Economics and Managerial

Decision Making
 Economics is “the study of the
behavior of human beings in
producing, distributing and consuming
material goods and services in a world
of scarce resources.”
Economics and Managerial
Decision Making
 Management is the discipline of
organizing and allocating a firm’s
scarce resources to achieve its desired
objectives. Involves the ability to
organize and administer various tasks
in pursuit of certain objectives.
 INTRODUCTION TO ME

How does managerial economics differ

from “regular” economics?
There is no difference in the theory;
standard economic theory provides the
basis for managerial economics.
The difference is in the way the
economic theory is applied.
Definitions of Managerial
Economics
 Integration of economic theory with
business practice for the purpose of
facilitating decision making and forward
planning by management. – Prof. Spencer
Sigelman.
 The purpose of Managerial economics is to
show how economic analysis can be used in
formulating business policies – Prof. Joel
Dean
Economics and Managerial
Decision Making
 Managerial economics is the use of
economic analysis to make business
decisions involving the best use
(allocation) of an organization’s scarce
resources.
 Managerial economics is (mostly)
applied microeconomics.
Managerial economics deals with

“How decisions should be made by

managers to achieve the firm’s goals -
in particular, how to maximize profit.”

(Also government agencies and

nonprofit institutions benefit from
knowledge of economics, i.e. efficient
recourse allocation is important for
them too...)
Micro and
Macroeconomics
 2 major branches of economics
 Micro – derived for Greek word
micros meaning small
 Macro – derived form Greek word
macros means aggregative –
whole – large
Microeconomics

 Branch of economics which is concerned with

analysis of behaviour of the individual
economic units or variables such as an
individual consumer or a producer or the price
of a particular product.
 Basically deals with individual decision making
and the problem of resource allocation.
 Examines in particular as to how individual
consumers and producers behave and how
their behaviors interact
Importance and uses of
microeconomics
 Explains price determination and allocation of
resources
 Direct relevance in business decision making
 Serves as a guide for business/ production
planning
 Serves as a basis for prediction
 Useful in determination of economic policies of
the government
 Serves as the basis for welfare economics
 Explain the phenomena of international trade
Macroeconomics

 Branch of economics which deals with the

aggregate behaviour of the economy as a
whole
 Macroeconomics is essentially aggregate
economics
 Study of economic system in general
 Study of very large, economy – wide
aggregate variables like national income, total
savings, total consumption, total investment,
money supply, unemployment, price levels,
economic growth rate etc.
Importance of
macroeconomics
 Explains the working of the economy
as a whole
 Knowledge is indispensable for policy
makers
 Useful for the planner for preparing
economic plans for the country’s
development
 Helpful in international comparison
Distinction between micro
and macroeconomics
MICRO- MACRO -
 Study of individual  Study of aggregate

 Individualistic  Aggregate approach

approach  Variables – agg dd,
 Variables – indl dd,ss, agg ss, price level
price etc. etc
Review of Economic
Terms
 Microeconomics is the study of individual
consumers and producers in specific
markets.
– Supply and demand
– Pricing of output
– Production processes
– Cost structure
– Distribution of income and output
Review of Economic
Terms
 Macroeconomics is the study of the
aggregate economy.
– National Income Analysis (GDP)
– Unemployment
– Inflation
– Fiscal and Monetary policy
– Trade and Financial relationships among nations
Review of Economic
Terms
 Scarcity is the condition in which
resources are not available to satisfy
all the needs and wants of a specified
group of people.
Review of Economic
Terms
 Resources are factors of production
or inputs.
– Examples:
 Land
 Labor

 Capital

 Entrepreneurship
Review of Economic
Terms
 Opportunity cost is the amount or
value that must be sacrificed in
choosing one activity over the next
best alternative.
Economics and Managerial
Decision Making
 Relationship to other business disciplines
– Marketing: Demand, Price Elasticity
– Finance: Capital Budgeting, Break-Even Analysis,
Opportunity Cost, Economic Value Added
– Management Science: Linear Programming,
Regression Analysis, Forecasting
– Strategy: Types of Competition, Structure-
Conduct-Performance Analysis
– Managerial Accounting: Relevant Cost, Break-
Even Analysis, Incremental Cost Analysis,
Opportunity Cost
Economics and Managerial
Decision Making
 Questions that managers must answer:
– How can we maintain a competitive
advantage over our competitors?
 Cost-leader?
 Product Differentiation?
 Market Niche?
 Outsourcing, alliances, mergers,

acquisitions?
Economics and Managerial
Decision Making
 Questions that managers must
answer:
– What are the risks involved?
 Risk is the chance or possibility that
actual future outcomes will differ from
those expected today.
Economics and Managerial
Decision Making
 Types of risk
– Changes in demand and supply conditions
– Technological changes and the effect of
competition
– Changes in interest rates and inflation rates
– Exchange rates for companies engaged in
international trade
– Political risk for companies with foreign
operations
Nature of Managerial
Economics
 Managerial economics aims at
providing decision making to firms. It
draws heavily on the prepositions of
micro economic theory that studies the
phenomenon at individual level i.e
behaviour of individual consumers,
households and firms.
Nature of Managerial
Economics
 The concepts of economics which ME
frequently uses are :
 Elasticity of demand.
 Marginal cost.
 Marginal revenue.
 Market structures and their
significance in pricing policies.
Nature of Managerial
Economics
 ME makes use of both Micro & Macro
economics. Micro economics assists
the firm in forecasting & macro
economics studies the aggregate
levels. Macro economics indicates the
relationship between, for example,
level of consumption and national
income, level of national income and
employment etc.
Nature of Managerial
Economics
 This helps the management in knowing the
level of demand at a future period of time,
based on the relationship between the
national income and the demand for a
particular product.
 Eg : Demand for cars, televisions,
refrigerators etc can have a impact of
changes in the level of national income.
Nature of Managerial
Economics
 ME is prescriptive in nature. It recommends
how a thing should be done in alternative
conditions.
 Eg: It may be derived from economic
analysis the it is more profitable to produce
100 units of a particular product by using 5
machines and 15 workers than using 2
machines and 25 workers.
Nature of Managerial
Economics
 ME uses a scientific approach. In
practice some firms may use simple
rules based on past experience.
However, the quality of decisions
made can be improved by using a
systematic approach. This is achieved
by the study of ME.
Scope of ME
 The scope of ME is so wide that it
touches almost all areas of the
manager’s decision making. It deals
with demand analysis, forecasting,
production function, cost analysis,
inventory management, resource
allocation, capital budgeting. A brief
introduction to these areas will give an
idea of the scope of ME.
Scope of ME
 Demand Analysis and forecasting :
 A correct analysis of the future demand for
a companies product enables a manager to
take decisions related to the production
scheduling & inventory management.
 For this he has to consider things such as
income elasticity and cross elasticity.
 This process of accessing the future demand
is called as demand forecasting.
Scope of ME
 Production function :
 We know that resources are scarce and
have alternative uses. Inputs play a imp.
role in the economics of production.
 The factors of production should be
combined in a particular way to maximize
output.
 Alternatively, when the prices of some
inputs shoots up, a manager has to work
out a change in the use of inputs so as to
bring the total costs of production as low as
possible.
 Thus, production function helps ME.
Scope of ME

 Cost analysis :
 Cost analysis talks of determinants of
costs, relationship between costs and
output, forecast of cost and profit etc.
which is essential for managerial
decision making.
Scope of ME

 Inventory management :
 Large capital of companies is blocked
in inventory. If this capital can be
save, it can be used for alternative
production priorities.
Scope of ME
 Pricing :
 The price of the product often determines
how much of what product will be
purchased.
 Merely knowing the cost of production is not
enough to set the price. Various other
aspects such as the market conditions,
conditions of competition, various options
available for pricing also have to be
considered.
 Subject matter and scope
of microeconomics
Microeconomics

Pricing Distribution Welfare (Welfare

(Theory of value) (Factor Pricing) economics)

Theory of Theory of General Theory Theories of

demand pricing of Distribution
Theory of
Production
Rent Wages Interest Profits