Fundamentals of Managerial Economics

Managerial Economics

• Managerial economics is the study of how to direct scarce resources to efficiently achieve a managerial goal.

Basic Principles of Effective Management

• Identify goals and constraints
• Recognize the nature and importance of profits
• Understand incentives
• Understand markets
• Recognize the time value of money
• Use marginal analysis
• Make data-driven decisions

Identify Goals and Constraints

• Identify well-defined goals
• Make decisions
• Identify constraints

Recognize the Nature and Importance of Profits

• Accounting Profit = Total Amount of Money – Cost of Producing Goods or Services
• Economic Profit = Total Revenue – Total Opportunity Cost

Understand Incentives

• Provide incentives to resource holders to alter their use of resources

Understand Markets

• Consumer-Producer Rivalry: competing interests of consumers and producers
• Consumer-Consumer Rivalry: among consumers, reducing negotiating power
• Producer-Producer Rivalry: among producers, competing for customers
• Government and the Market: may induce government intervention when disadvantaged in the market process

Recognize the Time Value of Money

• Present Value: the current value of future cash flows
• Example: $100 in 10 years at 7% interest rate is $50.83
• Net Present Value: the sum of the present values of future cash flows
• Example: purchasing a machine with a cost of Rs. 330,000 and a useful life of 5 years, yielding cost reductions of Rs. 50,000 to Rs. 90,000 per year

Use Marginal Analysis

• Control Variable: the level of the managerial control variable that maximizes net benefits
• Marginal Benefit (MB): the additional benefits from using an additional unit of the control variable
• Marginal Cost (MC): the additional cost incurred by using an additional unit of the control variable
• Example: finding the optimal level of control at which MB = MC

Make Data-Driven Decisions

• Quantitative managerial decisions: using data to make decisions
• Observation: collecting data to understand relationships between variables
• Examples: regression analysis and using a spreadsheet to perform a regression