MANAGERIAL ECONOMICS

Prof. Swaha Shome

Managerial Economics
Objectives
– Understand usefulness of economics
in describing managerial behavior.
– Understand how economics can be
used to improve managerial
decisions.
– Appreciate vital role of business in
society.
What is Managerial Economics?

Howard Davies -
“It is the application of economic analysis to
business problems; it has its origin in
theoretical microeconomics.”
Why Managerial Economics?

 A powerful “analytical engine”.

 A broader perspective on the firm.
 what is a firm?
 what are the firm’s overall objectives?
 what pressures drive the firm towards profit and away
from profit
 The basis for some of the more rigorous analysis of
issues in Marketing and Strategic Management.
Contents

 Introduction to economics- scarcity, choice

and Efficiency. Role of Government
 Demand and Supply analysis
 Consumer behaviour
 Production and costs
 Markets
TEN PRINCIPLES OF ECONOMICS

 How people make decisions:

 People face trade offs
 The cost of something is what you have to
give up.
 Rational people think at the margin
 People respond to incentives
 How people interact?
 Trade can make everybody better off
 Markets are usually a good way to organize
economic activity
 Government can sometimes improve market
outcomes
 How the economy as a whole works?
 A country’s standard of living depends on the
its ability to produce goods and services
 Prices rise when Govt prints too much money
 Society faces a short run trade off between
inflation and trade off
Market Structures

 Perfectcompetition
 Monopoly
 Oligopoly
 Monopolistic Competition
 Pricingpractices- transfer pricing
 Current developments
Scarcity and Economic System

1. What are the opportunity costs of the choices you

make?
2. How does a production possibility frontier (PPF)
illustrate opportunity cost, specialization of
resources, inefficiency, and economic growth?
3. What are the differences between command
economies, free market economies, and mixed
economies in terms of the ways they address the 3
basic economic questions?
Opportunity Cost - Components

 Direct money cost of a choice may only be a part of

opportunity cost of that choice
 Opportunity cost of a choice
= explicit costs + implicit costs
– Explicit cost—dollars actually paid out for a choice
Accounting cost
– Implicit cost—value of something sacrificed when no
direct payment is made
Opportunity Cost and Society

 Resources in whole society are limited.

 All production carries an opportunity cost
– To produce more of one thing
Mustshift resources away from producing
something else
 No free lunch!
Increasing Opportunity Cost

 According to law of increasing

opportunity cost
– The more of something we produce
The greater the opportunity cost of producing
even more of it
 This
principle applies to all of society’s
production choices
Production Possibilities Frontiers

 ProductionPossibilities Frontiers (PPF)

shows the combinations of two goods that
can be produced with resources and
technology available
Opportunity cost
Situation X Y
• Opp. cost of X =
Amount of Y to be 1 0 20
compensated for
2 1 18
one more unit of X
3 2 15

• Opp. cost of X 4 3 11
increases as you 5 4 6
produce more of X
6 5 0
Opportunity Cost - Illustrated

 Sacrificeof alternatives in
production/consumption of a good

 Eg.Let a farm produce 1000 tonnes of wheat

or 2000 tonnes of sugar
Opportunity Cost of producing 1 ton wheat = 2
tonnes of sugar foregone.
Production Possibility Curve

 Enclosed region –
unemployment
 Outside graph – not 6

feasible 5

Various combinations of 3

Y
2 classes of goods 2

produced provided 1

resources in the 0

economy are fully 0 1 2 3

X
4 5 6

employed
Production Possibility Frontier

 Curve shows all possible 2-goods combination that an

economy can produce
- Specified time period
- Resources fully & efficiently employed
- Issues of choice & opportunity cost
 Concave to origin – increasing opportunity cost
 Region interior to PPF – economy has not attained
Productive Efficiency - unemployment
 PPF Shift
8

7 Economic Growth
6 Improvement in skills
5
Improved Technology
Increase in factors of
Y

3
production
2

0
0 1 2 3 4 5 6 7 8

X
 Economic Activity is transformation of inputs
into output

 What to produce?
 How to produce?
 For whom to produce?

 Economics is concerned with identification,

explanation and solution of these problems
Resource Allocation
 Problem of resource allocation
– Which goods and services should be produced with society’s
resources?
 Where on the PPF should economy operate?
– How should they be produced?
 No capital at all
 Small amount of capital
 More capital
– Who should get them?
 How do we distribute these products among the different groups
and individuals in our society?
The Three Methods of Resources
Allocation

 Market Economy
– Resources are allocated through individual decision
making
– Dominant method
 Command Economy (Centrally-Planned)
– Resources are allocated according to explicit
instructions from a central authority.
Mixed economy- a combination of markets and
state
The Nature of Markets
A market is a group of buyers and sellers
with the potential to trade with each other
– Global markets
Buyers and sellers spread across the globe
– Local markets
Buyers and sellers within a narrowly defined area
INVISIBLE HAND

 In trying to maximize his own welfare an

individual is led by an invisible hand to
achieve the best for all.
 A competitive market economy will provide
an efficient allocation of resources through
the price mechanism
The Importance of Prices
A price is the amount of money that must be paid
to a seller to obtain a good or service
 When people pay for resources allocated by the
market
– They must consider opportunity cost to society of their
individual actions
 Markets can create a sensible allocation of
resources
 Objective – maximum possible ends by
sacrificing the minimum possible resources

 Ends are unlimited but can be graded in

priority
 Means are limited and they have alternative
uses
 This leads to the twin issues of efficiency
and choice
Types of Economic Systems

 Aneconomic system is composed of two

features
– Mechanism for allocating resources
Market
Command

– Mode of resource ownership

Private
State
Figure 4: Types of Economic Systems

Resource Allocation
Market Command

Centrally
Market
Private Planned
Capitalism
Capitalism

Resource
Ownership

Centrally
Market
State Planned
Socialism
Socialism
Role of Government

 Increasing efficiency by:

a. Increasing competition
b. control of externalities
c. public goods
 Equity: redistribution of income by taxes and public
expenditure
 Macro-stability : control inflation, ensure growth,
reduce unemployment and stabilize exchange rates
Externalities
 Externalitiescan occur in production or
consumption.
 External costs : pollution due to industries, traffic
congestion etc
 External benefits: research, ancilliary industries,
reducing pollution
 External costs in consumption – passive smoking
Public Goods

 Private goods are depletable and excludable.

 Hence there is no extra cost for serving an
additional user. This makes pricing of such
goods difficult.
 It is difficult to collect fees for public goods
thus discouraging private enterprise.
Mixed economy

 The government and the private sector

interact in solving economic problems.
 Government controls a significant share of
the output through taxation, transfers,
provision of public goods and also regulates
the extent to which individuals pursue their
self interest.