ME Chapter 1.pdf

INTRODUCTION TO MANAGERIAL ECONOMICS Nature and Scope of Managerial Economics 2 What is Managerial Econmics? Managerial economics is economics applied in decision making. It connects theory and practice. It is based on economic analysis for identifying problem,...

INTRODUCTION TO MANAGERIAL ECONOMICS Nature and Scope of Managerial Economics 2 What is Managerial Econmics? Managerial economics is economics applied in decision making. It connects theory and practice. It is based on economic analysis for identifying problem, organizing information and evaluating alternatives. 3 Macroeconomics vs Microeconomics Macroeconomics studies the aggregate economy or how the economy behaves nationally. Gross National Product (GNP) or Gross Domestic Product (GPD), inflation, annual budgets, scarcity, poverty, etc. can come under macroeconomics. Microeconomics focuses on the individual decision making of the two major sectors in the economy- business sector and the household sector. 4 Basic Economic Concepts Scarcity – basic economic problem arising from unlimited wants but with given limited resources. Supply – the total amount of goods and services that is available to consumers. Demand – the consumer's desire to purchase a particular good or service. Equilibrium – the state in which the supply and demand for a good or service are in balance. 5 Basic Economic Concepts Explicit Cost – a payment made to others while running a business that represents cash outflows. Implicit Cost – a cost that exists without the exchange of cash and is not recorded for accounting purposes. Opportunity Cost – the value of the best alternative forgone where, given limited resources, a choice needs to be made between several mutually exclusive alternatives. 6 Scope of Managerial Economics Microeconomics: Macroeconomics:  Theory of Demand  Economic  Theory of Environment Production  Social Environment  Pricing Theory  Political Environment 7 Nature of Managerial Economics Microeconomic in nature Work with given macroeconomic condition Practical Goal-oriented Prescriptive Helps in decision making and forward planning Integration of economic theory and business practice. 8 9 Business vs Economic Profit Cost - In economics, cost is not only limited to monetary value that you have to pay. Cost is defined as something that is given up to gain something. Opportunity Cost - Value of the best alternative forgone where a choice needs to be made between several mutually exclusive alternatives. 10 Business vs Economic Profit Business (Accounting) Profit is the net income that a company generates, found at the bottom of its income statement. Economic profit considers a company’s free cash flow, which is the actual amount of cash generated by a business, taking into account opportunity costs. 11  Accounting Profit Economic Profit  Calculated with the help of  Calculated with the help of accounting principles set by economic rules and procedures. authorized policy board.  Used by a company to determine  Used in the computation of income market entry, stay, or exit. tax and financial performance of  Total revenue minus implicit and the company. explicit cost  Total revenue of the company less the total explicit costs.  Explicit cost is used only in the computation of accounting profit. 12 Role of Profit in the Economy Economic profits play an important role in any market-based economy. Above-normal profits serve as a valuable signal that firm or industry output should be increased. Below-normal profits, on the other hand, signal the need for contraction and exit. 13 Example: Consider a company that is faced with the following two mutually exclusive options: Option A: Invest excess capital in the stock market Option B: Invest excess capital back into the business for new equipment to increase production Assume the expected return on investment (ROI) in the stock market is 10% over the next year, while the company estimates that the equipment update would generate an 8% return over the same time period. What is the opportunity cost of choosing Option B? How about Option A? 14 Thanks! Any questions? 15