limited. Since everything in
the world is limited, including the clean air we breathe and the potable water we drink, this limits
our production of goods and services. Such limitations restrict our options and demand our
choices. In other words, “we can’t have the best of both worlds”. We must choose what we will
have and what we must forgo. The fact that economic resources are scarce (and thus, have
competing uses) gives rise to opportunity cost: the cost of something is what you give up in order
to get it. In other words, decisions involve trade-offs.
Simply put, economics is the study of how people make choices among the competing uses of
resources in order to satisfy their needs.

Division of Economics
You may be unaware about the breadth of what you are going to study in economics. Some think
that economics will teach them how to make money and what to do with it. Perhaps, you may be
thinking that economics will teach you about the stock market. Or perhaps, economics deals only
with demand and supply.
To understand the breadth of what you will be studying, economics is organized into two major
division:
Microeconomics. The study that examines the behavior of the basic decision making unit: the
firm and its industry, and the household. This involves examining the market through the laws of
demand and supply, the production and cost decisions of the firm, and the different industries or
market structures.
Macroeconomics. The study that examines the behavior of the national aggregates: income,
prices, output, employment, among others. This deals with understanding the problems of
inflation and unemployment, the factors that determine the national output, and the policies to
stimulate the economy.

The Method of Economics

Economics seeks to answer two kinds of questions – positive and normative.
Positive economics. It seeks to understand economic behavior by focusing on facts and cause-
effect relationship. It generally answers the question “What is?”
Positive economics is often divided into two:
 ▪ Descriptive economics. This involves gathering and compiling data that describe a
phenomenon and fact. Examples of such data are those collected by the Philippine
Statistical Authority (PSA).
▪ Economic theory. This involves generalizing about the data and interpret them. This is a
statement that describes about the relationship between two or more variables and
predicts responses to changes in one or more of the variables. A well-tested and widely-
accepted theory is called an economic principle or economic law. One example is the law
of demand postulated by Alfred Marshall in 1890: when price rises of a particular good,
quantity demanded falls, and vice versa.
Normative economics. It seeks to evaluate the result of economic behavior as good or bad. This
involves value judgments and prescriptions for courses of action. It generally answers the
question “What ought to be?”
Application
Answer the following:
1. Is money a factor of production? Why or why not?

2. On the Forbes’ List of the World’s Billionaires List of 2020, America’s Jeff Bezos ranks as
the “world’s wealthiest person for the third year in a row” with a net worth of U.S $113
billion. Does this “world’s wealthiest man” face scarcity?
Source: https://www.forbes.com/billionaires/ accessed on July 29, 2020

3. If you were the president of the country, would you be more interested in your advisers’
positive views or their normative views? Explain.

Well done! You just finished the first lesson of Module 1. If you are ready to proceed, the next
lesson will discuss the nature and scope of Managerial Economics.
 Module No. and MODULE 1 Introduction to Economics and the Scope of
Managerial Economics
Title Lesson No. and
LESSON 2 Nature and Scope of Managerial Economics
Title 1. Define managerial economics and discuss its relationship to
other fields of study
Learning Outcomes 2. Explain related concepts on the existence of the firm
The lesson will take you about an hour and a half to complete.
Time Frame

Introduction
Decision making lies at the core of most management problems. The concept of scarcity
emphasized in the previous lesson forces individuals and firms to choose among the many uses
of resources. And once a decision is made, we forgo the next best alternative because nearly all
decisions involve trade-offs.
This lesson will introduce you how economic tools and techniques are applied to managerial
decision making.

Activity
Pause for a moment and consider a day in your life when you had to make a big decision. By
way of a diagram, illustrate the decision making process you made to arrive at your best
decision.
Analysis
✔How did you evaluate your choices? Were there assumptions made?
✔How did you deal with the problem of risk and uncertainty regarding the future and the
outcomes of your decision? Were there alternative strategies involved?
✔Based on the activity above, define mangerial economics and discuss how its tools can be
useful in management decision problem.

Abstraction
What is managerial economics? Managerial economics is defined as the “application of
economic theory and the tools of analysis of decision science to examine how an organization
can achieve its aims or objectives efficiently” (Salvatore, 2004).
This definition can best be examined using the figure below:

Management decision problems

Seeks to achieve a goal subject to some limitations

Economic theory
Seeks to predict and explain economic Decision sciences
behavior Estimates models to determine optimal
behavior

Managerial economics
Application of economics theory and decision science tools
to solve managerial decision problems

Optimal solution
to managerial decision problems

FIGURE 1.1 Managerial economics as a tool to find the optimal solution to management decision problems
Management decision problems exist when an organization of any type tries to achieve some
goal subject to some limitation. For instance, a firm aims to maximize its sales subject to the
availability of important inputs and the applicable laws and regulations. A public school system
may aim at providing a quality education to as many students as possible, but subject to the
national budget allotted by the state.
The organization can understand and help solve its management problems by the application of
economic theory and the tools of decision sciences. Economic theory seeks to find explanation to
and predict economic behavior. These widely-accepted theories refer to microeconomics and
macroeconomics. Economic theories usually utilizes a model – a simplification of a complex
phenomenon. Model abstracts from reality by cutting away irrelevant details to focus more on
the most important factors of the event.
For example, the theory of the firm assumes that the firm aims to maximize profits, and so, it
predicts how much of a particular output a firm should produce under different forms of market
structure. This is an abstraction since in reality, a firm has multiple goals and objective, yet the
profit-maximizing firm model accurately predicts the firm’s behavior. Thus, we accept this.
Models are formal statements of economic theory and can be estimated and tested using the tools
of decision sciences. These utilize the tools of mathematical economics and econometrics.
Mathematical economics is used to express the models in equational form. Econometrics, on the
other, utilizes the tools of statistics, specifically regression analysis, to data and estimate the
model and make forecasts.
For instance, economic theory postulates that demand (Q) of a particular commodity (X) is a
function (or dependent on) of price of the commodity itself (PX), the price of related goods (PXY),
and income (I). Assuming other factors constant, we can now state this model mathematically:
Q = f (PX , PXY , I)

By collecting data on Q, PX , PXY , and I for a particular commodity, the firm can then estimate
the empirical (econometric) relationship. This will allow the firm the determine how much of Q
would change if PX , PXY , and I change. Such estimate can be used by the firm to forecast future
demand of the commodity.
To summarize, managerial economics uses economic theory and quantitative tools to find most
efficient (optimal) solution to a managerial problem.
Relationship to other functional areas of business. All firms are divided structurally into
different units or departments. These include accounting or finance, production and operations,
human resources, and marketing. These functional areas can apply the theories and methods
discussed earlier, in such a way applicable to a particular situation and tasks that they have to
perform (Wilkinson, 2005). Thus, managerial economics integrates economic theory, decision
sciences, and the functional areas of business as it examines how they interact with one another
as the firm attempts to achieve its goal most efficiently (Salvatore, 2004).
 Decision Making Process
Decision making lies at the core of most management problems. How much of a commodity to
produce? What is the best price to charge to maximize sales? What is the optimal level of inputs
to employ to minimize cost? How much advertisement expenditure to be made to promote the
sales? These are some of the problems that require a decision to be made by manager.
Figure 2 below illustrates the five steps involved in managerial decision making process.

Establishing Objectives

Defining the Problem

Identifying Alternative Courses of

Action

Considering Legal and Social Constraints

Considering Financial, Technological,
Evaluating Alternative Courses of
Infrastructure, and Input Constraints
Action and Selecting the Best

Implementing and Monitoring the

Decision

FIGURE 1.2 Managerial Decision Making Process

Theory of the Firm

The theory of the firm is the basic model of business. Firms are essential organizations that
combines resources that are used to produce and distribute goods and services. Owners of an
enterprise enter into contracts with workers and other owners of resources, such as land, capital
and other resources (see Figure 1.3). Firms include sole proprietorships, partnerships, and
corporations. In an article by R. Coase (1937), he postulated the reason why individuals choose
to form partnerships, companies and other business entities rather than trading separately through
contracts on a market. He viewed the firm as an institution which economizes on transaction
costs, or the costs of processing information, such as search, bargaining, and contracting costs.
By internalizing many transactions, that is, performing many functions within the firm, the firm
saves on these transactions, including “sales taxes, avoids price controls and other government
regulations that apply only to transactions among firms” (Salvatore, 2004).
 Customers

Investors FIRM

The objective and value of the firm

In its simplest version, the theory of the firm postulates that the primary objective of the firm is
to maximize its wealth or value of the firm. The value of the firm is the present value of the
firm’s expected net cash flow, that is, the value of expected future profits, discounted back to the
present an appropriate interest rate (Hirschey, 2012).
Formally state, the value of the firm is given by:
Value of the firm = Present value of expected profits

𝜋1 𝜋2 𝜋𝑛
= + +⋯+
(1+𝑖)1 (1+𝑖)2 (1+𝑖)𝑛

𝜋𝑡
𝑛
= ∑
𝑡=1 (1+𝑖)𝑡

where, π1, π2, …, πn, represent expected profits in each year (t) and i is the appropriate discount
rate; 𝑡=1 means “add together” all the 𝜋1 𝑡 resulting from substituting the values of 1 to n
(1+𝑖)
∑𝑛
for t.

Since profits are equal to total revenues (TR) minus total costs (TC), the equation above can be
rewritten (or expanded) as:

Value of the firm = 𝑇𝑅𝑡 +𝑇𝐶𝑡 (1+𝑖)

∑𝑛 𝑡=1

The expanded equation above can be used to examine how the value of the firm model relates to
a firm’s various functional units. Specifically, TR depends on sales which is the responsibility of
the marketing department. The TC, on the other hand, lies at the responsibility of the production
and human resources department. The finance department has the primary
responsibility for acquiring capital and hence, for the interest rate or discount
factor (i).

The equation also can be viewed in regard to the interaction of various

departments with each other. For instance, the marketing department can help
reduce the cost associated with a given level of output by promoting off-season
sales and influencing client order size. The production department can increase
sales by improving quality and developing new products. The finance department
can provide relevant and timely information on sales and costs. The decision on
stimulating sales and controlling costs is a vital and critical task. As such, this
should be examined in terms of their effects on the firm’s value.

Application
Answer the following:
1. Explain the importance of economic theories to managers.

2. Describe the effects of each of the following managerial decisions on the value of the
firm:
a. The firm is required to install new technology to reduce plastic pollution.

b. A new advertising campaign which increases the firm’s sales substantially.

c. The central bank takes actions that lower interest rates substantially.

d. A surge in consumer spending which resulted to increase inflation rate.

Great job! You just finished the second lesson of Module 1.