Introduction to

Managerial Economics
Module 1
Objective:

• 1.Discuss what managerial economics is

and its relationships to other disciplines
• Lesson 1.1:
Economic theory and business economics

• Lesson 1.2:
Managers, Firms and Markets

• Lesson 1.3:
Fundamentals of Managerial Decision Making
Economic Theory and Business Economics
Lesson 1.1
Economics

• Economics is the science of making decisions

in the presence of scarce resources.
• Resources are simply anything used to produce
a good or service or, more generally, to
achieve a goal.
• Decisions are important because scarcity
implies that by making one choice, you give up
another.
Can you buy all of these shirts?
• We don’t have unlimited supply of everything.

• Using a resource would cost something as well.

 Resources are simply
anything used to produce a
good or service or, more
generally,
to achieve a goal.
https://www.weforum.org/agenda/2022/03/how-does-the-war-in-ukraine-affect-oil-prices/
How does oil prices affect firms and
people?
Economic Decisions

• Allocation of scarce resource and a

manager’s task is to allocate resources
so as to best meet the manager’s goals.
• Time is one of the scarcest resources of
all.
• Your primary decision problem is to
allocate a scarce resource—time—to
achieve a goal
Resources
Time
Managerial Economics

• Managerial economics is the study of how to

direct scarce resources to achieve a
managerial goal (Baye and Prince, 2022).
Can a company employ a lot of employees if they want to?
https://www.cnbc.com/2023/01/18/microsoft-is-laying-off-10000-employees.html
• The key to making sound decisions is
to know what information is needed to
make an informed decision and then
to collect and process the data.
What resources are abundant in your
area?

What resources are scarce?

Baybay- coastal area- seafoods
Economic theory simplifies complexity

❑ Theory allows people to gain insights into

complicated problems using simplifying
assumptions to make sense out of confusion, to
turn complexity into relative simplicity.
❑ Using economic theory is in many ways like using
a road map.
❑ The economic approach to understanding
business reduces business problems to their most
essential components.
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Managerial Economics and
Traditional Economics
• Macroeconomics and Microeconomics are the two
major subfields of economics.

Microeconomics deals with the behavior of

individual entities like the individual, firms and
households.
Macroeconomics deals with the overall
performance of the economy.
• Managers make a ton of decisions
concerning demand, supply, the production
and the market.

Customers

Company

Competitors
Managerial Economics and Accounting
• Accounting is the process of recording the
financial operations of a firm.

• With this, accounting and Managerial Economics

are related because a manager would need lots of
accounting data in order to make sound
decisions.
 Economic cost of using resources

❑ Market supplied resources

Customers
▪ Resources owned by others and hired, rented or
leased in resources markets.

▪ i.e. labor services of skilled and unskilled

workers, raw materials purchased in resource
markets from commercial suppliers, capital
equipment rented or leased from equipment
supplier
27
 Economic cost of using resources

❑ Owner supplied resources Firms or farms

▪ Resources owned and used by a firm.

▪ Three most important owner – supplied

resources:
• Money provided to the business by the
owner
• Time and labor provided by firm’s owner.
• Any land, buildings, or capital owned by
the owned and used by the firm.
28
 Economic cost of using resources

❑ Explicit costs
▪ Opportunity cost of using market-supplied
resources are the out of the pocket monetary
payments made to the owner of the resources.

29
 Economic cost of using resources

❑ Implicit costs
▪ Non-monetary opportunity costs of using owner-
supplied resources.
Time
▪ Opportunity cost of using owner-supplied resources is
the best return the owner of the firm could have
Effort received had they taken their own resource to
market instead of using it themselves.

Opportunity cost
Reputation of investment 30
 Economic cost of using resources

❑ Total economic cost

▪ Sum of opportunity costs of market-supplied resources
plus opportunity costs of owner supplied resources.

+ =

31
 Economic Profit vs Accounting Profit

❑ Economic Profit
▪ Total revenue – total economic cost
▪ Total revenue – explicit costs – implicit costs

❑ Accounting Profit
▪ Total revenue – explicit costs

✔ Accounting profit does not subtract implicit costs from

total revenue.
✔ Firms owners must cover all costs of all resources used by
the firm.
✔ Objective is to maximize economic profit 32
 Economic Profit vs Accounting Profit

❑ Sample problem
During a year of operation, Pedro collects Php175,000 in revenue and
spends Php80,000 on raw materials, labour expense, utilities, and rent.
Pedro has provided Php500,000 of his own money to his firm instead of
investing the money and earning a 14 percent annual rate of return.

Costs and Profit Derivation

Explicit cost 80,000
Implicit cost 70,000 (500,000 * 14%)
Total economic cost 150,000 (implicit cost + explicit cost)
Accounting profit 95,000 (total revenue – explicit cost)
Economic Profit 25,000 (total revenue – total economic cost
33
Managerial Economics and
Operations Research
• Operations Research is the application of scientific
principles and quantitative analysis to solve business
problems.

• Just like in Operations research where optimizing or

finding the best alternative is very important,
Managerial economics would need to apply such
concepts in decision-making to best utilize the scarce
resources.
Summary

• Economics- decisions, scarce resources

• Managers- decisions, goal

Related fields:
1. Microeconomics and macroeconomics

2. Accounting

3. Operations research
Summary- Terms learned

• Market supplied resources

• Owner supplied resources
• Explicit costs
• Implicit costs
• Total economic profit vs. total accounting profit
Managers, firms and markets
Lesson 1.2
Managers
Manager
• A manager is someone who is
responsible in allocating resources to
achieve a company’s vision.

• A manager is accountable for his own

actions and for the actions of others
like the employees, other inputs and
machineries (Baye and Prince, 2014).
Manager

• (1) direct the efforts of others, including those

who delegate tasks within an organization such
as a firm, a family, or a club;
• (2) purchase inputs to be used in the production
of goods and services such as the output of a
firm, food for the needy, or shelter for the
homeless; or
• (3) are in charge of making other decisions, such
as product price or quality.
𝑨 𝒎𝒂𝒏𝒂𝒈𝒆𝒓’𝒔 𝒕𝒂𝒔𝒌 𝒊𝒔
𝒕𝒐 𝒎𝒂𝒙𝒊𝒎𝒊𝒛𝒆 𝒕𝒉𝒆
𝒔𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓’𝒔
𝒘𝒆𝒂𝒍𝒕𝒉.
Firms
 Maximizing the value of the firm

❑ Value of the firm

▪ The price for which it can be sold.
▪ the value the firms earns
▪ Equal to net present value of expected future
profits. 𝑡
𝜋1 𝜋2 𝜋𝑡 𝜋𝑡
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑓𝑖𝑟𝑚 = + 2 + ⋯+ 𝑡 =෍ 𝑡
(1 + 𝑟) (1 + 𝑟) 1+𝑟 1+𝑟
𝑡=1

▪ 𝜋𝑡 = the economic profit expected in period 𝑡

▪ 𝑟 = the risk adjusted discount rate
▪ 𝑡 = the number of years in the life of the firm
44
 Maximizing the value of the firm

• When today’s decisions affect profits in future time

periods, price or output decisions that maximize
profit in each (single) time period will not maximize
the value of the firm.

Activities that damage the environment

Activities that damage the community

 ₱
₱

Markets
 Market structure and managerial decision
making

❑ What is a market?
▪ Any arrangement through which buyers and sellers
exchange anything of value.

▪ Markets are arrangements that reduces the cost of

making transactions.

▪ The structure of the market governs the degree of

pricing power possessed by a manager and
determine the environment in which the firm
operates.
48
Households Firms

MARKETS
 Market structure and managerial decision
making

❑ Economic characteristics needed to

describe a market.
✓ The number and size of the firms operating in
the market.
✓ The degree of product differentiation among
competing producer.
✓ The likelihood of new firms entering a market
when incumbent firms are earning economic
profits.
50
 Market structure and managerial decision
making

❑ Perfect competition
▪ A large number of relatively small firms
sell an undifferentiated products in a
market with no barriers to the entry of
new firms.
▪ Price-taker with no market power.

51
• Most market for agricultural goods and other
commodities traded both national and international
exchanges closely match the characteristics of
perfect competition.
 Market structure and managerial decision
making

❑ Monopoly

▪ A single firm, protected by some kind of

barrier to entry, produces a product for
which no close substitutes are available.

▪ A price setting firm.

53
The existence of a barrier to entry allows
monopolist to raise its price without concern
that economic profit will attract new firms.
 Market structure and managerial decision
making

❑ Monopolistic competition
▪ A large number of firms that are small
relative to the total size of the market
produce differentiated products without the
protection of barriers to entry.

▪ The product differentiation gives

monopolistic competitors some degree of
market power.

▪ Price setter rather than price-takers. 55

Restaurant 1- Korean unli
Restaurant 2- Carenderia
 What other
restaurants can
you think of?
 Market structure and managerial decision
making

❑ Oligopoly
▪ Only a few big firms produces most or all of
the market output.
▪ Any firm’s pricing policy will have a
significant effect on the sales of other firms
in the market.
▪ The strategic decision making in oligopoly
market is the most complex of all decision-
making situation.
59
Which airline do you prefer when
travelling?
Globalization of market

▪ The economic integration of markets located in nations

throughout the world.

▪ Takes place when goods, services and resources flow

freely across national borders.

▪ Provides managers with an opportunity to sell more

goods and services to foreign buyers and to find new
and cheaper resources.

▪ Benefits comes with a threat of a more intensified

competition by foreign businesses.
62
Basic circular flow

• In Economics, most of the analysis starts with the

basic circular flow. It shows the interdependence of
two entities in the economy: households and firms.
The model describes the flow of money and
products throughout the economy in a simplified
way (Jimenez, 2022).
Circular flow model
4 factors in the market:

▪ Land
▪ Labor
▪ Capital
▪ Entrepreneurship

➢ These 4 factors of will become inputs of production

to the firm.

➢ The output will be the goods and services, which

can be purchased by the household again.
• Fundamental questions to answer:

• What goods and services will be produced?

(Products)
• How will the goods and services be produced?

(Methods)
• Who will get the goods and services?

(People)

• How will the system accommodate change?

• How will the system promote progress?
Summary

• Managers in different market structures

Market structures
1. Perfect competition

2. Monopolistic competition

3. Oligopoly

4. Monopoly

• Circular flow
Summary- terms learned

• Manager
• Sustainability
• Circular flow
Fundamentals of Managerial
Decision-making
Lesson 1.3
THE ECONOMICS OF EFFECTIVE MANAGEMENT

Before embarking on this special use of managerial

economics, we provide an overview of the basic
principles that comprise effective management.

In particular, an effective manager:

1) identify goals and constraints
2) recognize the nature and importance of profits,
3) understand incentives
4) understand markets
5) recognize the time value of money,
6) use marginal analysis
7) make data-driven decisions.
1. Identify goals and constraints
• The first step in making sound decisions is to have
well-defined goals because achieving different goals
entails making different decisions.

• Constraints are an artifact of scarcity.

 What specific goal do you want?
---produce products---

How many should be produced?

Attainable, achievable, actionable…

---10,000 products---

Think of the long-term…

When will you start, what would you

do this year?
• If your goal is to maximize your grade in this course
rather than maximize your overall grade point average,
your study habits will differ accordingly. The 24-hour day
affects your ability to earn an A in this course.

• A budget affects the ability of the food bank to

distribute food to the needy.
2. Recognize the nature and
importance of value
• Remember economic costs wherein explicit and
implicit costs should be accounted for us to
know our economic profits.
• Profits signal the owners of resources where the
resources are most highly valued by society.
• By moving scarce resources toward the
production of goods most valued by society, the
total welfare of society is improved.

• The overall goal of most firms is to maximize

the firm’s value.
• Wealth maximization is focused on the long-
term earnings that a company can gain
through time while profit maximization is
focused on the short-term earnings.
Environmental issues Social issues
• If a company is focused on the value rather than the
short-term earnings or profits, a company will try to
be socially responsible.

• In this way, they will not do some actions that might

cause their reputation or actions that might be
unethical or illegal.
Social enterprises
Junknot
Rolyolikha
Other examples

Help the community of coconut farmers

Human Nature
Five forces framework

• A key theme of this textbook is that many

interrelated forces and decisions influence the
level, growth, and sustainability of profits.
• If you or other managers in the industry are
clever enough to identify strategies that yield a
windfall to shareholders this quarter, there is no
guarantee that these profits will be sustained in
the long run.
3. Understand incentives
Different employees= different incentives
• Incentives are there to encourage a person to do
something.

• As a manager, you need to understand your

employees and come up with incentive packages to
boost employees to work hard and do their tasks
well and thus increase the shareholders’ wealth.
If targets are reached…
4. Understand markets
• Markets bring together the suppliers and the buyers.

• As a manager, you should remember that a

transaction is a two-way process.

• Moreover, there is an exchange of value from both

parties.

• As a participant in the market, you have the power,

the bargaining position.

• You can negotiate for prices sometimes, sometimes

not.
5. Recognize the time value of
money
 Which is more important?
Your Php100 today or Php100 in the future?
• With time value of money, it is said that the money
you have now is more important than receiving
money in the future.

• This is because the money that you have now can

gain an interest. Imagine, if you put your Php 100.00
in the bank.

• If the bank issues 10% annual interest for deposits

made then, you will have Php 110.00 in the bank
after a year.
As of Feb. 5, 2024-5 yr overview
As of Feb. 5, 2024-5 yr overview
 If you didn’t receive the money and invested it,
then you would not have earned anything at all.
6. Use marginal analysis
• Marginal analysis is about answering whether a
decision would have marginal benefits than the
marginal cost.
• As much as possible, actions done should generate
more marginal benefits than the marginal costs.

• For example, Ethyl is a Human resources manager

and was given a report about the 6 workers in the
production. She wants to develop an incentives
program. When she did the marginal analysis, she
noticed that employee 2 and 4 were not productive,
creating more cost than benefit to the firm. Thus,
she would need to think of ways to encourage
workers to work efficiently.
7. Make data-driven decisions
• Thanks to the digital age, most managers have vast
quantities of data at their fingertips.
• Businesses and other organizations have personnel who
use econometrics—the statistical analysis of economic
data—to obtain quantitative estimates of how a
plethora of managerial control variables impact benefits
and costs.
 Use data-driven estimates of demand, costs,
and the competitive/strategic environment to
make sound managerial decisions.
 Summary:
“The Economics of effective
management”
1. Identify goals and constraints
2. Recognize the nature and importance of value
3. Understand incentives
4. Understand markets
5. Recognize the time value of money
6. Use marginal analysis
7. Make data-driven decisions
Thank you!