Managerial Economics

Chapter (1):
The Nature and Scope
of Managerial Economics
February 7th, 2017
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 Course Outline

Course Contents
 Firm Goals and Managerial Economics.
 Demand, Supply and Market Equilibrium.
 Demand and Supply Elasticity.
 The Theory of Production.
 The Theory of Cost.
 Perfect Competition.
 Pure Monopoly.
 Monopolistic Competition.
 Oligopoly.

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 Course Outline

Assessment Method

Assignments 10%

Term Paper & Presentations 10%

Mid-term Exam 20%

Final Exam 60%

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 Course Outline

References:

 Thomas, C., and Maurice, C., “Managerial

Economics: Foundations of Business Analysis and
Strategy,” MacGraw-Hill Publishing , 12th Ed. 2016,
ISBN: 0078021909.

 Baye M., "Managerial Economics and Business

Strategy,", MacGraw-Hill Publishing , 7th Ed. 2010,
ISBN: 0073375960.

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 Course Outline

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 Definition of Managerial Economics

Managerial Economics Defined

 The application of economic theory and the tools

of decision science to examine how an
organization can achieve its aims or objectives
most efficiently.

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 Definition of Managerial Economics (Cont.)

EXAMPLE 1:
 A firm may seek to maximize profits subject to
limitation on the availability of essential inputs
(skilled labor, capital, and raw materials) and legal
constraints ( minimum wage laws, health and
safety standards, and pollution emission
standards).
 Not-for-profit organizations (such as hospitals,
universities, museum) and government agencies
also seek to reach some goal or objective subject to
some constraints.
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 Definition of Managerial Economics (Cont.)

 Managerial economics studies the

decision-making process, that is, the means
by which an organization can achieve its
objective most efficiently.

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 Definition of Managerial Economics (Cont.)
Managerial Decision Problems

Economic theory Decision Sciences

Microeconomics Mathematical Economics
Macroeconomics Econometrics

MANAGERIAL ECONOMICS
Application of economic theory
and decision science tools to solve
managerial decision problems

OPTIMAL SOLUTIONS TO
MANAGERIAL DECISION PROBLEMS

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 Definition of Managerial Economics (Cont.)

EXAMPLE 2:
• Economic theory postulates that the quantity
demanded of a commodity (Q) is a function of, or
depends on, the price of the commodity (P), the
income of consumers (Y), and the prices of related
(i.e. complementary and substitute) commodities (Pc,
and Ps, respectively).
• Assuming constant tastes, we may postulate the
following (mathematical) model:
Q = f ( P, Y, Pc, Ps )
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 Definition of Managerial Economics (Cont.)

• Collecting data on Q, P, Y, Pc, Ps , for a particular

commodity, we can then estimate the empirical
(econometric) relationship.
• This will permit the firm to determine how much Q
would change as a result of a change in P, Y, Pc, and
Ps, and to forecast the future demand for the
commodity.
• These steps are essential in order for the management
to achieve the goal, or objective, of the firm (profit
maximization) most efficiently.
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 The theory of the firm

Theory of the Firm

 Firms exists because the economies they generate in
production and distribution confer great benefits to
entrepreneurs, workers, and resource owners.

 Primary goal is to maximize the wealth or value of the

firm.

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 The theory of the firm (Cont.)

Value of the Firm

The present value of all expected future profits:

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 The theory of the firm (Cont.)

EXAMPLE 3:
At a discount rate of 10 percent, the value of a firm that
generates $100 of profits for each of the two years and
is sold for $800 at the end of the second year is:

According to the theory of the firm, it is this value (PV)

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that the firm seeks to maximize,
 Profit of the firm

Definitions of Profit
 Business Profit: Total revenue minus the explicit or
accounting costs of production.

 Explicit costs are the actual out-of-pocket

expenditures of the firm to hire labor, borrow capital,
rent land and buildings, and purchase raw materials.

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 Profit of the firm (Cont.)

 Economic Profit: Total revenue minus the explicit

and implicit costs of production.

 Implicit costs are the money value of the inputs

owned and used by the firm in its own production
processes. These include the salary that the
entrepreneur could earn in managing another firm
and the return that the firm could earn by investing
its capital and renting its land and other inputs to
other firms.

 Opportunity Cost: Implicit value of a resource in

its best alternative use.
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 Profit of the firm (Cont.)

Function of Profit
 Profit is a signal that guides the allocation of
society’s resources.

 High profits in an industry are a signal that buyers

want more of what the industry produces.

 Low (or negative) profits in an industry are a

signal that buyers want less of what the industry
produces.
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 Profit of the firm (Cont.)

EXAMPLE 4:
• Suppose that during a year a firm has revenues of $100,000
and explicit costs of $80,000 for hiring labor, borrowing
capital, and purchasing raw materials. Suppose also that
the entrepreneur could have earned $30,000 by managing
another firm and an additional $5,000 by lending out the
capital invested in the firm to another firm facing similar
risks.

• The business profit of this firm is $20,000.

• The economic profit is -$15,000 (an economic loss).

• It is the concept of economic profit that provides the signal

for the efficient allocation of society’s resources.
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 Nature & Scope of Managerial Economics

The End

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