Managerial Economics

Basic Principles and

Methodology
(Chapter 1)

John Mark Bartolome

MBA 1C
Managerial Decisions and Principles in Today’s Economy

 All types of business activities are becoming more complex and

frequently, more global.
 Technological changes and globalization of economic activity have
become increasingly important sources of change.
 Managers face many more opportunities and many more choices
than they have had.
 Managers determine not only what kind of input to use but where
to obtain both its input. (labor , equipment, parts and materials
etc.)
 Broadening of opportunities to sell their products.

Managerial Economics focuses on its central themes

1. Identifying 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
organizations.

The function of managerial economics is to provide set of tools for

analyzing decision problems and developing criteria for choosing the
best possible solution to such problems.

Managers should understand the economic dimensions of business

problems and apply economic analysis to the specific problems they
encounter often choose more wisely than those who do not.
Ten Economic Principles for Managers

Although the three central themes above broadly define what

managerial economics is about, we can be more specific about the
economic principles that capable managers understand and employ.
Any list such as the one that follows can be debated and modified, but
Managerial economics believe the 10 principle capture the essence of
what managerial economic analysis holds for managers.

Principle No. 1: The Role of Manager Is to Make Decisions

 Business firms come in all sizes. Some are small others can be
large firm.
 No firm has unlimited resources – Managers must make decisions
about how the resources available to the firm are employed.
 The firm’s resources are Materials, Human, and financial.
Managers must decide how and where plant and equipment will
be employed, what kinds of labor will be hired and how much,
and how to utilize available funds, including those that borrowed
or raised by selling shares in the firm (equity financing)

Principle No. 2: Decisions Are Always Among Alternatives – if there

were no alternative to an action, there would be no choice. Sometimes
a choice is between changing and not changing something.

Principle No. 3: Decision Alternatives always have Cost and Benefits -

 Increase output of product by one unit
 The additional cost is the amount the firm must spend to produce
one more unit of output.
 And the benefit is the change in the firm’s sale revenue that it will
get from selling one more unit output.
Principle No. 4: Anticipated objective of management is to increase
the firm’s value.
 What makes a firm valuable to its owner is the firm’s ability to
generate profit.
 The firm’s profit is the difference between its total revenue from
sales (TR) and total cost (TS) of producing and selling output.

Principle No. 5: The firm’s value is measure by its expected profit.

 Investors cannot know the size of actual profits before they
occur. Thus, it is expected profit that determine, at any given
point of time, what the value of the firm is.

Considering the following date

If both corporations are about the same size , operate in the same
industry, and face equal risk which would you expect to have the
highest share price in 2006?
Principle No. 6: The firm’s sales revenue depends on demand for its
product.
 Whatever a firm’s product or service, its ability to generate
revenue from sales depend on the action of buyer.
 If not enough consumers want a given good or services, it will not
succeed in the marketplace.

A GOOD EXAMPLE – DIVX Video disk

This was a DVD that would self-destruct after it had been viewed.
Consumer will not buy the product, since the DIVX disc cost more than
the normal dvd tape. And the normal dvd tape could be viewed
repeatedly. (DIVX disappeared from the market)

Principle No. 7 : The firm must minimize cost for each level of output.
 As much as possible businesses follow the least cost rule wherein
they strive to produce output at the lowest price possible costs
and thereby have the maximum revenue left over for profit.
 For any firm, profit is the difference between its total revenue
from sales and its total cost. Profit = (TR-TC).

Principle No. 8: The Firm Must Develop a Strategy Consistent with its
Market.
 Markets are made up of groups of buyers and seller. From a
strategic standpoint, if a market has many buyer in it, the firm’s
major considerations will be the number of seller other than itself
in the market and how those sellers behave.
 The firm must develop a strategy consistent worth its market.
Principle No. 9: The firm’s must growth on rational investment
decisions.
 Capital investment decisions aim includes allotting the capital
investment funds of the firm in the most effective manner to
make sure that the returns are the best possible returns. The
company ought to decide as to which of the capital investments
that are given, would ensure the maximum value to their business
and thus they can make their capital investment decision.

Principle No. 10: Successful firms deal rationally and ethically with
laws and Regulations.
 A concept that means no one is above the law. The rule of law
means that there are clear, understandable rules that everyone
has to follow – citizens, governments and of course, businesses.
It’s a way of keeping our justice system fair and ensuring that
everyone complies with the law.
 Know what the rules are, for ignorance is no excuse.

Economist and the Application of Managerial Economics

 Precision using quantitative techniques
 Analyze problems in terms of alternatives and expected
outcomes.
 Looking for the best alternative solution to a problem and not
surprisingly, expecting fellow managers and co-workers to provide
the substantive input required to find the solution.

Role of Managerial economics in Problem Solving

 Managerial economics not only looks at the problem in pricing
But also such area as “Production, input use, cost, profit and
investment decision.
Managers and their objectives
 The managers of a firm are responsible for making most of the
economic decisions - the type of product produced, its price, the
production technology utilized and the financing of production.
 Managers ensure that the firm maintains a satisfactory level of
profits and, preferably, a high rate of profit growth.

Macroeconomics, Microeconomics and the corporate economist

Microeconomics - Greek word micros – small

 is the study of individuals parts of economy and business
decisions. (One consumer, One household, One firm, One
Industry).

Macroeconomics - Greek word Macros – BIG

 Interested in the economy as whole
 Looks at the decisions of countries and governments.
 Deals with interest rate, federal budget, federal taxes
 Countries unemployment rate.
 Changes of prices of goods & services
 National Income

Corporate Economist - Are frequently asked to prepare research and

suggest strategies related to both macro and microeconomic issues.
REVIEW OF BASIC DEMAND AND SUPPLY ANALYSIS

Law of Demand - states that as price increases, quantity demanded

decreases: and as price decreases, quantity demanded increase.

Justification for the law of demand

1. Income Effect - When the price of goods decreases, the consumer
can afford to buy more of it or vice-versa.
2. Substitution Effect - It is expected that consumers tend to buy
goods with a lower price. Hence, in case that the price of goods
that consumers buy increases, they will look for substitutes with a
lower price.

Determinants of Demand – Are those that Actually Influence the

quantity of Demand.

Non – Determinants of Demand

1. Consumer’s Income - A change in income will cause a change in
demand.
2. Consumer’s Expected of Future Prices - When someone expects
higher prices in the future especially for the price of gasoline, the
tendency for car owners is to buy more gasoline immediately.
 Panic buying
3. Consumer’s Tastes and preferences - Are major factors in
determining the demand for any product.
4. Population - An increase in the population means more demand
for goods and services. Inversely, less population means less
demand for goods and services.
Prices of related product

Complementary products - Are goods that go together or cannot be

used without the other. They are related in such a way that an increase
in the price of one good will cause a decrease in the demand of other
goods.

Substitute Products – Are goods that can be used in place of other

goods.

Demand Schedule - shows the tabular representation of the

relationship between the quantity of a good demand and the price of
that good.

Demand Curve is typically downward sloping. It describes the negative

relation between the price of a good and the quantity that consumers
want to buy at a given price.
Supply – willingness and ability of producer to produce goods and/or
services at any given price.

Law of Supply – states that as price increases, quantity supplied also

increases: and as price decreases quantity supplied also decreases.

Supply Schedule – shows the tabular representation of the relationship

between the quantity of a good supplied and its price.

Supply curve shows graphically the relationship between the quality

supplied and corresponding prices, with other variables held constant.
The equilibrium price in any market is the price at which quantity
demanded equals quantity supplied. The equilibrium price in the
market for coffee is thus $6 per pound. The equilibrium quantity is the
quantity demanded and supplied at the equilibrium price.

When we combine the demand

and supply curves for a good in a
single graph, the point at which
they intersect identifies the
equilibrium price and equilibrium
quantity. Here, the equilibrium
price is $6 per pound. Consumers
demand, and suppliers supply, 25
million pounds of coffee per
month at this price.

Book Reference/s:
Managerial economics
Economics concept and principles (with agrarian reform and
taxation) second edition