INTRODUCTION TO MANAGERIAL
ECONOMICS
DEFINITION OF MANAGERIAL
ECONOMICS
- Managerial economics is economics
applied in decision making. It is that
branch of economics which links
abstract theory with managerial
practice.
● Economics is a science concerned
with the problem of allocating scarce
resources with competing ends.
● Managerial economics may also be
taken as economics applied to
problems of choice of alternatives
and allocation of scarce resources
by the firms; is goal oriented and
aims at maximum achievement of
objectives.
Mcnair and Meriam - “Managerial
economics is the use of economic modes of
thoughts to analyze business situations.”
Spencer - Managerial economics is the
integration of economic theory with
business practice for the purpose of
facilitating decision-making and
forward-planning by the management.”
Bringham and Pappas - “Managerial
economics is the application of economic
theory and the methodology to business
administration and practice.”
SIX STEPS IN DECISION MAKING
1. Define the problem
2. Determine the objective - In most
private-sector decisions, profit is the
principal objective of the firm and the
usual barometer of its performance.
Thus, among alternative courses of
action, the manager will select the
one that will maximize the profit of
the firm.
3. Explore the alternatives - Decision
makers cannot hope to identify and
evaluate all possible options. Still,
one would hope that attractive
options would not be overlooked for,
and not mistakenly dismissed.
4. Predict the consequences
5. Make a choice
6. Perform sensitivity analysis - It is
important to understand and be able
to explain to others the “why” of your
decision. Sensitivity analysis
considers how an optimal decision is
affected if key economic factors or
conditions vary.
SCOPE OF MANAGERIAL ECONOMICS
POSITIVE OR NORMATIVE
Positive Economics
- Descriptive in character; describes
economic activities as they are.
- According to Prof. Lionel Robbins,
economics is a positive science and
believed that economists should be
‘neutral’ between ‘ends’ and he
cannot pronounce on the validity or
ultimate judgments of value.
Normative Economics
- Passes judgments of value in the
context of the firm. Managerial
economics is mainly normative in
nature.
Area of Study
Demand analysis and forecasting
- Accurate estimation of demand by
analyzing the forces acting on
demand of the product; attempts at
 finding out the forces of determining
sales.
- Forecasting sales and manipulating
demand
Cost and production analysis
- Production analysis deals with the
physical terms of the product, while
cost analysis deals with monetary
terms.
- Cost analysis is concerned with cost
concepts, cost-output relations,
economies of scale, production
function and cost control.
Pricing decisions, policies and practices
- The core of managerial economics.
- The success or failure of a firm
mainly depends on accurate price
decisions to effectively compete in
the market.
- Price determination under different
market conditions, pricing methods
and police product line pricing and
price forecasting.
Profit management
- Profit planning like break-even
analysis is studied under this
category.
Capital management
- The most troublesome problem for
the management of business
involving high-level decisions.
- Deals with planning and control of
capital expenditure.
- Cost of capital, rate of return, and
selection of project etc.
Linear programming and theory of games
- Part of managerial economics as
there is a trend towards integration
of managerial economics and
operations research.
Profit: The central concept in managerial
economics
Modern firms pursue multiple objectives
such as welfare, obligations to society and
consumers, etc. However, profit
maximization receives top priority, if not sole
objective.
Optimization - Aims at optimizing a given
objective. It offers numerical solutions to the
problem of making optimum choices and is
basic to managerial economics in
decision-making.
RELATIONSHIP OF MANAGERIAL
ECONOMICS WITH OTHER DISCIPLINES
As using the logic of economics,
mathematics and statistics to provide
effective ways of thinking about business
decision problems.
Macroeconomics
- Managerial economics draws from
micro and macro economics so that
it can apply these principles to solve
the day-to-day problems faced by
businessmen.
- National income, social accounting,
managerial efficiency of capital,
multiplier, business cycles, fiscal
policies, etc.
Mathematics
- Businessmen deal with various
concepts which are measurable. The
use of mathematical logic provides
clarity of concepts and gives a
systematic framework within which
 quantitative relationships may be
analyzed.
Statistics
- Businessmen deal mainly with
concepts that are quantifiable like
demand, price, cost of operation etc.
- Statistical methods provide a sound
base for decision making and help
the businessmen achieve the
objective without much difficulty.
Accounting
- Accounting information is one of the
primary sources of data required for
managerial decisions.
HOW IS MANAGERIAL ECONOMICS
USEFUL?
1. Evaluating choice alternatives
2. Making the best decision
THEORY OF THE FIRM
- Firms exist because the economies
they generate in production and
distribution confer great benefits to
entrepreneurs, workers, and
resource owners.
- Primary goal is to maximize the
wealth or value of the firm.
- A firm may seek to maximize profits
subject to limitation on the
availability of essential inputs and
legal constraints.
VALUE OF THE FIRM
- Present value of all expected future
profits.
BUSINESS PROFIT - Total revenue minus
the explicit or accounting costs of
production.
EXPLICIT COSTS - the actual out-of-pocket
expenditures of the firm to hire labor, borrow
capital, rent land and buildings, and
purchase raw materials.
ECONOMIC PROFIT - Total revenue minus
the explicit and implicit costs of production.
IMPLICIT COSTS - the money value of the
inputs owned and used by the firm in its
own production processes.
OPPORTUNITY COST - Implicit value of a
resource in its best alternative use.
Function of Profit
- Profit is a signal that guides the
allocation of society’s resources.
- High profits are a signal that buyers
want more of what the industry
processes, and vice versa.
DISEQUILIBRIUM PROFIT THEORIES
A. FRICTIONAL PROFIT THEORY
- Disequilibrium and abnormal profits
observed following unanticipated
changes in demand or cost
conditions.
- Unanticipated shocks produce
positive or negative economic profits
for some firms.
B. MONOPOLY PROFIT THEORY
- Above-normal profits caused by
barriers to entry that limit
competition.
- Some firms earn above-normal
profits because they are sheltered
from competition by high barriers to
entry.
- Economies of scale, high capital
requirements, patents or import
protection enable some firms to build
monopoly positions.
COMPENSATORY PROFIT THEORIES efforts of business in directions that
A. INNOVATION PROFIT THEORY society desires.
- Above-normal profits arise following
successful inventions or
modernization.
- Profits that are due to innovations
are susceptible to onslaught of
competition from new and
established competitions.
- Innovation = high profit/demand

B. COMPENSATORY PROFIT
THEORY
- Above-normal rates of return
rewards firms for extraordinary
success in meeting customer needs
and maintaining efficient operations.
- Also recognizes economic profit as
an important reward to the
entrepreneurial function of owners
and managers.

ROLE OF BUSINESS IN SOCIETY

- Firms survive by public consent to
serve social needs. If social welfare
could be precisely measured,
business firms might be expected to
operate in a manner that maximizes
some index of social being.
- Maximization of social welfare
requires answering the following
important questions: What
combination of goods and services
should be produced?; how should
goods and services be produced
and distributed?
- If firms conspire with one another in
setting prices, they may be able to
restrict output, obtain excessive
profits, and reduce social welfare.

SOCIAL RESPONSIBILITY OF BUSINESS

- An important consideration
inducement used to channel the