MANAGERIAL ECONOMICS (LECTURE 1)

ECONOMICS MANAGERIAL ECONOMICS

➔ Queen of Social science. o Is the branch of knowledge in which theories of
- ‘Oikos’(Household) + ‘Nomos’(Management) economic analysis are used for solving business
management problems and determination of business
o A social science that deals with efficient application of policies.
scarce resources in order to satisfy the unlimited needs o Serves a bridge between economics and business
and wants of men. management.
o Called as “maximizing behavior” or more approximately Economics Decision Making
“optimizing behavior” o Theories o Selection of best
o Optimizing means selecting the best out of available o Principle alternative out of
resources with the objective of maximizing gains from o Concepts various possible
given resources. alternatives.
o According to J.S. Mill, Economics is “the practical
science of production and distribution of wealth.” o Risk and Uncertainty

ECONOMICS Scope of Managerial Economics

→ wealth creation ✓ Objectives of a Firm (earn more profit and minimize
• Activities of mankind are studied which are concerned cost)
with earnings and spending of money. ✓ Demand Analysis and Forecasting (foresee what will
• For the successful handling of these activities’ certain happen in the future; identify trends and demands)
laws and rules are formulated which are known as ✓ Production and Cost Analysis
various theories of economics. ✓ Pricing Decisions
• Use of these rules & tools for analyzing business ✓ Profit Management
conditions and applying them for arriving at various ✓ Capital Management
economic decision is known as Managerial Economics ✓ Market Structure
✓ Inflation and Economic Conditions
BRANCHES OF ECONOMICS
MICROECONOMICS MACROECONOMICS Nature of Managerial Economics
Individual markets Whole economy (GDP) ▪ Micro-economic in Nature: The problem of a particular
Effects on price of a good Inflation (general price level) firm is studied and not the whole economy.
Individual labor market Employment/unemployment ▪ Theory of Firm or Economics of Firm: All the economic
Individual consumer Aggregate demand (AD) theories, concepts and economic models known as
behavior
“Theory of Firm” or Economics of Firm” are studied in
Supply of goods Productive capacity of economy
Managerial Economics.
▪ Importance of Macro Economics too: Macroeconomics
MANAGERIAL ECONOMICS helps to understand the overall environment in which a
→ focuses on microlevel firm operates its activities. The knowledge of
• Managerial Economics is the study of Economic Theories, Macroeconomics enables the managers to coordinate
Principles and Concepts which is used in Managerial and adjust their business in the best possible way with
Decision Making. environmental forces with which they have no control.
• According to Spencer and Siegelman, “Managerial E.g., Fiscal Policy & Monetary policy.
Economics may be defined as the integration of Economic ▪ Applied Approach: Managerial economist analyses
theory with business practice for the purpose of facilitating good or bad effects of various
decision making and forward planning by management.” ▪ decisions on the firm.
• Decision Making - selecting one out of a set of two or more ▪ Normative vs Positive in Nature.
alternatives or in other words, making a choice.
[The problem of selection arises because the supply of ECONOMIC MODEL
factors of production such as land, labor, capital and An economic model is a simplified version of reality that
enterprise are scarce or limited] allows us to observe, understand, and make predictions
about economic behavior. The purpose of a model is to take
MANAGERIAL ECONOMICS a complex, real-world situation and pare it down to the
essentials.
Application of
Economics Mathematical and
Managerial → simplified representation of the real world
theories,
statistical tool
Decision → It is the structural and scientific method of constructing
Principles and Application Making or developing solutions by using basic economic
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MANAGERIAL ECONOMICS (LECTURE 1)

Steps to construct economic models: • According to this principle, profit can be existed either
1. Defining Problem by increasing sales or total revenue or by decreasing
2. Formulation of Hypothesis total cost.
3. Data collection Decision Rule: TC < TR... TC = TR ... TC > TR (worst)
4. Analysis of data using basic principle of economics and
quantitative techniques E. Time Perspective Principle
5. Testing Hypothesis • According to the principle all decisions should be under
6. Evaluating Results Two Formats i.e. short run and long run, because of the
7. Conclusion for Decisions decisions characteristics.
• So each decision should be made in Short run basis as
Basic Principles of Managerial Economics well as long run basis.
a. Opportunity Cost Principle • According to short run decision the long run decision will
b. Marginalism Principle get change.
c. Equi-Marginalism Principle Long-run, inpit
d. Incremental Principle F. Discounting Principle
e. Time Perspective Principle • According to this principle, if a decision affects costs and
f. Discounting Principle revenues in long-run, all those costs and revenues must
be discounted to present values before valid
A. Opportunity Cost Principle comparison of alternatives is possible.
• Choice involves sacrifice. • This is essential because a Peso worth of money at a
• The cost involved with the sacrifice. future date is not worth a Peso today. Money actually
• It is the cost of a next best opportunity which is lost will has time value.
be called an Opportunity Cost • This could be understood using the formula,
• Example: P1,000 can be used for purchasing a book or
drinking coffee at StarBucks. FV = PV*(1+r)t and
PV= FV/(1+r)t
B. Marginalism Principle
• Marginal Cost & Marginal Profit/Benefit • Where…
• Marginal Cost is the cost which incurred to produce the FV = Future value
next or one more unit. PV = the Present Value
MC = (TC)n - (TC)n-1 r = the discount (interest) rate
• Marginal Revenue is the benefit which gets by t = the time between the future value and present value.
producing one more or next unit.
MR = (TR)n - (TR)n-1 Quantitative Techniques used in Managerial Economics
• Cost will be less and benefit will be more. ▪ Variables
Decision Rule: ▪ Functions
MR>MC... People will race to purchase ▪ Schedules
MR=MC... ▪ Graphs
MR<MC – people will most likely not buy; firm ▪ Derivatives
would usually not produce ▪ Differentiation
▪ Integration
C. Equi-Marginalism Principle
• Allocation of scarce resources on different alternative
uses should be equally distributed.
i.e., MPa = MPb = MPc= MPd
Or
MPa = MPb = MPc= MPd
CoPa CoPb CoPc CoPd

D. Incremental Principle
• Incremental principle gives an idea to increase the
production not only with one more product it could be
any quantity till the profit exists.

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MANAGERIAL ECONOMICS (LECTURE 2)

THEORETICAL DERIVATION OF THE DEMAND CURVE FOR Deriving a Demand Curve for Physician Visits
MEDICAL SERVICE Note: Now let q represent physician visits
• Medical care is an input in producing health Suppose Pq rises. This will lead to:
• Health yields utility to the consumer Subject to law of 𝑴𝑼𝒒 𝑴𝑼𝒛
<
diminishing marginal utility. 𝑷𝒒 𝑷𝒛

We can generally graph the relation between medical care
and utility as follows:
• Consumer can increase U by purchasing less q, and
more z
• Increased Pq = lower demand for q
• Consumer’s purchase of medical carea is a “derived
demand”

Downward sloping demand curve for physician visits.

The graph shows that as the level of medical care rises, each
additional unit of medical care yields a smaller increase in
utility.

Consumer’s Optimal Choice of Health Demand

Define: MU = marginal utility of medical care • Demand is the amount of goods and services that
P = price consumers are willing and able to buy at alternative
q = quantity of medical services prices over a particular period of time.
z = quantity of all other goods Tradeoff • Law of Demand: Ceteris Paribus, as Price of a good
increases, Qd of that good will tend to decline and vice
▪ Given the consumer’s income, she chooses q and z versa.
to maximize utility. Qd of PA = f (Price of PA)
▪ Utility maximization rule:
𝑴𝑼𝒒 𝑴𝑼𝒛 • Direct Demand- g/s that satisfy consumer desires.
=
𝑷𝒒 𝑷𝒛 • Derived Demand- demand for intermediate goods
Total utility reaches its peak when the marginal utility gained Ex. Demand for steel (an intermediate goods) is
from the last Php spent on each product is equalized. derived from the demnd for final goods (e.g.,
automobiles)
i.e. The consumer equalizes “the bang for the buck”
across all goods Non-Price Determinants of Demand:
Qd = f ( Y, Nc, Pr, Tx, T&P, Subs, Pe, Ads, Dy )
Suppose that instead: Where: Y = Income of Consumers
𝑴𝑼𝒒 𝑴𝑼𝒛 Nc = No. of Consumers
>
𝑷𝒒 𝑷𝒛 Pr = Prices of other goods (Complements or
substitutes)
▪ Last Php spent on medical care generates more U than T&P= Tastes and Preferences
last Php spent on other goods Tx = Taxes
▪ Consumer could U by purchasing more medical care (q), Subs = Subsidies
and less other goods (z) Pe = Expectations of Future Prices
➢ Then MUq would fall, MUz would rise, until the 2 Ads = Advertising
ratios are equalized Dy = Distribution of Income (e.g., Annual, semi-
annual, monthly, weekly or daily).
• The higher the population, the ↑ Qd and vice versa.
• ↑ Taxes, the ↓ the Qd.
• ↑ Subsidies, the ↑ the Qd.

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DEMAND, SUPPLY AND MARKET EQUILIBRIUM

THE BASIC DECISION-MAKING UNITS QUANTITY DEMAND

• A firm is an organization that transforms resources • Quantity demanded is the amount (number of
(inputs) into products (outputs). Firms are the primary units) of a product that a household would buy in a
producing units in a market economy. given time period if it could buy all it wanted at the
• An entrepreneur is a person who organizes, manages, current market price.
and assumes the risks of a firm, taking a new idea or a -- willingness and ability to buy of the consumers
new product and turning it into a successful business.
-- are risk takers DEMAND IN OUTPUT MARKETS
• Households are the consuming units in an economy. • A demand schedule is a table
-- consumers showing how much of a given
-- filipinos are service oriented product a household would be
willing to buy at different prices.
THE CIRCULAR FLOW OF ECONOMIC ACTIVITY • Demand curves are usually
• The circular flow of economic activity shows the derived from demand schedules.
connections between firms and households in input and
output markets.
• Output, or product,
markets are the markets in THE DEMAND CURVE
which goods and services are The demand curve is a graph
exchanged. illustrating how much of a
• Input markets are the given product a household
markets in which resources— would be willing to buy at
labor, capital, and land—used different prices.
to produce products, are
exchanged.
• Payments flow in the opposite direction (profit and
income) as the physical flow of resources, goods, and
services (counterclockwise).
THE LAW OF DEMAND
INPUT MARKETS • The law of demand
Input markets include: states that there is a
• The labor market, in which households supply work negative, or inverse,
for wages to firms that demand labor. relationship between price
• The capital market, in which households supply and the quantity of a good
their savings, for interest or for claims to future demanded and its price.
profits, to firms that demand funds to buy capital • This means that
goods. demand curves slope
• The land market, in which households supply land downward.
or other real property in exchange for rent.
OTHER PROPERTIES OF DEMAND CURVES
DETERMINANTS OF HOUSEHOLD DEMAND • Demand curves intersect the quantity (X)-axis, as a
A household’s decision about the quantity of a particular result of time limitations and diminishing marginal
output to demand depends on: utility.
• The price of the product in question. • Demand curves intersect the (Y)-axis, as a result of
• The income available to the household. limited incomes and wealth.
• The household’s amount of accumulated wealth. -- reached saturation point
(Gives them capacity to purchase however and INCOME AND WEALTH
whatever they want) • Income is the sum of all households wages, salaries,
• The prices of related products available to the profits, interest payments, rents, and other forms
household. of earnings in a given period of time. It is a flow
• The household’s tastes and preferences. (changes measure.
in trends and demands) • Wealth, or net worth, is the total value of what a
• The household’s expectations about future income, household owns minus what it owes. It is a stock
wealth, and prices. measure.

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DEMAND, SUPPLY AND MARKET EQUILIBRIUM

RELATED GOODS AND SERVICES

• Normal Goods/superior goods are goods for which THE IMPACT OF A CHANGE IN INCOME
demand goes up when income is higher and for which
demand goes down when income is lower.
• Inferior Goods are goods for which demand falls when
income rises.
• Substitutes are goods that can serve as replacements
for one another; when the price of one increases,
demand for the other goes up. Perfect substitutes are
identical products.
• Complements are goods that “go together”; a decrease • Higher income decreases the demand for an inferior
in the price of one results in an increase in demand for good
the other, and vice versa. • Higher income increases the demand for a normal good
Ex. Gasoline and car, sugar and coffee
SHIFTS OF DEMAND VERSUS MOVEMENT ALONG A THE IMPACT OF A CHANGE IN THE PRICE OF RELATED
DEMAND CURVE GOODS
- a change in demand due to a change in price
• A change in
demand is not the
same as a change in
quantity demanded.
• In this example,
a higher price causes
lower quantity
demanded.
• Changes in
determinants of demand, other than price, cause a
change in demand, or a shift of the entire demand
curve, from DA to DB.
FROM HOUSEHOLD TO MARKET DEMAND
• When demand • Demand for a good or service can be defined for an
shifts to the right, individual household, or for a group of households
demand increases. This that make up a market.
causes quantity • Market demand is the sum of all the quantities of a
demanded to be good or service demanded per period by all the
greater than it was households buying in the market for that good or
prior to the shift, for service.
each and every price
level. Assuming there are only two households in the market,
To summarize: market demand is derived as follows:

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DEMAND, SUPPLY AND MARKET EQUILIBRIUM

SUPPLY IN OUTPUT MARKETS A CHANGE IN SUPPLY VERSUS A CHANGE IN QUANTITY

• A supply schedule is a table SUPPLIED
showing how much of a product • A change in supply is not
firms will supply at different the same as a change in
prices. quantity supplied.
• Quantity supplied represents the • In this example, a higher
number of units of a product that price causes higher
a firm would be willing and able to quantity supplied, and a
offer for sale at a particular price move along the demand
during a given time period. curve.
• In this example, changes
in determinants of supply, other than price, cause an
increase in supply, or a shift of the entire supply curve,
THE SUPPLY CURVE AND THE SUPPLY SCHEDULE from SA to SB.
• A supply curve is a graph illustrating how much of a
product a firm will supply at different prices. • When supply shifts to
the right, supply increases.
This causes quantity
supplied to be greater than
it was prior to the shift, for
each and every price level.

To summarize:

THE LAW OF SUPPLY

• The law of
supply states that there
is a positive relationship
between price and
quantity of a good
supplied.
• This means that
supply curves typically
have a positive slope.
- ability and willingness of the supplier to produce.
DETERMINANTS OF SUPPLY FROM INDIVIDUAL SUPPKY TO MARKET SUPPLY
• The price of the good or service. (the higher, tends • The supply of a good or service can be defined for an
to produce more) individual firm, or for a group of firms that make up a
• The cost of producing the good, which in turn market or an industry.
depends on: • Market supply is the sum of all the quantities of a good
• The price of required inputs (labor, capital, or service supplied per period by all the firms selling in
and land), the market for that good or service.
• The technologies that can be used to
produce the product, MARKET SUPPLY
• The prices of related products. • As with market demand, market supply is the horizontal
summation of individual firms’ supply curves.

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DEMAND, SUPPLY AND MARKET EQUILIBRIUM

MARKET EQUILIBRIUM DECREASES IN DEMAND AND SUPPLY

• The operation of the market depends on the interaction
between buyers and sellers.
• An equilibrium is the condition that exists when
quantity supplied and quantity demanded are equal.
• At equilibrium, there is no tendency for the market price
to change.
- Only in equilibrium is quantity
supplied equal to quantity
demanded.
- At any price level other than P0,
the wishes of buyers and sellers • Lower demand leads to lower price and lower
do not coincide. quantity exchanged.
MARKET DISEQUILIBRIA • Lower supply leads to higher price and lower
• Excess demand, or quantity exchanged.
shortage, is the condition that
exists when quantity RELATIVE MAGNITUDE OF CHANGE
demanded exceeds quantity
supplied at the current price.
• When quantity
demanded exceeds quantity
supplied, price tends to rise
until equilibrium is restored.

• Excess supply, or
surplus, is the condition that
exists when quantity supplied
exceeds quantity demanded at • The relative magnitudes of change in supply and
the current price. demand determine the outcome of market
• When quantity supplied equilibrium.
exceeds quantity demanded,
price tends to fall until
equilibrium is restored.

INCREASES IN DEMAND AND SUPPLY

• When supply and demand both increase, quantity

will increase, but price may go up or down.

• Higher demand leads to higher equilibrium price

and higher equilibrium quantity.
• Higher supply leads to lower equilibrium price and
higher equilibrium quantity.

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 ELASTICITY OF DEMAND AND SUPPLY
in order to determine the value of products sold in the market.
FUNCTIONS OF PRICES:
determine who among the millions will be
Macrolevel [
1. Rationing Device able to avail or buy the goods or service.
2. Transmitter of Information conveys information; there may shortage
or surplus.
Price Control
1. Price Ceiling – is a
maximum price that seller
may change for good,
usually set by the
government
Ex. Rent control
distorted price, tendency for
shortage to occur.
support prices
2. Price Floor – is a price
above equilibrium price
that the buyers have pay.
Ex. Agricultural support
price, Minimum wages
Elasticity degree of response of consumer
❑ A relatively flat demand curve implies that a small
increase in price leads to a
large fall in # visits demanded.
❑ A measure of the responsiveness of one variable to
changes in another variable; the percentage change
in one variable that arises due to a given percentage
change in another variable.
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Cross Price Elasticity:
✔ A measure of the responsiveness of the demand for
a good to changes in the P of a related good;
✔ The cross-price elasticity is positive whenever
goods are substitutes.
✔ While, negative whenever goods are
complements.
Income Elasticity
✔ A measure of the responsiveness of the demand for
a good to changes in consumer income;
✔ The income elasticity is positive
whenever the good is a normal good.
✔ The income elasticity is negative
whenever the good is an inferior
good.
Factors affecting Income Elasticity:
✔ Nature of the good.
✔ Inferior goods have negative income elasticity.
✔ Normal goods have positive income elasticity.
✔ Luxury goods have income elasticity greater than
one.
✔ Necessary goods have income elasticity less than
one.
Price Elasticity of Supply:
o The responsiveness of supply to changes
in price.
o If Ɛs is inelastic (˂1)- it will be difficult for suppliers
to react swiftly to changes in price.
o If Ɛs is elastic (˃1)- suppliers can react quickly to
changes in price.
Paradox of the Bumper Harvest:
❑ When prices of food crops increase, the demand
does not increase proportionally.
❑ Hence the revenue earned by farmers fall.
❑ The government announces a floor price for the
farmers-agricultural price subsidy.
❑ This interference with prices comes at a cost to the
Government in a form of Storage Costs and
Government granaries.
Arc Elasticity
❑ To get the average elasticity between two points on
a demand curve, we take the average of the two
end points (for both price and quantity) and use it
as the initial value.
ELASTICITY OF DEMAND AND SUPPLY
Types of Demand Elasticity:
1. Own-Price Elasticity of Demand
Example: If the elasticity of demand for physician visits is -.6,
a 10% increase in price leads to a 6% decrease in the number
of visits demanded.
Elasticities are scale free.
2. Income Elasticity of Demand
Ex: If the elasticity of demand for physician visits is .1, a 10%
increase in income leads to a 1% increase in the number of
visits demanded.
For most types of medical care, EY should be positive
3. Cross-price elasticity of demand:
Example: If the elasticity of demand for Tylenol with respect
to the price of Advil is 1.5, a 10% increase in the price of Advil
leads to a 15% increase in the quantity of Tylenol demanded.
Determinants of Elasticity
❑ Number and closeness of substitutes- the greater
the number of substitutes, the more elastic.
❑ The proportion of Income taken up by the product-
the smaller the proportion the more inelastic.
❑ Price of the product- lower the price, the lower the
elasticity.
❑ Luxury or Necessity- for example, addictive drugs.
❑ Time period- the longer the time under
consideration, the more elastic a good is likely to
be.
Application of Elasticity:
Elastic - a smaller change in the denominator (P) leads to a greater change in
the numerator (QD). (Horizontal line) ex. product with a lot of alternatives, and
competitors, and unnecessary
- every time the denominator changes, numerator also change.
-- result is always negative
Inelastic - a greater change in the denominator (P) leads to a smaller change in
the numerator (QD). (Vertical line) ex. needs, gas, medicine, dialysis or
treatment.
consumers are unresponsive to price change because the product is important
and there is a limited substitute. [relatively unresponsive]
Cross - two products involved
indicator/denominator - price of PB
If the price of PB increase, and the impact on the demand of Product A
decreases, then they're inversely related. which means the elasticity of demand
or coefficient is less than 0 (complements)
PB increase, PA Increase, - positively related. greater than 0 (substitutes)
Income
Indicator/denominator - income
If the income increase, and the impact on the demand of Product A decreases.
then, it's less than 0 (inferior goods)
Price Elasticity of Supply
- Both supply and price of product increases
- always positive
Tax incidence
demand is elastic, consumer will not pay the burden of the tax
the one who will pay are the owner
demand is inelastic, consumer most likely avail the service, or buy the product.
- pag implement ng tax nakadepende sa kung anong kind ng elasticity.