MANAGERIAL ECONOMICS

Mintarti Rahayu

Introduction to Managerial Economics

Managerial Economics

The application of economic theory and the tools of analysis of decision science in the

managerial decisions so that an organization can achieve its aims or objectives most

efficiently

Management decision problems

OPTIMAL SOLUTION TO MANAGERIAL DECISION

PROBLEMS

MANAGERIAL ECONOMICSApplication of Economic theory

and decision science tools to solve managerial decision problems

Economic Theory:Microeconomics & Macroeconomics

Decision Science toolsMathematics,

statistics, lenear programming

Decision Making ProcessDecision Making Process

PP

AA

CC

EE

DD

PP roblemroblem

AA lternativeslternatives

CC riteriariteria

EE valuationvaluation

DD ecisionecision

The objective of Managerial Economics is….

To seek laws and principles that support achievement of the economic objectives of an

organization.

Profit Revenue

Cost

The scope of decision making that is the concern of Managerial Economics: generating revenue &

controlling cost

Decision making methods Understanding consumer behavior:

consumer reaction against change in price, promotion, product quality, etc. ; demand estimation & forecasting

Understanding cost component & behavior, relevant cost, cost estimation & forecasting

Pricing decision, product attributes, strategic decision

Positive and Normative Economic

Managerial Economics is normative (about laws & principles how to achieve objectives / “how ought to” ), but based on positive perspective (based on what occur in management practices / “ what actually happened” )

certainty & uncertainty

Economic theory: in certainty and perfect information

Managerial Economics: in uncertainty and imperfect information.

Managerial Economics use Managerial Economics use symbolic symbolic modelsmodels: verbal, graphic, : verbal, graphic,

mathematicmathematic

ModelModel: the : the simplification of a simplification of a complicated system or situationcomplicated system or situation; ; an abstraction of reality that is an abstraction of reality that is done by ignoring details that are done by ignoring details that are not essentially related to the not essentially related to the objective of building a model.objective of building a model.

The objectives of building a model :Teaching: to show how a complicated

system worksExplanating: to explain the logic

relationships among phenomenaPredicting: to predict future behavior

based on former system

Theory of Firm :1. Definition of “Firm” ;2. The Objective of a Firm & The Constraints in

achieving it3. “Profit”

1. Firm: an organization that organize various resources to produce and sell goods and services

Theory of the FirmCombines and organizes resources for the

purpose of producing goods and/or services for sale.

Internalizes transactions, reducing transactions costs.

Primary goal is to maximize the wealth or value of the firm.

Next…2. The objective of a Firm : to maximize “value”

of the firm Value = PV of all “expected future profits” TR depend on Sales or Demand of Product

and Pricing decision --- (Marketing Department)

TC depend on Production Technology and Input Price --- (Production Department and Human Resource Dept)

“r” depend on Firm Risk and Cost of Capital --- (Financial Department)

Alternative TheoriesSales maximization

Adequate rate of profitManagement utility maximization

Principle-agent problemSatisficing behavior

Constraints in achieving the firm’s objectives:

Resources constraints ( e,g,: materials, HR, production capacity, fund, etc. )

legal constraints ( e.g.: minimum wages, working safety, pollution handling, etc. )

Business EthicsIdentifies types of behavior that businesses

and their employees should not engage in.Source of guidance that goes beyond

enforceable laws.

Function of ProfitProfit is a signal that guides the allocation of

society’s resources.High profits in an industry are a signal that

buyers want more of what the industry produces.

Low (or negative) profits in an industry are a signal that buyers want less of what the industry produces.

Definitions of ProfitBusiness Profit: Total revenue minus the

explicit or accounting costs of production.Economic Profit: Total revenue minus the

explicit and implicit costs of production.Opportunity Cost: Implicit value of a resource

in its best alternative use.

Next…3. PROFIT Accounting/Business Profit = TR – explicit costs

( useful for Taxition Accounting purposes )

Economic Profit = TR – explicit costs – implicit costs

( useful for investment decision )“Normal Profit” : Economic Profit = 0

Profit theory: Excess Profit may

take place because of:

Risk Different from the long run

profit ( that tend to be normal )

Monopoly Return for innovation More efficient than the

other firms in general

Theory of the FirmCombines and organizes resources for the

purpose of producing goods and/or services for sale.

Internalizes transactions, reducing transactions costs.

Primary goal is to maximize the wealth or value of the firm.

Why do firms exist?The role of transaction costsTypes of transaction costs

search and information costsbargaining and decision costspolicing and enforcement costs

Optimal economic organization minimizes transaction costs

Firms can reduce transaction costsAdvantages of firms over markets

Fewer transactionsInformation specializationReputational concerns

But firms can become large and unwieldy, foregoing advantages

The Changing Environment of Managerial EconomicsGlobalization of Economic Activity

Goods and ServicesCapitalTechnologySkilled Labor

Technological ChangeTelecommunications AdvancesThe Internet and the World Wide Web