MANAGERIAL

ECONOMICS
CHAPTER 1
NATURE, SCOPE, AND PRACTICE OF MANAGERIAL ECONOMICS
ECONOMICS
• The study of how society uses its scarce resources

• Social science that deals with the production,

distribution, and consumption of goods and
services

• Focuses on the FOUR FACTORS OF PRODUCTION

• Divided into TWO broad categories:

Microeconomics and Macroeconomics
MANAGERIAL ECONOMICS

The branch of economics which studies the

application of the theories, tools, and findings of
economic analysis to managerial decision-making
in all organizations which allocate limited or scarce
resources.
DECISION-MAKING PROCESS
1. Define a problem or opportunity

2. Gather information

3. Analyze the situation

4. Develop options

5. Evaluate alternatives

6. Select a preferred alternative

7. Act on the decision

STEP 1: DEFINE A PROBLEM OR
OPPORTUNITY

✓ The first step is to recognise a problem or to see

opportunities that may be worthwhile.

✓ Will it really make a difference to our

customers?

✓ How worthwhile will it be to solve this problem

or realise this opportunity?
STEP 2: GATHER INFORMATION

✓ Also known as DETERMINE THE OBJECTIVE

✓ What is relevant and what is not relevant to the

decision?

✓ What do you need to know before you can make a

decision, or that will help you make the right one?

✓ Who knows, who can help, who has the power

and influence to make this happen (or to stop it)?
STEP 3: ANALYZE THE SITUATION

✓ What alternative courses of action may be

available to you?

✓ What different interpretations of the data may be

possible?
STEP 4: DEVELOP OPTIONS

✓ Also know as PREDICT THE CONSEQUENCES

✓ Generate several possible options.

✓ Be creative and positive.

✓ Ask “what if” questions.

✓ How would you like your situation to be?

STEP 5: EVALUATE
ALTERNATIVES

✓ What criteria should you use to evaluate?

✓ Evaluate for feasibility, acceptability and

desirability.

✓ Which alternative will best achieve your

objectives?
STEP 6: SELECT A
PREFERRED ALTERNATIVE

✓ Explore the provisional preferred alternative for

future possible adverse consequences.

✓ What problems might it create?

✓ What are the risks of making this decision?

STEP 7: ACT ON THE DECISION

✓ Put a plan in place to implement the decision.

✓ Have you allocated resources to implement?

✓ Is the decision accepted and supported by

colleagues?

✓ Are they committed to making the decision

work?
MICROECONOMIC
THEORY

The branch of economics which studies the

behaviour of prices, costs, and other economic
magnitudes that result from the interactions
among the small units that make up the economic
system.
MAXIMIZATION BEHAVIOUR IN
DECISION-MAKING

❖ The level of output which yields the largest total

profit.

❖ A business firm that has maximization of profits

as its sole objective will seek that level of
production where profit is the highest.

❖ Setting high standards in choosing the ‘best

option’
SATISFICE BEHAVIOUR IN
DECISION-MAKING
❖ Introduced by HERBERT SIMON and he
observed that human beings may not optimize
so much as they ‘SATISFICE’, meaning that they
work to meet a certain level of consumption
satisfaction rather than the very best pattern of
consumption.
MAXIMIZING VS. SATISFICING
EXAMPLE:
When choosing which car to purchase, Gerald will
consider the use of the vehicle (for his long commute to
work) and decide that he would like his new car be fuel
efficient. He may also decide that he would like the seats
to be heated. He then looks at three cars for sale:

Car 1: A new car with heated seats, but low fuel efficiency.
Car 2: An older car that is fuel efficient and has heated
seats.
Car 3: A new car which is fuel efficient and boasts heated
seats and a spacious interior, at little more than the cost
of car 2.
MANAGERIAL ECONOMIST
❖ The task of managerial economist should be
multifaceted, especially in Philippine business
organizations where multidisciplinary approaches to
problems are necessary.

❖ Nature and scope of managerial economics

necessarily require a GENERALIST approach to the
problem of allocating scarce resources among
competing organizational objectives.
 MANAGERIAL
ECONOMICS
CHAPTER 2.1
CORPORATE PLANNING AND ECONOMICS
THE FOUR MANAGERIAL SKILLS

PLANNING

ORGANIZING

LEADING

CONTROLLING
CORPORATE PLANNING
❖A formal, systematic, managerial process
organized by responsibility, time and formation,
to ensure that operational planning, project
planning and strategic planning are carried out
regularly to enable top management to direct
and control the future of the enterprise.

❖ Pervades all the functional areas of business:

Marketing, Production, Personnel, and Finance.
THE THREE PHASES OF
CORPORATE PLANNING

OPERATIONAL

STRATEGIC PLANNING

PROJECT
OPERATIONAL PLANNING

❖The forward planning of existing

operations in existing markets with
existing customers and facilities.
PROJECT PLANNING

❖ Also known as development planning or capital

expenditure planning.

❖ Generation and appraisal of the commitment to

and the working out of the detailed execution of
an action outside the scope of present
operations, which is capable of separate
analysis and control.
STRATEGIC PLANNING

❖ The determination of the future posture of the

business with special reference to its product-
market posture, its profitability its size, its rate
of innovation, and its relationships with its
executives, its employees, and certain external
institutions.
OPERATIONAL VS. STRATEGIC
❖ TIME PERIOD – Your strategic plan outlines long-
term goals for the next three to five years. What
you’ll be doing to achieve those goals in the shorter
term (typically the next fiscal year) is outlined in your
operational plan.

❖ GOAL FOCUS – The goal of your strategic plan is to

outline the company’s long-term vision and how all
departments should work together to achieve it. The
goal of your operational plan isn’t company-
focused—it is department-focused.
OPERATIONAL VS. STRATEGIC
❖ PLAN GENERATION – Your organization’s high-level
leadership team—the executive team is responsible for
creating the strategic plan. Once it’s created, the
strategic plan will be pushed forward by cross-functional
teams who work together to ensure the strategy is
successful.

❖ BUDGET – Your organization may implement a Strat-Ex

budget that aligns part of your budget directly to your
strategic projects or initiatives. The budget for your
operational plan comes from your department’s annual
budget.
OPERATIONAL VS. STRATEGIC
❖ REPORTING – When you report on your strategic plan
(typically both annually and quarterly), your strategic
planning committee or executive team will want to look
at how your company is performing on its chosen
measures.

Your operational reports, on the other hand, outline

hundreds of projects or tasks people in the department are
working on. Monthly operational reporting meetings give
the leadership—and the rest of the department—an
indication of each project’s status.
BASIC CONCEPTS ABOUT
PLANNING
❖ The PLANNING is the process of preparing for the
commitment or resources in the most economical fashion
and, by preparing for it, of allowing this commitment to be
made faster and with less hitches.

❖ The biggest stumbling block to the planning efforts of

many firms is probably the failure to recognize that it is
the process or the mechanism for planning, and not the
written plan, that matters.

❖ Planning is, therefore, anticipatory decision-making.

 MANAGERIAL
ECONOMICS
CHAPTER 2.2
CORPORATE PLANNING AND ECONOMICS
THE COMPONENTS OF
STRATEGIC PLANNING

❖ Strategic Planning is often interchangeably

used with long-range planning, it must be
stressed that the essence of a strategic plan is
the intended impact of the future posture of
the business toward its customers, markets,
executives, employees, suppliers, creditors,
etc.
 THE COMPONENTS OF
STRATEGIC PLANNING
❖ In order to meet the challenges of the changing world,
every business organization must address FIVE CRITICAL
QUESTIONS:

1. What will the world tomorrow be like?

2. What are the company’s hopes for the future?

3. Where is the corporation currently headed?

4. How will the business appear in the future?

5. How can the organization change and what will it look

like?
THE COMPONENTS OF
STRATEGIC PLANNING
❖ The FOUR BASIC ACTIVITIES OF STRATEGIC
PLANNING are needed to be able to answer these
questions:

1. Objectives formulation

2. Environmental Appraisal

3. Corporate Appraisal

4. Strategy Formulation
 THE COMPONENTS OF
STRATEGIC PLANNING
❖ In line with the four basic activities, the managers charged
with strategic planning have the responsibility to:

• Formulate corporate objectives;

• Analyze the relevant environment;

• Appraise the company with respect to that environment

• Generate strategic options;

• Obtain top management’s decision on a particular option;

• Express and communicate the resulting strategic

decisions in an operationally useful manner.
STRATEGIC ENVIRONMENT
APPRAISAL
❖ Having formulated its basic objectives, the firm is now
ready to scan and assess its external environment. This
environment can be assessed by referring to THREE
SUBJECTS which enable a corporation to relate its
operations and prospects with those of an industry and of
the entire nation.

• Economics of an Industry

• Economics of a Nation

• Economic Forecasting
 STRATEGIC ENVIRONMENT
APPRAISAL
A corporation must first relate itself to the industry
where it belongs. These is where Economics of an Industry
comes in. Then it must situate itself in the context of the
entire national economy. It must know what the
macroeconomic trends are.

The economics of an industry will then have to be

combined with the economics of a nation as well as the
results of economic forecasting so that the short-term
prospects for the corporation can be assessed.
 CORPORATE APPRAISAL
❖ The firm should analyze itself by going over the
Economics of the Firm.

❖ In general, corporate appraisal requires that the firm

undergo ‘soul-searching’ by specifically evaluating its
strengths and weaknesses.

❖ The aim of this appraisal is to gather, in summary form, the

major parameters which define the company as it currently
exists.
CORPORATE APPRAISAL
❖ It is useful to prepare checklist of the company’s
strengths, weaknesses, and resources. Here is the
possible checklist:

❖ Product/Market Posture – quality of product, share of

market, size of market, service organization, nature of
competition, and number of competitors.

❖ Production – number, size, and capacity of plants;

nature of production equipment; sources of supply of
materials; productivity
CORPORATE APPRAISAL
❖ Finance – nature of assets, profitability, unused cash
resources, borrowing capacity, structure of costs,
pattern of cash flows

❖ Technology – research and development capacity

❖ Organization and Management – nature of organization,

management capabilities, planning and control
systems, succession arrangements

❖ Labor Force – size of labor force, state of training,

pattern for union relation
STRATEGY FORMULATION
❖ If the appraisals have been done well, they will give a
picture of the strengths, weaknesses, opportunities
and threats to the company; an estimate of where
presently conceived operations and projects will carry
the company over the next few years; an estimate of
the nature of any gap between such projection and
desired results; and a limited number of options to fill
the gap.
STRATEGY FORMULATION
❖ The generation of strategic options is a critical
activity. It is an imaginative and creative act.

❖ The THREE CRUCIAL FACTORS:

❖ Environmental Change

❖ Corporate SWOT

❖ Capability Profile
 LONG-RANGE PLANNING

❖ Is a “process direct toward making today’s decisions

with tomorrow in mind and a means of preparing for
future decisions so that they may be made rapidly,
economically, and with as little disruption to the
business as possible. “ (E. Kirby Warren’s: Long-
Range Planning: The Executive Viewpoint)
 LONG-RANGE PLANNING
❖ Long-range planning thus provides that all important
mechanism which enables a decision-maker to react
quickly and intelligently to change.

❖ It provides time to plan change and to see

opportunities in what others consider threats or
difficulties.

❖ It lessen the impact of unavoidable disruptions that

change usually introduces to any organization.
 THE PHILIPPINE SETTING
❖ Long-range planning was introduced only in the mid-
1950s and found widespread acceptance only in the
1960s among American corporations. It is
understandable then that Filipino executives began to
talk about long-range planning only in the 1970s.

❖ 1950s and 1960s was dubbed as the Age of

Continuity.
 THE PHILIPPINE SETTING
❖ “Tomorrow is not going to be too different from
yesterday. Just protect the normal rate of growth in
sales. And if you have to increase your price, don’t
worry: after all, you’re in a seller’s market. The
demand still far exceeds the supply.”

❖ At the end of 1970s, stability came to an end.

 THE ‘OUTSIDE-IN’ APPROACH
❖ David Ewing, has coined this interesting phrase to describe
an approach to long-range planning. Since the approach
goes from the external factors to the internal organization.

❖ Managers starts with the question: What are the most

significant market opportunities or consumer needs to be
met, given the existing and predictable economic
environment?

❖ The next question follows: In view of organization’s

strengths and weaknesses, which of these opportunities or
needs should we try to meet?
 THE ‘INSIDE-OUT’ APPROACH

❖ Stresses the capability profile of the firm.

❖ The thorough listing of strengths and weaknesses

serves as a guide to investment prospecting.

❖ Only those opportunities that are directly related to the

company’s distinctive competence will be examined
exhaustively.
A SKELETAL LONG-RANGE PLAN

❖ We shall divide long-range plan into FOUR

CATEGORIES:

❖ Market Planning

❖ Manpower Planning

❖ Technological Planning

❖ Organizational Planning
 MARKET PLANNING

❖ Market planning should increasingly focus on a more

efficient regional distribution system.

❖ Philippine firms will find it necessary to develop

products that meet the top-priority needs of the
population.
 MANPOWER PLANNING
❖ In this age of discontinuity, we need executives whose
main concern is their contribution to the attainment of
corporate goals.

❖ As Peter Drucker said, we need businessmen who will

“learn to build and manage a human group which is
capable of anticipating the new, capable of converting its
vision into technology, products and processes, and
willing and able to accept the new.”

❖ An important part of manpower planning is productivity

planning.
 TECHNOLOGICAL PLANNING
❖ Long-range plans should meet firmly the challenge of
technological innovation and adaptation.

❖ In the Philippines, labor is abundant that’s why most

firms adopted labor-saving or capital-intensive
technologies. To take advantage of this, Philippine
firms are now being prodded to use more labor-
intensive technologies.
ORGANIZATIONAL PLANNING

❖ Executives must be aware that developments in other

firms and industries can mean profit or less for their
business organizations.

❖ Therefore, the manager must be engaged in a

continuous educational process through which he
systematically updates his knowledge of the dynamic
science that is economics.
 MANAGERIAL
ECONOMICS
CHAPTER 3.1
THE GOAL OF MAXIMUM PROFIT
THE GOAL OF MAXIMUM PROFIT
❖ Profitability is the only means to attain
financial viability. In the absence of profit, any
firm will hardly be able to fulfill its
responsibilities to different stakeholders.
Hence, profit is not considered a corporate
objective in itself, but a requirement for the
attainment of objectives.
PROFIT
❖ The difference between total revenue from the
sales of goods and services and the total
costs incurred in producing and selling these
goods and services.

Profit = Total Revenue – Total Cost

or
Pr = TR - TC
PROFIT MAXIMIZATION

❖ Given the formula, there are three possible

approaches/ways of increasing profit:

1. With TC constant, increase TR

2. With TR constant, decrease TC

3. Increase TR and decrease TC

APPROACH 1: WITH TC
CONSTANT, INCREASE TR
❖ When a businessman tries to increase total
revenue by promoting sales, total costs can
hardly be expected to remain constant.

❖ Sales may have risen precisely because more

inputs (and therefore higher costs) went into
the production and marketing of more goods
that were sold.
APPROACH 2: WITH TR
CONSTANT, DECREASE TC
❖ When a businessman reduces his costs
(which be accompanied by less inputs), total
revenue may not remain constant.

❖ It could very well decrease also because of

reduced selling effort and/ or decreased
production. It is therefore, not clear whether
profit will rise if total costs are decreased.
APPROACH 3: INCREASE TR AND
DECREASE TC
❖ This approach seems to be the best of both
worlds. In fact, it is the simplistic advice of a
number of management consultants. “Increase
revenue and decrease costs!” Let us,
therefore, see how economic analysis opens
new horizons in profit planning to the firm
manager.
THE OPTIMUM COMBINATION
❖ How do firms usually attains a preferred level
of profit? One very common practice is to
determine the price of a commodity based on
the firm’s average cost plus a fixed mark-up;
that is,

Price per unit = Average Cost + Mark-up

THE OPTIMUM COMBINATION
❖ Since average cost is defined as the cost
incurred in producing a single unit, then
pricing a commodity at any level above
average cost yields profit. In the last formula,
profit per unit is the difference between price
and average cost that is,

Profit (or Mark-Up) = Price per unit - Average Cost

❖ Total profit, in turn, equals profit per unit times

total quantity sold.
OPTIMIZATION
❖ The firm’s cost accountant tells the manager
how much each unit costs and the manager
simply applies the formula to determine price
and subsequently total profit.

❖ By applying economic analysis, firms can

attain still higher levels of profits even beyond
the projected mark-up rate. The firm manager
must have a clearer understanding of the
concept of optimization.
OPTIMIZATION
❖ The rationale behind optimization can be stated
as follows:

As the revenue and cost increase

simultaneously, though at different rates, the
combination that yields maximum profit (the
optimum combination) is that which corresponds
to the level of production at which the difference
between revenue and cost is greatest.
THE OPTIMUM COMBINATION

The illustration shows that profit does not

necessarily increase with greater revenue. If cost
rises faster than revenue, profit declines.
THE OPTIMUM COMBINATION
Example A:
Selling Costs Sales Profits
A. (1st Stage) P 2,000 P 10,000 P 8,000
B. (2nd Stage) 4,000 15,000 11,000
C. (3rd Stage) 6,000 18,000 12,000
D. (4th Stage) 8,000 19,000 11,000
E. (5th Stage) 10,000 19,800 9,800

It is clear from this example that only by choosing

combination C will the firm manager be maximizing total profits.
To be contented with other combinations just because they, too,
yield profits would not be optimizing. And this is the case when
a fixed mark-up rate is the basis for profit. It is clear also that
more sales does not necessarily mean more profits.
 THE OPTIMUM COMBINATION
Example B:
Sales Volume Revenue Total Costs
Price Profits
(units) from Sales (P1 per unit)
A P 10 P 1,000 P 10,000 P 1,000 P 9,000
B 8 2,000 16,000 2,000 14,000
C 6 3,000 18,000 3,000 15,000
D 4 4,000 16,000 4,000 12,000
E 2 5,000 10,000 5,000 5,000
Since we assumed that demand is present, a price of P10, though
resulting in less sales volume, yields a profit of P9 per unit. An analysis of
various alternatives shows that profits is not maximum in either case. Some
price level between these two extremes corresponds to our optimum
combination of sales and costs. In our example, this price is at P6 where
profit is maximized at P5 per unit.
OPTIMIZATION

❖ These examples are hypothetical. Actual

situations are not as simple as these, but they
serve to illustrate the concept of optimization.
 MANAGERIAL
ECONOMICS
CHAPTER 3.2
THE GOAL OF MAXIMUM PROFIT AND
ECONOMIC ORDER QUANTITY MODELS
ECONOMIC ORDER QUANTITY (EOQ)
❖ Referred to “how much to order” this will
identify the optimal order quantity in terms of
minimizing the sum of annual cost which vary
with order size.

❖ This method is used to identify the order size

that will minimize the sum of the annual costs
of holding inventory and the annual costs of
ordering inventory.
ECONOMIC ORDER QUANTITY (EOQ)
❖ The cycle begins with receipt of an order of Q
units. When the quantity on hand is just
sufficient to satisfy demand during lead time,
an order for Q units is submitted to the
supplier.

❖ Orders are timed to avoid having excess stock

on hand and to avoid stock-outs.
ECONOMIC ORDER QUANTITY (EOQ)
❖ There are three (3) order size models that are
described in this chapter:

1. The economic order quantity model

2. The economic order quantity model with

non-instantaneous delivery

3. The quantity discount model

BASIC ECONOMIC ORDER
QUANTITY MODEL
❖ The optimal order quantity reflect between
carrying cost: as order size varied, one type of
cost will increase while the other one
decreases.

❖ Consequently, annual ordering cost can be

held down by ordering large quantities at
infrequent intervals but that would result in
higher average inventory levels and therefore
increased carrying cost.
BASIC ECONOMIC ORDER
QUANTITY MODEL
❖ The average inventory is simple one half (1/2)
of the order quantity; using H to represent the
average annual carrying cost per unit.

❖ Thus, total annual carrying cost is given by the

formula:

𝑸
Annual Carrying Cost = H
𝟐
BASIC ECONOMIC ORDER
QUANTITY MODEL
❖ On the other hand, annual ordering cost will
decrease as order size increases, since for a
given annual demand, the larger the order
size, the fewer the number of orders needed.

❖ Thus, total annual ordering cost is given by

the formula:

𝑫
Annual Ordering Cost = S
𝑸
BASIC ECONOMIC ORDER
QUANTITY MODEL
❖ While Total Annual Cost is associated with
carrying and ordering inventory that gives us:

TC = 𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝑪𝒐𝒔𝒕 + 𝑨𝒏𝒏𝒖𝒂𝒍 𝑶𝒓𝒅𝒆𝒓𝒊𝒏𝒈 𝑪𝒐𝒔𝒕

= Q/2 H + D/Q S

Where:

D = Demand, in units per year

Q = Order quantity, in units
S = Order cost, in Peso
H = Carrying cost, in Peso per unit per year
BASIC ECONOMIC ORDER
QUANTITY MODEL
❖ Note that the total cost reaches its minimum at
the quantity where carrying and ordering costs
are equal. Thus, the Optimal Order Quantity
(𝑸o), can be obtained by using the formula:

𝟐𝑫𝑺
𝑸o = 𝑯
Example:
Seo Jun Auto Tire supply a local distributor for a
national tire company expects to sell 9,000 radial tires
for next year. Annual carrying cost are Php20.00 per tire
and ordering cost are Php70.00. The distributor
operates 288 days a year.

Compute:

1. The EOQ or Qo
2. Number of times per year does the store re-order
3. Length of an Order Cycle
4. The Total Cost (TC)
QUANTITY DISCOUNT
❖ Quantity discount are price reductions for
large orders offered to customers to induce
them to buy in large quantities.

❖ If quantity discount are offered, the customer

must determine the possibilities the benefits
of reduced price and fewer orders that will
result from buying in large quantities against
the increase in carrying cost caused by higher
average inventories.
QUANTITY DISCOUNT
❖ Therefore, the objective of buyer in the case of
quantity discount is to select the order quantity
that will minimize total cost.

❖ Hence, the total cost is given by:

TC = 𝑪𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝑪𝒐𝒔𝒕 + 𝑶𝒓𝒅𝒆𝒓𝒊𝒏𝒈 𝑪𝒐𝒔𝒕 + 𝑷𝒖𝒓𝒄𝒉𝒂𝒔𝒊𝒏𝒈 𝑪𝒐𝒔𝒕

= (Q/2) H + (D/Q) S + PD

Where:

P = unit price
Example:
The maintenance department of Twice University uses
816 pcs. of broom annually. Ordering costs are
Php12.00, carrying cost are Php4.00 per piece a year,
and the new price schedule indicates that orders of
less than 50 pieces will cost Php20.00 per piece, 50 to
79 pieces will cost Php18.00 per piece, 80 to 99 pieces
will cost Php17.00 per piece, and a large orders will
cost Php16.00 per piece. Determine the optimal order
quantity and the total cost.
 MANAGERIAL
ECONOMICS
CHAPTER 4
PRODUCTION PROCESS AND COST ANALYSIS
PRODUCTION THEORY
❖ Production is the process of converting input
into output. It is represented by the figure
below:

INPUT PROCESS OUTPUT

❖ Therefore, production paves the way for the

creation of utility or usefulness of a product
or service.
PRODUCTION FUNCTION
❖ The production function expresses the amount
of output that can be produced given certain
amounts of input. In general, the production
function can be expresses as:

Q = 𝒇 (L, K)

where: Q is the level of output

L is the number of units of labor
K is the number of units of capital
COSTS

❖ In the world of business, costs are always

associated with its success. A business firm
would not be able to generate sales without
incurring any cost. Thus, business tycoons
also need to consider and analyze costs.

❖ Costs are the firms’ expenses.

FIXED COSTS (FC)

❖ Fixed costs are expenses that does not

change even though there is an increase or
decrease in the volume of goods produced.

❖ These are required to be paid by companies,

independent of any business activity.
VARIABLE COSTS (VC)
❖ Variable costs are expenses that vary with the
volume of production output; they rise as
production increases and fall as production
decreases.

❖ For example, a company may have variable costs,

such as supplies associated with the production of
goods. As the company produce more goods, the
costs for suppliers will increase. Contrariwise,
when fewer of these goods are produced the costs
for supplies will consequently decrease.
TOTAL COSTS (TC)
❖ Total costs are the sum of variable costs and fixed
costs.

❖ Assume that a business firm has the following

costs for the following volume of output:
Output Fixed Costs Variable Costs Total Costs
1 Php 1,500 Php 400 Php 1,900
2 Php 1,500 Php 700 Php 2,200
3 Php 1,500 Php 1,100 Php 2,600
4 Php 1,500 Php 1,700 Php 3,200
5 Php 1,500 Php 2,700 Php 4,200
6 Php 1,500 Php 4,500 Php 6,000
TOTAL COSTS (TC)
❖ The relationship of the costs may be observed
through a graph.

7,000
6,000
5,000
Prices

4,000
Total Costs
3,000
Fixed Costs
2,000
Variable Costs
1,000
0
2 3 4 5 6
Quantity
 MARGINAL COSTS (MC)
❖ Marginal, in economic terms, means additional. Thus,
the concept of marginal cost to produce one more
unit.

❖ Using the data in the table from the preceding

example, we compute the marginal cost of producing
the 6th unit. We get it by deducting the total cost of
the 6th unit from the 5th unit produced. Thus,

Php 6,000 – Php 4,200 = Php 1,800

The marginal cost for adding the 6th unit is Php 1,800
AVERAGE COSTS (AC)

❖ This is the cost divided by the number of units

produced.

❖ Average Fixed Costs (AFC)

❖ Average Variable Costs (AVC)

❖ Average Total Costs (ATC)

AVERAGE FIXED COSTS (AFC)
❖ Average fixed cost is fixed costs divided by
output. It drops as output rise because we divide a
larger denominator into a numerator that is
constant.

❖ Suppose that the fixed cost is still Php1,500, the

average fixed cost for a unit is:

𝑭𝒊𝒙𝒆𝒅 𝑪𝒐𝒔𝒕 𝑷𝒉𝒑 𝟏,𝟓𝟎𝟎

Average Fixed Costs = 𝑶𝒖𝒕𝒑𝒖𝒕 =
𝟏
= Php1,500
AVERAGE FIXED COSTS (AFC)
❖ If the output would increase to 2, the AFC would
be:

𝑷𝒉𝒑 𝟏,𝟓𝟎𝟎
AFC = 𝟐
= Php 750

Average Fixed
Fixed Costs Output
Costs
Php 1,500 1 Php 1,500
Php 1,500 2 Php 750
Php 1,500 3 Php 500
Php 1,500 4 Php 375
Php 1,500 5 Php 300
Php 1,500 6 Php 250
AVERAGE VARIABLE COSTS (AVC)
❖ Average Variable Cost is variable cost divided by
output. As we all know variable costs increases as
production increases. However, it does not mean
that AVC increases progressively too. Usually, it
level offs at the beginning and gradually rises.

𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝑪𝒐𝒔𝒕 𝑷𝒉𝒑 𝟒𝟎𝟎

Average Variable Costs = 𝑶𝒖𝒕𝒑𝒖𝒕 =
𝟏
= Php 400
AVERAGE VARIABLE COSTS (AVC)

Average
Variable Cost Output
Variable Cost
Php 400 1 Php 400
Php 700 2 Php 350
Php 1,100 3 Php 367
Php 1,700 4 Php 425
Php 2,700 5 Php 540
Php 4,500 6 Php 750
AVERAGE TOTAL COSTS (ATC)
❖ Average Total Cost is the total cost divided by
output. Like AVC, ATC declines for a while but
eventually it will begin to rise.

Average Total
Total Cost Output
Cost
Php 1,900 1 Php 1,900
Php 2,200 2 Php 1,100
Php 2,600 3 Php 867
Php 3,200 4 Php 800
Php 4,200 5 Php 840
Php 6,000 6 Php 1,000
 EXAMPLE

Fixed Variable Total Marginal

Output AFC AVC ATC
Cost Cost Cost Cost

1 P 1,500 P 400 P 1,900 P 1,500 P 400

2 1,500 700 2,200 350 P 300

3 1,500 1,100 500

4 1,500 1,700 3,200 375 425

5 1,500 2,700 1,000

6 1,500 4,500 6,000

WHY AVC AND ATC CURVES U-SHAPED?
❖ Each is U-shaped because it start off with
relatively high but falling cost for small quantities
of output, reaches a minimum value, then has
rising cost at large quantities of output.

❖ When we look at the comparison, we can see that

AVC rises first before ATC, why so?

❖ This is explained through concepts of: Law of

Diminishing Returns, Economies of Scale and
Diseconomies of Scale.
LAW OF DIMINISHING RETURNS
❖ An economic concept that states that if one
variable factor of production is increased while
other factors are held constant, the output per
unit of the variable factor will eventually decline.

❖ While the marginal productivity of labor drops

as output increases, diminishing returns do not
mean negative returns until the number of
workers exceeds the available machines or
workspace.
ECONOMIES OF SCALE

❖ Economies of scale is the cost advantage that

arises with added output of production. It
arises because of the inverse relationship
between the quantity produced and per-unit
fixed costs.

❖ It is the one responsible for declining phase of

the ATC curve.
DISECONOMIES OF SCALE
❖ Diseconomies of scale is an economic concept
referring to a situation in which economies of
scale no longer work for a business.

❖ To a certain extent of experiencing continued

decreasing costs per increase in output, firms
see an increase in marginal cost when output is
increased.

❖ It is the one responsible for the rising part of the

ATC curve.
 MANAGERIAL
ECONOMICS
CHAPTER 5.1
MARKET STRUCTURE AND IMPERFECT COMPETITION
PERFECT COMPETITION
❖ This is a type of market where many seller
offer identical products and there is freedom
of entry and exit and perfect information in the
market.

❖ It has the characteristics: Large Number of

Small Firms; Homogeneous or Identical
Product and; Very Easy Entry and Exit
LARGE NUMBER OF SMALL FIRMS
❖ One of the characteristics of a perfectly
competitive market is composed of many firms
and buyers, that is, a large number of
independently-acting firms and buyers with each
firm and buyer sufficiently small to be unable to
influence the price of product transacted in the
market.

❖ This is fulfilled only when each firm in a market

has no significant share of total output and
therefore, no ability to affect the product’s price.
HOMOGENEOUS OR IDENTICAL
PRODUCT
❖ In a perfectly competitive market, the products
offered by the competing firms are identical
not only in physical attributes but also
regarded as identical by buyers who have no
preference between the products of various
producers.
VERY EASY ENTRY, AND EXIT

❖ There are no barriers to entry of new sellers or

impediments to the exit of existing sellers.

❖ Barriers can be in the form of financial,

technical, long term contracts, or government-
imposed barriers such as licenses, patents,
permits, copyrights, franchises, etc.
MONOPOLY
❖ A firm that is the only seller and controller of the
entire supply of a certain good or service, with no
close substitutes in the market.

❖ In the absence of government intermediation, this

firm is free to set the prices that it chooses and
will usually set the price that will generate the
largest possible profit.

❖ A firm that sets and chooses its price based on its

output decision is called a price setter, and they
obtains monopoly power.
MONOPOLY

❖Characterized by:

1. A single seller or producer

2. A unique product or service and;

3. Impossible entry into the market

SINGLE SELLER OR PRODUCER

❖A monopoly market is composed of a

single supplier selling to a multitude of
small, independently-acting buyers.

❖One firm provides the total supply of a

product in a given market.
UNIQUE PRODUCT
❖Means that there are no close substitutes
for the monopolist’s product.

❖The monopolist faces little or no

competition.

IMPOSSIBLE ENTRY
❖ Barriers to entry are so severe in a monopoly
that it is impossible for new firms to enter the
market.
PRICE DISCRIMINATION
❖ Is the practice of charging a specific product at
different prices which are not justified by cost
differences. There are three forms of price
discrimination:

1. Charging the market the minimum price that a

consumer is willing to pay.

2. Charging the specific price for the first set of

purchases and then reducing it for subsequent
purchases.

3. Charging some customers a certain price and then the

another price for other customers.
PRICE DISCRIMINATION
❖ It is not possible for all firms to engage in price
discrimination , it can only exist when the following
conditions are met:

1. Monopoly Power – the firm must be a monopolist or, at

least possess monopoly power at some degree, giving
them the ability to control its price and output.

2. Market Segregation – the market must be able to

segregate its consumers into unique classes, each having
different ability and willingness to pay for a product.

3. No resale – the original purchaser cannot resell the

product he bought.
 MANAGERIAL
ECONOMICS
CHAPTER 5.2
MARKET STRUCTURE AND IMPERFECT COMPETITION
OLIGOPOLY
❖ A market dominated by a few large producers
or sellers of a homogeneous or differentiated
product. Because of their ‘fewness’,
oligopolists have considerable control over
their prices, but each must consider the
possible reaction of rivals to its own pricing,
output, and advertising decisions.
OLIGOPOLY
❖ Basically, an oligopoly is a consequence of mutual
interdependence (a condition in which action of
one firm may cause a reaction from other
competing firms in the industry)

❖ In other words, a market structure with a few

powerful firms makes it easier for oligopolists to
collude.

❖ Hence, ‘few-sellers’ condition is met when these

firms are relatively large to the total market that
they can affect the market price.
 OLIGOPOLY

❖Characterized by:

1. Few sellers

2. Homogeneous or Differentiated Products and;

3. Difficult Market Entry

ILLUSTRATION OF OLIGOPOLY
Mr. Tan and Mr. Kim are initially selling gasoline at
Php60.00 per liter (E). Mr. Tan decides to lower its price to
Php50.00 per liter. Sales increase from 20,000 liters per week to
30,000 liters per week from point E to E1. Mr. Kim is unhappy
losing so many sales to Mr. Tan, and matches Mr. Tan’s price of
Php50.00 per liter.

Mr. Kim then decides to decrease the price of his

gasoline to Php30.00 per liter to make more profits similar to
what Mr. Tan did when he lowered the price of his gasoline
further from Php50.00 to Php30.00. The move of Mr. Kim is
shown as the movement from point E1 to E2. However, sales
volume only increased from 30,000 liters per week to 35,000
liters per week.
ILLUSTRATION OF OLIGOPOLY

❖ Many oligopolies face Kinked Demand Curves.

This is a curve that explains why prices changed
by competing oligopolists, once established, tends
to be stable. Basically, the demand curve for the
product of oligopolists has two segments: one
elastic, and the other inelastic.
OLIGOPOLY FEATURES
✓ Product Branding – Each firm in the market is
selling a branded (differentiated) product.

✓ Entry Barriers – Significant entry barriers prevent the

dilution of competition in the long run which maintains
supernormal profits for the dominant firms. It is
perfectly possible for many smaller firms to operate
on the periphery of an oligopolistic market, but none
of them is large enough to have any significant effect
on market prices and output.
OLIGOPOLY FEATURES

✓ Interdependent Decision-making – Interdependent

means that firms must take into account likely
reactions of their rivals to any change in price, output,
or forms of nonprice competition.

✓ Nonprice Competition – a consistent feature of the

competitive strategies of oligopolistic firms. (Example:
Free Deliveries and Installation, Extended Warranties
for consumers and credit facilities etc.)
DUOPOLY
❖ Another form of oligopoly wherein two corporations
produce similar goods or services which are almost
identical.

❖ Only two companies have the entire control of the

market and the firms’ interactions with one another
shape of the market.

❖ When there’s a duopoly in the market, the consumers

may tend to benefit from the actions of the two firms
when they compete on price since firms will drive the
price down in order to keep up in the competition with
each other.
DUOPOLY
❖ However, since there are only two firms sharing in
the market, this condition gives the duopolists an
opportunity to agree and charge a monopolistic
price in order to gain profit.

❖ There are two types of duopoly. The Courtnot

Duopoly and the Bertrand Duopoly named after
mathematician Antoine Augustin Courtnot and
French economist, Joseph Bertrand.
THE COURTNOT DUOPOLY
❖ The competition of the two companies is based on the
quantity of products supplied, saying that it is the quantity
which shapes the competition between two firms.

❖ The Courtnot Model believes that each company receives

price values on the availability of goods and services.

❖ The price each company receives for the product is based

on numerical count or quantity of the produced goods.

❖ Equilibrium is achieved when the two companies react to

the changes in production of each other.
THE BERTRAND DUOPOLY

❖ The Bertrand Duopoly focused on the price

since this is what drives competition in the
market between two companies. When given a
choice between two goods and services which
tend to be equal or similar, consumers will go
for the firm that will offer best price.
MONOPSONY
❖ Monopsony is similar to the concept of monopoly
that has one seller and many buyers. For
monopsony, there is only one buyer but many
sellers. The buyer is called monopsonist.

❖ Monopsony occurs when there is a market power

exercised by a firm when employing factors of
production, giving the monopsonist the control
when negotiating prices.
 MANAGERIAL
ECONOMICS
CHAPTER 6
CAPITAL BUDGETING AND RISK ANALYSIS
CAPITAL EXPENDITURES
❖ Refers to substantial outlay of funds the
purpose of which is to lower costs and
increase net income for several years in the
future.

❖ It includes expenditures that tie up fixed

assets but also expenditures for major
research on new products and methods and
for advertising that has cumulative effects.
CLASSES OF CAPITAL EXPENDITURES
❖ Capital expenditures may be classified into the
following:

1. Replacement Investments – this refers to investments

on replacement of worn-out or obsolete facilities;

2. Expansion Investments – this type of expenditure will

provide additional facilities to increase the production and
/ or distribution capabilities of the firm;

3. Product-line or New Market Investments – this refers

to expenditures on new products or new markets, and on
improvement of old products with the combined features
of replacement and expansion investments.
CLASSES OF CAPITAL EXPENDITURES
❖ Capital expenditures may be classified into the
following:

4. Investments in Safety and/or Environmental Projects –

these expenditures necessary to comply with government
orders, labor agreements, or insurance policy terms.
These are sometimes called mandatory investments or
non-revenue producing projects;

5. Strategic Investments – these are investments designed

to accomplish the overall objectives of the firm and;

6. Other Investments – this catch-all term includes office

buildings, parking lots, executive aircraft, etc.
CAPITAL BUDGETING
❖ The planning and control of capital
expenditures. This activity is essential
because it provides a systematic evaluation of
the firm’s alternatives.

❖ It helps management in choosing an

alternative that will provide the best yield for
the company.
VALUATION
❖ When the proposal’s real worth to the firm is
determined, the process is called valuation.

INVESTMENT
❖ Is made when a firm spends some of its funds for
the establishment of a project.

❖ Has two forms: (1) Initial Investments which refers

to the amount that has been devoted to a project
until it generates cash inflows from operations. (2)
Later Investments are made after the first cash
inflow.
CAPITAL BUDGETING

❖Objectives:

1. Establishing priorities;

2. Cash planning;

3. Construction planning;

4. Eliminating duplication; and

5. Revising plans
THE CAPITAL BUDGETING SYSTEM
❖The capital budgeting system is composed
of the following:

1. Preparation and submission of budget

requests;

2. Approval of budget;

3. Request for appropriation;

4. Submission of progress reports; and

5. Post approval reviews

EVALUATION OF PROPOSED
CAPITAL EXPENDITURES
❖ Proposed capital expenditures should be scrutinized
since they involve large outlays of funds. A number of
primary factors should be considered by management.
These are the following:

▪ Urgency – decisions should be made as quickly as

possible for requirements that are urgent.

▪ Repairs – management should consider the availability

of spare parts and maintenance experts. When these
are critical and they are not available, the concerned
proposal should be ruled out.
EVALUATION OF PROPOSED
CAPITAL EXPENDITURES
Continuation…

▪ Credit – This factors should be considered in the sense that

some credit terms may be highly favourable to the firm.

▪ Non-Economic Factors – these refers to social

considerations, and other non-economic persuasions and
preferences.

▪ Investment Worth – this refers to the economic evaluation

of a certain proposal.

▪ Risk Involved – this refers to the uncertainty of an expected

return.
METHODS OF
ECONOMIC VALUATION
❖There are three basic methods of
evaluating proposals. These are composed
of the following:

1. The Payback Method

2. The Average Rate of Return Methods; and

3. The Discounted Cash Flow Method

THE PAYBACK METHOD
❖ Determines the number of years required to
recover the cash investment made on a
project. The recovery of cash comes from the
cash inflows generated from the project.

𝑪𝒐𝒔𝒕
Payback Period = 𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘
THE PAYBACK METHOD
❖ The payback method, however, has some
disadvantages. These are the following:

1. It does not consider the time value of money;

2. The accept-reject criterion is stated in terms of years

rather than at a discount rate;

3. The firm’s attention is focused on cash flow rather than

on rate of return;

4. Careful projection of the timing of the investment outlays

and the year-by-year projection of cash inflows over the
entire life of the proposal are not encouraged; and

5. The salvage value of the proposal is not considered.

THE AVERAGE RATE OF
RETURNS METHOD
❖ Consists of the following:

❖ Average Return on Investment

𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘

Average Return on Investment =
𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝑶𝒖𝒕𝒍𝒂𝒚

❖ Average Return on Average Investment

𝑨𝒏𝒏𝒖𝒂𝒍 𝑪𝒂𝒔𝒉 𝑰𝒏𝒇𝒍𝒐𝒘

Average Return on Average Investment =
𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕Τ𝟐
 A SAMPLE INVESTMENT PROPOSAL
FOR THE PURCHASE OF A MACHINE

Acquisition Cost P 10,000,000

Economic Life 10 years
Salvage Value 100,000
Earnings and Costs per year
Income 5,000,000
Expenses - 2,000,000
Net Income before tax and depc’n 3,000,000
Less: Depc’n (Straight Line) 1,000,000
Net Income Before Tax 2,000,000
Less: Income Tax 620,000
Average Net Annual Earnings 1,380,000

Cash Inflows Per Year = Net Earnings + Depreciation = P 2,380,000

 MANAGERIAL
ECONOMICS
CHAPTER 6
CAPITAL BUDGETING AND RISK ANALYSIS
DISCOUNTED CASH FLOW METHODS

❖The time value of money is recognized

under the discounted cash flow methods.

❖There are two approaches available:

1. The Net Present Value Method

2. The Internal Rate of Return Method

DISCOUNTED CASH FLOW METHODS

❖Under these approaches, all future values

of proposal are discounted and compared
to the values of other proposals.

❖The discounting factor makes these two

methods preferred by users in evaluating
capital expenditure proposals.
NET PRESENT VALUE METHOD
❖ Under this method, a desired rate of return is used
for discounting purposes.

❖ The present value concept is applied to the cash

flows of a proposal and are discounted at the
desired rate of return for the periods involved.

❖ The sum of the present values of the outflows

(cost/investment outlay) is compared with the sum
of the present values of inflows (net income plus
depreciation).
NET PRESENT VALUE METHOD
❖ If the discounted cash inflows are larger than the
discounted cash outflows, the project will earn
more than the desired rate of return. The project
will be accepted.

❖ Conversely, if the discounted cash outflows are

larger than the discounted cash inflows, the
project will not be able to generate the desired
minimum rate of return. The proposal is, then,
rejected.
NET PRESENT VALUE METHOD

NPV= PVCI - PVCO

Where:

NPV = net present value (also the net value

derived after deducting the discounted
cash outflow from the discounted cash inflow)

PVCI = discounted value of the anticipated cash

inflows

PVCO = discounted value of the anticipated cash

outflows
NET PRESENT VALUE METHOD
❖ The formula for finding the present value of an
expected cash inflow is as follows:
𝑨
PV =
(𝟏+𝒓)𝒏
Where:

A = expected cash inflow

r = desired rate of return

n = number of years the cash inflow is expected

 A SAMPLE INVESTMENT PROPOSAL
FOR THE PURCHASE OF A MACHINE

Acquisition Cost P 10,000,000

Economic Life 10 years
Salvage Value 100,000
Earnings and Costs per year
Income 5,000,000
Expenses - 2,000,000
Net Income before tax and depc’n 3,000,000
Less: Depc’n (Straight Line) 1,000,000
Net Income Before Tax 2,000,000
Less: Income Tax 620,000
Average Net Annual Earnings 1,380,000

Cash Inflows Per Year = Net Earnings + Depreciation = P 2,380,000

INTERNAL RATE OF RETURN
METHOD
❖ The discount rate is not given. Rather, it becomes the
object of computation.

❖ The discount rate which yield a net present value of

zero or one approximating zero is the correct discount
rate. It may determined by trial and error.

❖ The acceptability of the proposal will depend on the

prevailing interest rates as compared with the
computed correct discount rate.

❖ If the prevailing rate is higher, the proposal is rejected,

and conversely, if it is lower, the proposal is accepted.