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Managerial Economics
Prescribed Text Books:
Managerial Economics by Thomas, C. R.Maurice, S. C. and Sarkar,
S., The McGraw-Hill Companies, 2010.
Managerial Economics: Principles and Worldwide Applications by
Salvatore, D., Adapted by Srivsatava, R., Oxford University Press,
2012.
Other Reference/Suggested Books:
Managerial Economics: Principles and Worldwide Applications by
Salvatore, D. and Siddhartha K. Rastogi, Oxford University Press, 2016.
Managerial Economics by William F. Samuelson, W. F. and Marks, S. G.,
John Wiley & Sons, Inc, 2012.
Managerial Economics: A Problem Solving Approach by Wilkinson. N.,
Cambridge University Press, 2005.
Managerial Economics: Theory and Practice by Webster. T. J., Academic
Press, 2003.
Theory and Problems of Managerial Economics by Salvatore, D., The
McGraw-Hill Companies, Schaums Outline Series.
Introduction to Managerial
Economics: Scope and Nature
What is Economics?
Economics is a social science that studies how
individuals, governments, firms and nations make
choices on allocating scarce resources to satisfy/
achieve their goals or objectives.
Some Popular Definitions of Economics
Factor Income
Factors of Production
Rent
Land Ends
(Economic Wages
Labor progress and Interest
Capital Welfare)
Means Profits
Organization
The Circular Flow of Economic Activity
Income spent Revenue earned
Product
Market
Goods demand Goods supplied
Taxes
Households Firms
Government
Taxes
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Subject matter of Microeconomics
Theory of Capital: Along with quantitative
techniques enables investors to calculate cost of
capital, efficiency of capital, efficient allocation
of capital, and choice of projects as per risk-
return analysis.
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Major Areas of Economics
Macroeconomics
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Three Basic Economic Questions
1. WHAT GOODS AND SERVICES SHOULD BE
PRODUCED?
2. HOW ARE GOODS AND SERVICES PRODUCED?
3. FOR WHOM ARE GOODS AND SERVICES
PRODUCED?
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Other Economic Questions
1. WHERE TO PRODUCE?
2. HOW MUCH TO PRODUCE?
3. ARE RESOURCES USED OPTIMALLY?
4. ARE RESOURCES FULLY EMPLOYED?
5. IS THE ECONOMY GROWING?
6. IN WHAT PHASE OF BUSINESS CYCLE
IS THE ECONOMY?
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Decision Sciences
Mathematical Economics
Expresses and analyzes economic models
using the tools of mathematics.
Econometrics
Employs statistical methods to estimate and
test economic models as well as forecasting
using empirical data.
What is Managerial Economics?
Managerial Economics refers to
the use of economic theory and
decision science tools to find the
optimal solution to managerial
decision problems.
Some Popular Definitions of Managerial Economics
BUSINESS ADMINISTRATION
MANAGERIAL DECISION
PROBLEMS
DECISION SCIENCES
ECONOMIC THEORY : TOOLS AND TECHNICS:
MICROECONOMICS AND MATHEMATICS,
MACROECONOMICS STATISTICS AND
ECONOMETRICS
MANAGERIAL ECONOMICS :
APPLICATION OF ECONOMIC
THEORY AND DECISION
SCIENCES TOOLS AND
TECHNICS TO SOLVE
MANAGERIAL DECISION
PROBLEMS
OPTIMAL SOLUTIONS TO
MANAGERIAL BUSINESS PROBLEMS
NATURE OF MANAGERIAL ECONOMICS
Some Examples of Managerial Decisions
1. Determination of Price and Output to Maximize Profit
Some Examples of Managerial Decisions
2. Market Entry and Price Wars
Some Examples of Managerial Decisions
3. Decision on Research and Development
Some Examples of Managerial Decisions
4. BP and Oil Exploration Risks
BP (known as British Petroleum prior to 2001) is in the business of
taking risks. As the third largest energy company in the world, its
main operations involve oil exploration, refining, and sale. The risks it
faces begin with the uncertainty about where to find oil deposits
(including drilling offshore more than a mile under the ocean floor),
mastering the complex, risky methods of extracting petroleum, cost-
effectively refining that oil, and selling those refined products at
wildly fluctuating world prices. In short, the company runs the whole
gamut of risk: geological, technological, safety, regulatory, legal, and
market related. Priding itself on 17 straight years of 100 percent oil
reserve replacement, BP is an aggressive and successful oil discoverer.
But the dark side of its strategic aspirations is its troubling safety and
environmental record, culminating in the explosion of its Deepwater
Horizon drilling rig in the Gulf of Mexico in April 2010. This raises the
question: What types of decisions should oil companies like BP take to
identify, quantify, manage, and hedge against the inevitable risks
they face?
What is Decision Making?
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The Theory of the Firm
A firm combines and organizes scarce resources
for the purpose of producing goods and/or
services for sale.
Internalizes transactions, reducing transactions
costs.
Economic theory assumes that the primary goal
of managers is to maximize the Wealth or Value
of the firm (the price at which the firm can be
sold).
Alternative Objectives of Firm
Profit Maximization
Sales Revenue Maximization (Baumol, W. J.,
1959)
Managerial Utility Maximization (Williamson,
O., 1963)
Growth Maximization (Marris, R., 1963)
Value of the Firm
The present value of all expected future profits
1 2 n n
t
=
PV
(1 + r )
1
+
(1 + r ) 2
+ + =
(1 + r ) n
(1 + r )
t =1
t
n
t
TRt TCt n
of Firm
Value= =
=t 1 = (1 + r ) t
t 1 (1 + r )
t
Where,
PV = Present Value;
1 , 2 , n are firms future expected profits;
r is the appropriate discount rate;
1,2,n is time period;
TR= Total Revenue; TC= Total Cost
Example
1. Calculate the value of a firm at a discount
rate of 10% that generates $100 of profits for
each of two years and is sold for $800 at the end
of the second year.
Example
1. Calculate the value of a firm at a discount rate of
10% that generates $100 of profits for each of two
years and is sold for $800 at the end of the second
year.
Solution:
Example
2. Help the managers of the XYZ Company who are
in a position to organize production Q in a way that
will generate the following two net income streams,
where i,j designates the ith production process in the
jth production period so that they can maximize the
value of the company. The time value of money is
10%.
Stream I: 1,1 (Q)=$100; 1,2 (Q)=$330
Stream II: 2,1 (Q)=$300; 2,2 (Q)=$121
Example
2. Solution:
Stream I:
Stream II:
Market-supplied Owner-supplied
resources resources
Non-monetary opportunity
costs of using owner-
Monetary payments to supplied resources (firms
owners of market-supplied make no monetary payment
resources to use its own resources)
Opportunity cost of using
owner-supplied resources are
not zero.
Examples
Explicit Cost: Cost of raw materials; wages and
salaries; power charges; rent of business or
factory premises; interest payment on capital
invested; insurance premium; taxes like property
tax, duties, license fees and other miscellaneous
business expenses like marketing and advertising
expenses, transport and distribution costs.
Implicit Cost: Wages of labor rendered by the
owner himself; interest on capital supplied by
him, rent of land and premises belonging to the
owner, managerial time and talent.
Economic Cost of Using Resources
Explicit Costs
of
Market-Supplied Resources
The monetary payments to
resource owners
+
Implicit Costs
of
Owner-Supplied Resources
The returns forgone by not taking
the owners resources to market
Calculate the following: (1) The Explicit Costs, (2) The Implicit
Costs, (3) The Business profit, and (4) The Economic Profit.
2. Solution
Salaries to hired people $45,000
Supplies $15,000
Rent $10,000
Utilities $1,000
Interest on bank loan $10,000
1. Total Explicit Costs $81000
Foregone salary $25,000
2. Total Implicit Costs $25,000
3. Business (Accounting) Profit $39,000 ($1,20,000 $81,000)
(Total Profit-Explicit Costs)
4. Economic Profit $14,000 ($1,20,000 $1,06,000)
(Total Profit- (Explicit+ Implicit
Costs)
Example
3. At the beginning of the year, a audio engineer quit his job and gave
up a salary of $1,75,000 per year in order to start his own business,
Sound Devices, Inc. The new company builds, installs and maintains
custom audio equipment for business that require high-quality audio
systems. To get started the owner of the company spent $1,00,000 of
his personal savings to pay for some of the capital equipment used in
the business. In 2016, the owner of the company could have earned a
15% return by investing in stocks of other new business with risk
levels similar to the risk level at Sound Devices. From the partial
income statement for Sound Devices, Inc., compute the following:
1. What are total explicit, total implicit and total economic costs in
2016?
2. What is accounting (business) profit in 2016?
3. What is economic profit in 2016?
4. Given your answer in question 3, evaluate the owners decision to
leave his job to start his company.
Example
Income and Expenditure Statement of Sound Devices, Inc for the year ended-
Mar-2016
Revenues
Revenue from Sales of Product and Services $9,70,000
Operating Costs and Expenses
Cost of Products and Services Sold $3,55,000
Selling Expenses $1,55,000
Administrative Expenses $45,000
Total Operating Costs and Expenses $5,55,000
Elasticity Responsiveness E
Elastic %Q>%P E> 1
Unitary Elastic %Q=%P E= 1
Inelastic %Q<%P E< 1
Price Elasticity of Demand (E)
Elasticity Responsiveness E
Demand is said to be elastic if
Elastic
the percentage change in
demand (in absolute value) is E> 1
more than the percentage
change in price.
Demand is said to be unitary
elastic if the percentage
Unitary Elastic change in demand (in absolute E= 1
value) equals the percentage
change in price.
Demand is said to be inelastic
if the percentage change in
Inelastic demand (in absolute value) is E< 1
less than the percentage
change in price.
Measurement of Price Elasticity of Demand
Bread 20 80 20 70
Butter 75 80 80 75
Cross Price Elasticity of Demand
Cross Price Elasticity of Demand