1-3

Learning Objectives
• Dear students, what will you learn in this module?
• In this module, you will learn the fundamentals of
Managerial Economics
• This knowledge will help you to achieve the
following module outcomes:
• What is managerial economics, and how it is a valuable tool for
analysing business situations?
• Why is it important to understand the difference between
accounting profits and economic profits?
• How do managers account for time gaps between costs and
revenues to make decisions?
• What economic principles can managers use to maximise profits?
 1-4

Learning Objectives
• This knowledge will help you to achieve the
following module outcomes:
• What is managerial economics, and how it is a valuable tool for
analysing business situations?
• Why is it important to understand the difference between
accounting profits and economic profits?
• How do managers account for time gaps between costs and
revenues to make decisions?
• What economic principles can managers use to maximise profits?
 5

MANAGERIAL
ECONOMICS
Terms and Definition
 1-6

What is ManagerialEconomics?
• Managerial economics is a valuable tool for
analysing business situations. It is a tool to
help managers make better decision.
• Why is managerial economics so valuable to a
diverse group of decision makers?
• In order to understand about managerial
economics and why it is so valuable, we need
to know the meaning of the term Manager and
Economics.
 1-7

“Manager” in Managerial Economics

Who is “the Manager”?
• A person who directs resources (whether its people, money,
machine, etc) to achieve a stated goal (growth, revenue,
profit etc)
• Directs the efforts of others (followers, common people,
employees etc)
• Purchases inputs used in the production of output.
• Directs the product price or quality decisions.
 1-8

“Economics” in Managerial Economics

What is Economics?
• The science of making decisions in the presence of scarce (limited)
resources.
• Resources are used to produce a good or service.
• Economic Decisions are important because there are trade-offs
between scarcity and competition.
 1-9

So, what is ManagerialEconomics

• It is the study to understand how to direct
scarce resources (such as capital, assets,
people etc) in the way that most efficiently
achieves a managerial goal.
• That goal could be lower cost, higher revenue,
and higher profit.
 1-10

What is Managerial Economics

• Managerial Economics help firms make
difficult business decision such as:
• Whether it should purchase components from other manufacturers
or produce them within the firm?
• Whether it should specialize in making one type of computer or
produce several different types?
• How many computers should it produces, and at what price should
it sells them?
 2-11

MANAGERIAL ECONOMICS
AS A TOOL FOR DECISION
MAKING
Using economics to manage organization effectively
 2-12

Managerial Economics aValuable Tool

• Dear students, now you know what is "Manager",
"Economics" and "Managerial Economics".
• Now we need to understand how managerial economics
is a valuable tool for analyzing business situations
 1-13

Economics of Effective Management

What is the use of economics for effective business
management?

 Since this course is designed for you as managers of

firms or businesses, we focus on studying the usage of
economics for effective managerial decisions as they
relate to maximising profits or the value of the firm.
 2-14

Economics of Effective Management

• What are the basic Economic Principles for Effective
Management?
• We will go through each principle to understand what can
influence the economic decisions.
• It begins with identify goals and constraints
• Sound decisions must have well-defined goals.
• The decision maker often faces constraints that affect the ability to
achieve a goal.
• For example, if your goal is to maximise your grade in this course
rather than maximise your overall grade point average, your study
habits will differ accordingly.
 1-15

The Goal of MaximizingProfits

• The goal of maximising profits requires a decision about
the optimal price for a product.
• Total Sales (Revenue) = Price x Unit of Product/Services Sold
• Profit = Sales – Cost

• The managers should decide how much to produce, use

of technology, input use, and how to react to the decision
made by competitors.
Accounting Profit vs. EconomicProfit
Accounting Profit
• The total amount of money taken in from sales (total
revenue) minus the dollar cost of producing goods and
services.
• Accounting Profit = Sales – Cost of Producing Goods and Services
Economic Profit
• The difference between the total revenue (sales) and the
total opportunity cost of producing the firm's goods or
services.
• Economic Profit = Total Revenue – Total Opportunity Cost of
Producing Goods and Services
• Please view
• https://www.youtube.com/watch?v=a0nUWrnuUdo
Opportunity Cost
• The opportunity cost of using a resource
includes both explicit (or accounting cost) and
implicit cost of giving up the best alternative
use of the resource.
• Implicit costs are very hard to measure and
therefore managers often overlook them.
• Please view
• https://www.youtube.com/watch?v=NwOYLV-L7pc
Explicit Cost vs. ImplicitCost
• For example, an employee could take a
vacation and travel.
• The explicit costs would include travel
expenses, the cost of a hotel room, and costs
related to entertainment.
• The implicit costs relate to the tradeoff,
namely the wages that the employee could
have earned if the vacation was not taken.
• https://keydifferences.com/difference-
between-explicit-cost-and-implicit-cost.html
Opportunity Cost
• Profits signal to resource holders where
resources are most highly valued by society.
• To know more on this, you may refer to the
textbook on the role of profits.
• Or
https://www.economicshelp.org/blog/572/
business/the-role-of-profit-in-an-economy/
 20

FRAMEWORK FOR
SUSTAINABLE INDUSTRY
PROFITS
5 Porter Forces
Framework for Sustainable IndustryProfits

• Michael Porter’s “five forces” framework

organises many complex managerial economics
issues into five categories or “forces” that impact
the sustainability of industry profits:
• Entry
• Power of Input suppliers
• Power of buyers
• Industry rivalry
• Substitutes and Complements
 1-22

Five Forces and IndustryProfitability

 Entry Costs
Entry  Network Effects
 Speed of Adjustment  Reputation
 Sunk Costs  Switching Costs
 Economies of Scale  Government Restraints

Power of Power of
Input Suppliers Buyers
 Supplier Concentration
 Buyer Concentration
 Price/Productivity of
Alternative Inputs
Level, Growth,  Price/Value of Substitute
Products or Services
 Relationship-Specific and Sustainability  Relationship-Specific
Investments of Industry Profits Investments
 Supplier Switching Costs
 Customer Switching Costs
 Government Restraints
 Government Restraints

Industry Rivalry Substitutes & Complements

 Concentration
 Price, Quantity, Quality,
or Service Competition
 Degree of Differentiation
 Switching Costs
Price/Value of Surrogate Products Network Effects
 Timing of Decisions
or Services Government
 Information
Price/Value of Complementary Restraints
 Government Restraints
Products or Services
 2-23

Five Forces and IndustryProfitability

Based on Michael Porter's Five Forces
Framework, you may refer to the descriptions
below for each of the elements:

Entry
• More competition and reduces the margins of
existing firms in the wide variety of industry
settings.
• Sustainable profits of existing firms depend on
barriers to entry.
 2-24

Five Forces and IndustryProfitability

Power of Input Suppliers
• Industry profits tend to be lower when suppliers
have the power to negotiate favorable terms for
their inputs.

Power of Buyers
• Industry profits tend to be lower when customers
have the power to negotiate favorable terms for
the products or services produced in the industry.
 2-25

Five Forces and IndustryProfitability

Industry Rivalry
• Sustainability of industry profits depends on the
nature and intensity of rivalry among firms. The
rivalry is less in the concentrated industries.

Substitutes and complements

• Industry profits also depend on the price and
value of interrelated products and services.
 2-26

Five Forces and IndustryProfitability

Five Forces Explained – Airline Industry
• https://www.youtube.com/watch?
v=hUWAwor9rcA

Five Forces Explained – Mobile Phone Industry

• https://www.youtube.com/watch?v=h7ve8WhgF6c
 27

ECONOMIC INCENTIVES
 1-28

Understanding Incentives
• Changes in profits (growth in profit) provide an
incentive to how resource holders use their
resources.
• Economic incentives are what motivates you to
behave in a certain way, while preferences are
your needs, wants and desires. Economic
incentives provide you the motivation to pursue
your preferences.
• People respond to Incentives
https://www.youtube.com/watch?v=s1doqxnKH8I
 1-29

Understanding Incentives
• Within a firm, incentives impact how resources
are used and how hard workers work.
• One role of a manager is to construct incentives
to induce maximal effort from employees.
• Salary
• Commission
• Bonus

• Many professionals and owners of small

establishments have difficulties because they do
not fully comprehend the importance of the role
incentives play in guiding the decisions of others
 1-30

What is a Market?
• Market transaction has two sides:
• Buyer.
• Seller.

• Bargaining position of consumers and producers is limited

by three rivalries in economic transactions:
• Consumer-producer rivalry.
• Consumer-consumer rivalry.
• Producer-producer rivalry.
 2-31

Role of Government in aMarket

• What is the role of the government to regulate the
market?
• When agents on either side of the market find themselves
disadvantaged in the market process, they attempt to
induce the government to intervene on their behalf.
• Can the Government run the Economy?
https://www.youtube.com/watch?v=La98xr40Cfk
 2-32

TIME VALUE OF MONEY

 2-33

The Time Value of Money

• Dear students, we now discuss how managers can use
present value analysis to properly account for the timing
of many decisions involves a gap between the time when
the costs of a project are borne and the time when the
benefits of the project are received.
• Managers can use present value analysis to properly
account for the timing of receipts and expenditures.
• Time value of money – concept of present value
https://www.youtube.com/watch?v=1CO5hf2ns18
 1-34

Present Value Analysis

• The amount that would have to be invested today at the
prevailing interest rate to generate the given future value.
• Present value of a future value
• The amount that would have to be invested today at the prevailing
interest rate to generate the given future value:
𝑃𝑉=𝐹𝑉/(1+𝑖)↑𝑛
• Present value reflects the difference between the future value and
the opportunity cost of waiting:
𝑃𝑉=𝐹𝑉−𝑂𝐶𝑊
 1-35

The Time Value of Money

• Consider a project that returns the following income
stream:
• Year 1, $10,000; Year 2, $50,000; and Year 3, $100,000.
• At an annual interest rate of 3 percent, what is the present value of
this income stream?

𝑃𝑉 =$10,000 /( 1+0.03 )↑ 1 +$50,000 /( 1+0.03 )↑ 2 +$100,000 /

( 1+0.03 )↑ 3 =$148,352.70
 2-36

Present ValueAnalysis
• The higher the interest rate, the higher the opportunity
cost of waiting to receive a future amount and thus the
lower the present value of the future amount.
 1-37

Net Present Value

• The present value of the income stream generated by a
project minus the current cost of the project:
• Given the present value of the income stream that arises
from a project, one can easily compute the net present
value of the project.

Profit maximization principle

• Maximizing profits means maximizing the value of the firm, which is
the present value of current and future profits.
 38

MARGINAL ANALYSIS
 1-39

Understanding Marginal Analysis

• Dear Students, Marginal analysis is the important concept
in economics.
• What is marginal analysis?
• The marginal analysis states that optimal managerial
decisions involve comparing the marginal (or incremental)
benefits of a decision with the marginal (or incremental)
costs.
• Given a control variable, , denote the
• total benefit as , total benefits derived from Q units.
• total cost as , representing the total costs of corresponding level of
Q.
 1-40

Understanding Marginal Analysis

• Marginal benefit refers to what people are willing to give
up in order to obtain one more unit of a good, while;
• marginal cost refers to the value of what is given up in
order to produce that additional unit.
• Additional units of a good should be produced as long as
marginal benefit exceeds marginal cost.
• Manager’s objective is to maximize net benefits (produce
goods at maximum profit)
• Marginal Analysis Video
https://www.youtube.com/watch?v=ywHW1-xP0PQ
 Marginal Analysis
• How can the manager maximize net benefits?
• Use marginal analysis
• Marginal benefit: 𝑀𝐵(𝑄)
• The change in total benefits arising from a change in the managerial
control variable, 𝑄.
• Marginal cost: 𝑀𝐶(𝑄)
• The change in the total costs arising from a change in the managerial
control variable, 𝑄.
• Marginal net benefits: 𝑀𝑁𝐵(𝑄)
𝑀𝑁𝐵(𝑄)=𝑀𝐵(𝑄)−𝑀𝐶(𝑄)
 1-42

Marginal Analysis Principle

• Marginal principle
• To maximize net benefits, the manager should increase the
managerial control variable up to the point where marginal
benefits equal marginal costs.
• At this level (MB = MC) marginal net benefits are zero; nothing
more can be gained by further changes in that variable.
Figure below depicts the marginal benefits,
marginal costs, and marginal net benefits.
Total benefits
Total costs Maximum total benefits

𝐶(𝑄)

𝐵(𝑄)
Maximum net
benefits

0 Quantity
(Control Variable)
 1-44

Determining the Optimal Level of a Control

Variable II
Net benefits

Maximum
net benefits

Slope =𝑀𝑁𝐵(𝑄)

0 Quantity
(Control Variable)
𝑁(𝑄)=𝐵(𝑄)−𝐶(𝑄)=0
Determining the Optimal Level ofa
Control Variable III
Marginal
benefits, costs
and net benefits

Maximum net
benefits 𝑀𝐶(𝑄)

0 Quantity
𝑀𝑁𝐵(𝑄) 𝑀𝐵(𝑄) (Control Variable)
 2-46

Maximum Total Benefits

• At the level Q where the marginal benefit curve intersects
the marginal cost curve, marginal net benefits are zero.
That level Q maximizes net benefits.
 2-47

RECAP
On Key Terms and Concepts