Managerial

Economics
COURSE CODE: ECN 51

MISHAEL JOY S. BARRERA

Economics Department
College of Business, Economics, and Accountancy
Course Description
Managerial Economics is the application of economic theory and
methodology to managerial decision making problems within various
organizational settings such as a firm or a government agency. It is a study
of how the theory of consumer behavior, firm and market structures can be
used to guide management decision making. Applications are made under
different market situations. Emphasis on the use of mathematical tools are
given. Students taking this course are expected to have had some exposure
to economics and be comfortable with basic algebra. Some knowledge of
calculus would also be helpful.
 Contents
Unit I. Introduction
1. Nature and Methods of Economics
a) Economics Defined
b) Importance of Economics
c) Basic Concepts and the Fundamental Economic Questions
2. Scope of Managerial Economics
a) Firms and Managerial Objectives
b) Economic Optimization
c) Firms and Profits
 Contents
Unit I. Introduction
3. Tools of Economic Analysis
4. Decision Theory
a)Decision Making under Certainty
b)Decision Making under Risk
c) Decision Making under Uncertainty
 Learning Outcomes
At the end of the unit, the students are expected to:

1. define and understand basic economic terms

2. discuss the scope of managerial economics
3. understand the different tools in economic analysis and its
application to managerial decision making
4. differentiate the three decision making environments; and
5. solve decision making problems using the expected value
criterion.
 Unit I
INTRODUCTION
4.
Decision Theory
Decision Theory

Represents a general approach to decision making which is

suitable for a wide range of management decisions,
including:

Capacity Planning Product and Service Design

Location Planning Equipment Selection
Product-Mix Policies
Decision Theory

A decision problem Decision Alternatives

is characterized by ▸ Different possible strategies
decision that the decision maker can
alternatives, states employ
of nature, and ▸ Courses of action or strategy
resulting payoffs that may be chosen by the
decision maker
Decision Theory

A decision problem States of Nature

is characterized by ▸ Refer to future events, not
under the control of the
decision decision maker, which will
alternatives, states ultimately affect decision
of nature, and results
resulting payoffs ▸ Outcomes over which the
decision maker has little or no
control
Decision Theory
Payoffs
A decision problem
is characterized by ▸ The consequence resulting from
a specific combination of a
decision decision alternative and a state
alternatives, states of nature
of nature, and ▸ Conditional values
resulting payoffs ▸ Can be expressed in terms of
profit, cost, time, distance, or
any other appropriate measure
Decision Theory
Payoff Table
▸ A table showing all possible combinations of decision
alternatives and states of nature
▸ Represents a range of potential future events
▸ Presents the potential economic outcomes of the
alternatives available to the decision maker
Decision Theory
Payoff Table

STATES OF NATURE
ALTERNATIVES O1 O2
A1 $$$ ($$$)
A1 $$$ ($$$)
A1 $$$ $$$
 Three-Egg Omelet Problem
You are preparing a three-egg omelet.
Having already broken two good eggs into
the pan, you are suddenly assailed by
doubts about the quality of the third. As yet
unbroken egg, two things may happen:
either the egg is good or it is rotten.
Three-Egg Omelet Problem
STATES OF NATURE
ALTERNATIVES 3rd egg is good 3rd egg is rotten
Break 3rd egg into 3-egg omelet No egg omelet, 2
pan good eggs
destroyed
Break 3rd egg into 3-egg omelet, one 2-egg omelet, one
saucer and inspect saucer to wash saucer to wash
Throw away 3rd egg 2-egg omelet, one 2-egg omelet
good egg destroyed
Decision Theory

6 Steps in Decision Theory

List the Select one

payoff of of the
Clearly Identify each Apply the
List all mathemati
define the the combination model and
possible cal
problem at possible of make your
alternatives. alternatives decision
hand. outcomes. decision.
and theory
outcomes. model.
Types of Decision-Making Environments

Certainty Risk Uncertainty

Decision makers Decision makers Decision makers do
know with certainty know the probability not know the
the consequence of of occurrence of each probabilities of the
every alternative or outcome. They tend various outcomes.
decision choice to maximize their
expected well-being.
Decision-Making under RISK
Decision-Making Under Risk

▸ Each possible state of nature has an assumed

probability
▸ States of nature are mutually exclusive
▸ Probabilities must sum to 1
▸ Determine the expected monetary value (EMV) for
each alternative
20

Maximization of Expected
Monetary Value (EMV)
“How much money you can expect to make from a certain decision.”
 𝒏

𝑬𝑴𝑽 = & 𝒑𝒊 𝑿𝒊
𝒊+𝟏
Where Xi is the ith outcome of a decision, pi is the
probability of the ith outcome, and n is the total
number of possible outcomes
Example

Problem:

Pareto Inc. wants to know if it can expand their

product line by manufacturing and marketing a
new product.
Example

Problem:

Pareto Inc. wants to know if it can expand their

product line by manufacturing and marketing a
new product.
STEP 2: Generate alternatives that are available.

a) Construct a large new factory

b) Construct a small new factory
c) Do nothing
STEP 3: Identify possible outcomes of the various
alternatives.

Market could be:

a. Favorable – high demand for
the product
b. Unfavorable – low demand for
the product
STEP 4: Express payoffs resulting from each possible
combination of alternatives.

STATES OF NATURE
Favorable Unfavorable
ALTERNATIVES
Market (PhP) Market (PhP)
Construct a
large new 200,000 (180,000)
factory
Construct a
small new 100,000 (20,000)
factory
Do nothing 0 0
STEP 5: Select the model depending on the environment.

STATES OF NATURE
Favorable Unfavorable
ALTERNATIVES
Market (PhP) Market (PhP)
Construct a large
new factory 200,000 (180,000)

Construct a small
new factory 100,000 (20,000)

Do nothing 0 0

Probabilities (pi) 0.5 0.5

STEP 6: Make your decision.

𝑬𝑴𝑽 𝑳𝑭 = 𝟎. 𝟓 𝟐𝟎𝟎, 𝟎𝟎𝟎 + 𝟎. 𝟓 −𝟏𝟖𝟎, 𝟎𝟎𝟎 = 𝟏𝟎, 𝟎𝟎𝟎

𝑬𝑴𝑽 𝑺𝑭 = 𝟎. 𝟓 𝟏𝟎𝟎, 𝟎𝟎𝟎 + 𝟎. 𝟓 −𝟐𝟎, 𝟎𝟎𝟎 = 𝟒𝟎, 𝟎𝟎𝟎

𝑬𝑴𝑽 𝑫𝑵 = 𝟎. 𝟓 𝟎 + 𝟎. 𝟓 𝟎 = 𝟎
MS. MISHAEL JOY S. BARRERA
Faculty, College of Business, Economics and Accountancy
+63917-182-2366 / barreramjs@mmsu.edu.ph

THANK YOU!