INTRODUCTION TO MANAGERIAL

ECONOMICS

DEFINITION
An application of economic theory and tools of
analysis of decision science tools to solve managerial
decision problems ((the 4 basic economic problems)
An application of economic concepts to business
problems
It applies economic models and reasoning in making
managerial decisions.
Managerial economics identifies ways to efficiently
achieve the organizations goals.
A firm is one of the economic units.Therefore, it can
be analyzed in the context of economic models.

Management Decision Problem

Economic Theory

Microeconomics
Macroeconomics

Decision Science

Numerical analysis
Statistical estimation
Forecasting
Optimization

Managerial economics
Optimal Solutions

RATIONALE FOR THE FIRM

OBJECTIVE OF THE FIRM

a) Maximize profit
Profit= Revenue cost
b) Maximize revenue
c) Minimize Cost
d) Maximize output

Many constrains exist that may influence the

decision making of firm. The constraints
include: Legal, Financial, Contractual,
Technological

Decision making means choosing one of the

best alternative from several alternatives

Managers must evaluate the implications of

alternatives and chooses the best alternative.
There are various areas involve in decision
making

Marketing- Maximize sales

Production-Minimize cost or maximize

output

Overall Management-maximize profit

Decisions are based on

limitations/constraints

FIRM IN MACROECONOMIC
ANALYSIS
(CIRCULAR FLOW DIAGRAM)

G&S

Product
Market
Revenue
Household

Firm
Costs
Resource
Resources

Market

IMPORTANCE OF MANAGERIAL
ECONOMICS

Guidance for business decision making

To solve managerial problems and the
theory can be applied to mgt decisions in
private and public sectors of the economy
(e.g of decisions-selection of goods and
services, choice of production methods,
determine price and output,etc)
Provide mgt with a strategic planning tool
Offer decision makers a way of thinking
about changes and framework for
analyzing the consequences of strategic
options

Basic training
Functional relation and economic model
Function- shows how one or more independent
variables can be transformed into, or associated with a
dependent variable.
e.g a) Univariate Y = f(X1)
b) Multivariate Y = f(X1, X2, X3)
Y dependent variable
X1,X2,X3
-independent variables
A change in X1,X2,X3 causes a change in Y.
e.g Total revenue depends on output
TR=f(Q)
Basic economic relations can be shown through:
-Table- list of economic data
-Graph-Visual representation of data
-Equation-analytical expression of functional
relationship.
TYPES OF FUNCTIONS
i) Linear Function
Y= a+ bX
a-intercept,

b-Slope/coefficient
6

ii) Quadratic function

ax 2 + bx + c = 0
iii) Cubic function
TC = 100 + 20 Q 5Q 2 + Q3
iv) Power Functions
Y = 8X6
Q = 1.5K0.6L0.2
METHODS OF DIFFERENTIATION
A) First Derivative
Derivative of a function (e.g dy/dx)
-Measure of its slope or marginal value at a
particular point.
-Measure the marginal change in Y asssociated
with a a very small change in X at that point.
e.g
Dependent variable- Y
Independent variable- X
Derivative: dy/dx

RULES OF DERIVATIVE
1. Derivative of a constant
e.g Y= 20
dy/dx = 0
2.Derivative of a constant times a function
Y = a f(X)
e.g Y = 3x
dy/dx = a f(X)
dy/dx = 3
3. Derivative of a power function
Y = ax b
e.g Y=4x2
dy/dx = b a X b-1
dy/dx= 8x
4. Derivative of a sum or difference
Y = f(X) + g(X)
Y = 2x + 4x 3
dy/dx= f(X) + g(X)
dy/dx= 2 + 12x2
5. Derivative of the product of two functions
Y= f(X) g(X)
dy/dx =f(X) g(X) + f(X) g(X)
y= (x 2 + 2x) (4x)
dy/dx= (2x + 2) (4x) + (x 2 + 2x) (4)
= 8x 2 + 8x + 4x 2 + 8x
= 12 x 2 + 16x

6.

Derivative of a quotient of 2 functions

Y= f(x) /g(x)
dy/dx = g(x)f(x) f(x) g(x)
[g(x)] 2
e.g Y = 2x 2 5x
x2
dy/dx = 5
x2

7.

Derivative of a function of a function (Chain

Rule)
e.g
y = (4x +2) 4
u= (4x +2)
y =u4
dy/dx=(dy/du) (du/dx)
= 4u3 4
=4(4x +2) 3 4
=16 (4x +2) 3

SECOND DERIVATIVE

i)

To distinguish maximum or minimum points of a

function.
Derivative of first derivative
The rate of change of the rate of change.
If negative- the rate of change is falling
If positive- the rate of change is increasing
Rule:
Maximum- Second derivative is negative
If total function is maximized, marginal
function has a negative slope
dy/dx= 0
d2 y/dx2 < 0

occurs if the slope passes through 0,

changing from positive to negative
dy/dx =0

dy/dx >0

dy/dx <0

10

 ii) Minimum- Second derivative is positive

Total function is associated with a
positive slope of marginal function
dy/dx = 0
d2 y/dx2 > 0

Occurs if the slope passes through 0,

changing from negative to positive.
y
dy/dx>0

dy/dx<0

dy/dx=0

PARTIAL DERIVATIVE
To show the change in Y as a
result of a change in one of the
independent variable while
holding other variables constant
11

To see the marginal effect of each independent

variable on dependent variable.
When the function has more than one independent
variable, we will use partial derivative to see how
each of the independent variable affect the value
of dependent variable.
E.g Total profit, = 60 x- 2x2-xy 3y2 +100y
d /dx = 60 4x y = 0

d /dy= -x-6y +100

OPTIMIZATION TECHNIQUE
Objective of the firms Maximize profit
Maximize revenue or sales
Minimize cost
Maximum or minimum values of functionsmarginal value or derivative is zero
Two methods in the optimization:
a) Without Constraint
Maximize or minimize without having any
constraint or limitation
e.g TR = 45Q 0.5Q2
d(TR)/d Q = 45-Q=0
Q =45
12

b) Constrained Optimization
Maximize or minimize the function subject to some
constraint.
E.g maximize output subject to limitations on
quantity of resources
Minimize total cost subject to output constraint
Maximize total utility subject to income constraint
e.g TC = 4x2 + 8y2 2xy
Constraint= x + y = 28--------

x+ y 28 = 0

Lagrangian function:
LTC =4x2 + 8y2 2xy - (x+ y 28)
dTC/dx =8x 2 y - =0
(1)
dTC/dy= 16y-2x - =0
(2)
dTC/d = -x-y +28 =0
(3)
Solution: x= 18
y= 10
= 124
Interpretation of Lagrangian multiplier()
Increase in output constraint by 1 unit, total cost
increases by $ 124

13

ECONOMIC CONCEPTS

Total, average, and marginal relationships

1.Revenue
a) Total Revenue (TR)-total number of dollars received
by a firm from the sale of a product
b) Average Revenue-Total revenue from the sale of
product divided by quantity of product sold
c) Marginal Revenue-additional revenue received from
selling additional unit of output

-A change in total revenue associated with one

unit change in output
TR= PQ
AR =TR/Q
MR = d(TR)/d Q
2. Costs
a)Total Cost(TC)- Sum of fixed costs and variable costs
b) Average Costs(AC)- Cost per unit of output
c) Marginal Cost-Additional cost for producing an additional
unit of A change in total cost associated with one unit
change in total cost
output
14

TC = FC + VC
AC =TC/Q
MC =d(TC)/ d Q

3.
Profit
a) Total profit-Total Revenue minus total cost
b)Average profit-Profit per unit of output
c) Marginal profit-Additional profit from additional
unit of output
Total profit= TR TC
Average profit=Total profit/Q
Marginal profit =(d ) /d Q

15