Managerial Economics

By: Adugna Tuji (PhD Candidate)

E-Mail: [email protected]

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 1.1. Definition of Managerial Economics
Economics is a social science that study of efficient

allocation of resources in order to attain the maximum

fulfilment of unlimited human wants or needs.
Because all decisions are essentially about the allocation

of scarce resources, economics is in fact the study of

decision making and problem solving in general.
Economics is the study of how societies transform scarce

resources into valuable commodities and distributing them

amon
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 Cont’d
Given unlimited wants and requirements it is important that

an economic make the best use of its limited resources.

Economics concerned with the explanation of the observed

behavior of economic agents.

Economic agents are: Consumers, Producers, Influencer

of capital markets, household/individuals, firms,

governments and central banks.

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 Cont’d
Economics is a social science that concerned with the
examination of the various alternatives in all aspects in the
choice making of economic agents.
Economics studies the behavior of human beings,
organizations, and any entity in situations involving choice.
Economic agents have unlimited requirements but they face
limited resources.
Thus, the task is to make the use of limited resources in such a
way that the agents get the maxima mum (optimal) benefits.
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 Cont’d
As the subject matter of economics get started to expand its

branches, the use of economic concepts and application

economic tools have got a paramount importance.
A close interrelationship between management and

economics had led to the development of managerial

economics.
The nature and scope of the science of economics have

dramatically grown and it has become very wide and vast.

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 Cont’d
• Managerial Economics is the application of economic
theory to decisions made by managers and firms.
• It is generally defined as the study of economic theories,
logic and tools of economic analysis, used in the process of
business decision making.
• It involves the understanding and use of economic theories
and techniques of economic analysis in analyzing and
solving business problems. Eg four basic economic
questions.
7/4/2021
the ffBy:diagram
Adugna Tuji
explains it well. 6
 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 SOLUTION TO
MANAGERIAL DECISION PROBLEMS

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 Cont’d
• Economic principles contribute significantly towards the

performance of managerial duties as well as

responsibilities(apply economic rules for decision making).
• Taking appropriate business decisions requires a good

understanding of the technical and environmental

conditions under which business decisions are taken

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 Cont’d
Managers with some working knowledge of economics can

perform their functions more effectively and efficiently than

those without such knowledge.
Application of economic theories and logic to explain and

analyze these technical conditions and business environment

can contribute significantly to the rational decision-making
process.

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 1.2. Why managerial Economics
Managerial Economics as a course required for effective
resource management was put in place due to the following
developments in the global business environment:
Growing complexity of business decision-making processes.

Increasing need for the use of economic logic, concept,

theories, and tools of economic analysis in the process of
decision-making.
Rapid increases in the demand for professionally trained
managerial manpower.
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 Cont’d
These developments have made it necessary that every
manager aspiring for good leadership and achievement of
organizational objectives be equipped with relevant
economic principles and applications.
Unfortunately, a gap has been observed in this respect
among today’s managers. It is therefore the aim of this
course to bridge such gap.

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 1.3. Nature of Managerial Economics
Since economics provides analytical tools and techniques

that managers need to achieve goals of the organization they

manage. A working knowledge of economics is essential for
managers.
Three major contributions of economic theory to business

economics have been enumerated:

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 Cont’d
1. Building of analytical models that help to recognize the

structure of managerial problems, eliminate the minor details

that can obstruct decision making, and help to concentrate
on the main problem area.
2. Making available a set of analytical methods for business
analyses thereby, enhancing the analytical capabilities of the
business analyst.
3. Clarification of the various concepts used in business
analysis, enabling the managers avoid conceptual pitfalls.
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 Cont’d
Managerial Economics is micro-economics in nature.

Contribution of Quantitative Techniques to Managerial

Economics
Mathematical Economics and Econometrics are utilised to

construct and estimate decision models useful in

determining the optimal behaviour of a firm.
Various optimisation techniques, such as linear
programming, in the study of behaviour of a firm.

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 Cont’d
•Managerial economics uses economic concepts and decision science
techniques to solve managerial problems.

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1.4. Economics Tools for Managerial Decision-
Making

1. The Fundamental concept

a. Marginal and Incremental Principle

b. Equi–Marginal Principle

c. Opportunity Cost Principle

d. Time Perspective Principle

e. Discounting Principle

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 Marginal and Incremental costs
• Marginal cost refers to the cost incurred on the production of
another or one more unit.
It implies additional cost incurred to produce an

additional unit of output It has nothing to do with fixed

cost and is always associated with variable cost.
Fixed costs are those costs which do not vary with either

expansion or contraction in output.

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 Cont’d
They remain constant irrespective of the level of output.

They are positive even if there is no production. They are

also called as supplementary or over head costs.
Variable costs are those costs which directly and

proportionately increase or decrease with the level of

output produced. They are also called as prime costs or
direct costs.

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 Actual costs and Opportunity Costs
Actual costs: They are the actual expenses incurred for

producing or acquiring a commodity or service by a firm.

Opportunity cost of a good or service is measured in terms

of revenue which could have been earned by employing that

good or service in some other alternative uses.
Opportunity cost is the highest valued alternative forgone

whenever a choice is made.

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 Accounting costs and economic costs
Accounting costs are those costs which are already

incurred on the production of a particular commodity.

It includes only the acquisition costs. They are the actual

costs involved in the making of a commodity.

Economic costs are those costs that are to be incurred by

an entrepreneur on various alternative programs.

It involves the application of opportunity costs in decision

making.
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 Discounting Principle
The process of reducing future values to their present values

is often referred to as discounting.

For this reason, the interest rate used in present value

calculations is often referred to as the discount rate

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 1.5. Scarcity and Decision Making
Scarcity can be defined as a condition in which resources are not
available in adequate amounts to satisfy all the needs and wants of a
specified group of people.
The concepts of scarcity and choice are central to the discipline of
economics.
These concepts are used to explain the behavior of both producers and
consumers.
Scarcity necessitates trade-offs. That which is forgone whenever a
choice is made is referred to by economists as opportunity cost. That
which is sacrificed when a choice is made is the next best alternative.
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1.6. Scope of Managerial /Business Economics
The scope of managerial economics refers to its area of

study. Managerial economics comprises both micro and

macroeconomics aspects of economics. However it is
thought as applied microeconomics.
Scope of Managerial Economics is wider than the scope of

business Economics
The scope covers two areas of decision making (A)

operational or internal issues and (B) Environmental or

external issues.
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 Cont’d
1. Operationalproblems: Are of internal nature. These
problems include all those problems which arise within the
business organization and fall within the control of
management. Some of the basic internal issues include:
 choice of business and the nature of product (what to
produce);
 choice of size of the firm (how much to produce);

 choice of technology (choosing the factor combination);

 choice of price (product pricing);

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 Cont’d
 how to promote sales;
 how to face price competition;
 how to decide on new investments;
 how to manage profit and capital; and,
 how to manage inventory.

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 Cont’d
This can be done via
Demand analysis and Forecasting

Theory of Production and cost

Theory of Exchange or Price Theory

Profit Analysis

Theory Capital budgeting

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 Cont’d
2. Environmental or external issues
• It refers to the general business environment in which the
firm operates
Types of economic system in the country. The general trend

in production, employment, income, prices, savings and

investments

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 Cont’d
Trends in the working of financial institutions like banks,

financial corporations, insurance companies etc..

Magnitude and trends in foreign trade.
Trends in labour and capital market. Government economic

policies viz., industrial policy, monitory policies, fiscal

policy, price policy etc.
• Social organizations, such as trade unions, consumers’
cooperatives, and producer unions.

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 Cont’d
• The political environment.

• The degree of openness of the economy.

 Managerial economics is particularly concerned with those

economic factors that form the business climate.
In macroeconomic terms, managerial economics focus on
business cycles, economic growth, and content and logic of
some relevant government activities and policies which form
the business environment.
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1.7. Managerial Economics as a Tool for DM
and Forward Planning
• Decision making is an integral part of modern management.
• Decision making is the process of selecting one action
from two or more alternative course of actions.
• Managers of business organizations are constantly faced
with wide variety of decisions in different areas which could
probably have variety of alternative solutions.

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 Cont’d
• Decision making processes involve five main phases, including:

• Phase One: Determining and defining the objective to be

achieved.
• Phase Two: Collection and analysis of information on economic,
social, political, and technological environment.
• Phase Three: Inventing, developing and analyzing possible
course of action
• Phase Four: Selecting a particular course of action from
available alternatives.
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 Cont’d
• Phase five:The implementation and monitoring of the
selected alternative.
Note that phase two and three are the most crucial in

business decision-making.
They put the manager’s analytical ability to test and help in

determining the appropriateness and validity of decisions in

the modern business environment.

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 Cont’d
Personal intelligence, experience, intuition and business

insight of the manager need to be supplemented with

quantitative analysis of business data on market conditions
and business environment
It is in fact, in this area of decision-making that economic

theories and tools of economic analysis make the greatest

contribution in business.

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 Cont’d
If for instance, a business firm plans to launch a new product
for which close substitutes are available in the market,
One method of deciding whether or not this product should
be launched is to obtain the services of a business consultant.
The other method would be for the decision-maker or
manager to decide. In doing this, the manager would need to
investigate and analyze the following thoroughly:
(a) production related issues; and,
(b) sales prospects and problems.
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 Cont’d
With regards to production, the manager will be required to
collect and analyze information or data on:
available production techniques;
cost of production associated with each production
technique;
supply position of inputs required for the production
process;
input prices;
production costs of the competitive products; and,
availability of foreign exchange, if inputs are to be
imported.
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 Cont’d
Regarding the sales prospects and problems, the manager
will be required to collect and analyze data on:
general market trends;
the industrial business trends;
major existing and potential competitors, as well as their
respective market shares;
prices of the competing products;
pricing strategies of the prospective competitors;
market structure and the degree of competition; and,
the supply position of complementary goods.

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 Cont’d
The application of economic theories involving business
problems helps in facilitating decision-making in the following
ways:
First, it can give clear understanding of the various necessary
economic concepts, including demand, supply, cost, price, and
the like that are used in business analysis.
Second, it can help in ascertaining the relevant variables and
specifying the relevant data. For example, in deciding what
variables need to be considered in estimating the demand for two
different sources of energy, petrol and electricity.
Third, it provides consistency to business analysis and helps in
arriving at right conclusions.
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 Cont’d
• Forward Planning
Managerial economics helps manager in forward planning
For example: The knowledge of various economic theories

viz, demands theory, supply theory etc. also can be helpful

for future planning of demand and supply.

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1.8. Characteristics of Managerial Economics
Managerial economics is Micro economic in character.
It is Normative economics: Which focuses on the value of

economic fairness of what the economic should be.

Pragmatic: It is purely practical oriented
Uses theory of firm
Takes the help of macroeconomics
Aims at helping the management
It is a scientific and art
Prescriptive rather than descriptive
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 1.9. Functions and Responsibilities of
Managerial Economist
A managerial economist can play an important role by

assisting the management to solve the difficult problems.

Managerial economists have to study external and internal

factors influencing the business while taking the decisions.

It answers the following questions

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 Cont’d
1. Is competition likely to increase or decrease?
2. What are the population shifts and their influence in
purchasing power?
3. Will the price of raw materials increase or decrease? Etc.
4. Managerial economist can also help the management in
taking decisions regarding internal operation of the firm.
• Following are the important specific functions of
managerial economist;

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 Cont’d
Sales forecasting.

Market research.

 Production scheduling

Economic analysis of competing industry.

Investment appraisal.

Advise on foreign exchange management.

Advice on trade.

Environmental forecasting.

Economic analysis of agriculture sales forecasting

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 Cont’d
The responsibilities of managerial economists are the
following;
To bring reasonable profit to the company.
To make accurate forecast.
To establish and maintain contact with individual and data
sources.
To keep the management informed of all the possible
economic trends.
To prepare speeches for business executives.
To participate in public debates
To earn full status in the business team.

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 Cont’d
• Managerial Economics and Gap between Theory and
Practice
It is a general knowledge that there exists a gap between
theory and practice in the world of economic thinking and
behavior.
By implication, a theory which appears logically sound
might not be directly applicable in practice.
Take for instance, when there are economies of scale, it
seems theoretically sound that when inputs are doubled,
output will be more or less doubled, and when inputs are
tripled, output would be more or less tripled.
This theoretical conclusion may not hold in practice.

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 Cont’d
Economic theories are highly simplistic because they are

advocated on the basis of economic models based on

simplifying assumptions.
Through economic models, economists create a simplified

world with its restrictive boundaries from which they derive

their conclusions.
It is a general belief that assumptions of economic models

are unrealistic in most cases.

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 Circular Flow
It is representation of the organization of the economy.

Decisions are made by households and firms.

Households and firms interact in the markets for goods and

services (where households are buyers and firms are sellers)
and in the markets for the factors of production (where firms
are buyers and households are sellers).
 The outer set of arrows shows the flow of dollars, and the
inner set of arrows shows the corresponding flow of goods
and services.
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 The Circular Flow

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