2. Introduction, Basic Principles and
Methodology
The central themes of Managerial
Economics:
1. Identify problems and opportunities
2. Analyzing alternatives from which choices
can be made
3. Making choices that are best from the
standpoint of the firm or organization
3. • Not true that all managers must be
managerial economists
• But managers who understand the
economic dimensions of business
problems and apply economic analysis to
specific problems often choose more
wisely than those who do not.
4. Some Economic Principles of
Managers
1.Role of manager is to make decisions. Firms
come in all sizes but no firm has unlimited
resources so managers must decide how
resources are employed
5. 2. Decisions are always among alternatives.
3. Decision alternatives always have costs
and benefits
Opportunity cost = next best alternative
foregone.
Marginal or incremental approach
4. Anticipated objective of management is to
increase the firm’s value
6. • Maximize shareholder’s wealth
• Negative impact = principal-agent problem
5. Firm’s value is measured by its expected
profits
Time value of money, discount rates
6. The firm must minimize cost for each level
of production
7. 7. The firm’s growth depends on rational
investment decisions
Capital budgeting decisions
8. Successful firms deal rationally and
ethically with laws and regulations
8. Macroeconomics & Microeconomics
• Economists generally divide their discipline into
two main branches:
• Macroeconomics is the study of the aggregate
economy.
– National Income Analysis (GDP)
– Unemployment
– Inflation
– Fiscal and Monetary policy
– Trade and Financial relationships among nations
9. • 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
Microeconomics is the basis of managerial economics
10. • Methodology, data and application
Methodology- is a branch of philosophy that
deals with how knowledge is obtained.
How can you know that you are managing
efficiently and effectively?
You need some theory to do some analysis.
Without theory, there can be no good
analysis
11. Microeconomics (probably more than other
disciplines) provides the methodology for
managerial economics
Managerial Economics is about both
methodology and data
You need data to plug into some model to do
some analysis.
This gives you the information to manage
Managerial Economics lends empirical content to
the study of effective management
12. Review of Economic Terms
• Resources are factors of production or inputs.
– Examples:
• Land
• Labor
• Capital
• Entrepreneurship
13. • Managerial Economics
– The study of how to direct scarce resources in
the way that most efficiently achieves a
managerial goal.
14. • Managerial economics is the use of economic
analysis to make business decisions involving
the best use (allocation) of an organization’s
scarce resources.
15. • 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
16. • Questions that managers must answer:
– What are the economic conditions in a particular
market?
• Market Structure?
• Supply and Demand Conditions?
• Technology?
• Government Regulations?
• International Dimensions?
• Future Conditions?
• Macroeconomic Factors?
17. • Questions that managers must answer:
– Should our firm be in this business?
– If so, what price and output levels achieve our
goals?
18. • 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?
• International Dimensions?
19. • 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.
20. • 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
21. • Because of scarcity, an allocation decision must
be made. The allocation decision is comprised of
three separate choices:
– What and how many goods and services should be
produced?
– How should these goods and services be produced?
– For whom should these goods and services be
produced?
22. • Economic Decisions for the Firm
– What: The product decision – begin or stop
providing goods and/or services.
– How: The hiring, staffing, procurement, and
capital budgeting decisions.
– For whom: The market segmentation decision
– targeting the customers most likely to
purchase.
23. • Three processes to answer what, how, and
for whom
– Market Process: use of supply, demand, and
material incentives
– Command Process: use of government or
central authority, usually indirect
– Traditional Process: use of customs and
traditions
24. • Profits are a signal to resource holders
where resources are most valued by
society
• So what factors impact sustainability of
industry profitability?
• Porter’s 5-forces framework discusses 5
categories of forces that impacts
profitability
25. 1. Entry
2. Power of input sellers
3. Power of buyers
4. Industry rivalry
5. Substitutes and Complements
26. Entry:
Heightens competition
Reduces margin of existing firms
Ability to sustain profits depends on the
barriers to entry: cost, regulations,
networking, etc.
Profits are higher where entry is low
27. Power of input suppliers:
Do input suppliers have power to negotiate
favorable input prices?
Less power if
a. inputs are standardized,
b. not highly concentrated
c. alternative inputs available
Profits are high when suppliers power is low
28. Power of buyers:
High buyer power if
a. buyers can negotiate favorable terms for
the good/service
b. Buyer concentration is high
c. Cost of switching to other products is low
d. perfect information leading to less costly
buyer search
29. Industry rivalry:
Rivalry tends to be less intense
a. in concentrated industries
b. high product differentiation
c. high consumer switching cost
Profits are low where industry rivalry is
intense
30. Substitutes and complements:
Profitability is eroded when there are close
substitutes
Government policies (restrictions e.g. import
restriction on drugs from Canada to US)
can affect the availability of substitutes.
31. Sustainabl
e Industry
Profits
Power of
Input Suppliers
Supplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints
Power of
Buyers
Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints
EntryEntry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale
Network Effects
Reputation
Switching Costs
Government Restraints
Substitutes & Complements
Price/Value of Surrogate Products
or Services
Price/Value of Complementary
Products or Services
Network Effects
Government
Restraints
Industry Rivalry
Switching Costs
Timing of Decisions
Information
Government Restraints
Concentration
Price, Quantity, Quality, or
Service Competition
Degree of Differentiation
The Five Forces Framework
32. Market Interactions
• Consumer-Producer Rivalry
– Consumers attempt to locate low prices, while
producers attempt to charge high prices.
• Consumer-Consumer Rivalry
– Scarcity of goods reduces the negotiating
power of consumers as they compete for the
right to those goods.
33. • Producer-Producer Rivalry
– Scarcity of consumers causes producers to
compete with one another for the right to
service customers.
• The Role of Government
– Disciplines the market process.
34. Overview of Lectures
Lecture 1: Demand
Lecture 2: Supply
Lecture 4: Quantitative Demand Analysis
Lecture 5: The Theory of Individual Behavior
Lecture 6:Demand Estimation & Forecasting
Lecture 7: Production
Lecture 8: Cost of Production
36. Lecture 17: Labor and Capital Market
Lecture 18: Capital Market
Lecture 19: Economic Equations and Their
Solutions
Lecture 20: Economics Applications of
Derivatives
Lecture 21: ECONOMIC APPLICATION OF
DERIVATIVES – A
Lecture 22: ECONOMIC APPLICATION OF
DERIVATIVES - A
37. Lecture 23: ECONOMIC APPLICATION OF
MAXIMAAND MINIMA-A
Lecture24: MAXIMIZATION OR
MINIMIZATION (OTIMIZATION) OF
MULTI-VARIABLE FUNCTIONS OR TWO
OR MORE VARIABLE
Lecture 25: CONSTRAINED OPTIMIZATION
Lecture 26: CONSTRAINT OPTIMIZATION –
A
Lecture 27: Correlation & Regression
38. Lecture 28: Measuring a Nation’s Income
Lecture 29: Money
Lecture 30: Monetary Policy
Lecture 31: Fiscal Policy and NI Determination