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Managerial Economics For Managers

This document provides an overview of managerial economics. It defines managerial economics as the application of economic theory and decision-making tools to help organizations achieve their objectives efficiently. It discusses how managerial economics draws from microeconomics, macroeconomics, mathematical economics, econometrics, and economic models. It also summarizes key aspects of the theory of the firm, including what a firm is, reasons for firms' existence, how their value is calculated, and constraints they operate under. Overall, the document outlines the nature and scope of managerial economics as a field that applies economic analysis to managerial decision-making.

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Gautam Bindlish
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38 views30 pages

Managerial Economics For Managers

This document provides an overview of managerial economics. It defines managerial economics as the application of economic theory and decision-making tools to help organizations achieve their objectives efficiently. It discusses how managerial economics draws from microeconomics, macroeconomics, mathematical economics, econometrics, and economic models. It also summarizes key aspects of the theory of the firm, including what a firm is, reasons for firms' existence, how their value is calculated, and constraints they operate under. Overall, the document outlines the nature and scope of managerial economics as a field that applies economic analysis to managerial decision-making.

Uploaded by

Gautam Bindlish
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Managerial Economics

for Managers
Nature & Scope

Managerial Economics
Defined
The application of economic theory
and the tools of decision science to
examine how an organization can
achieve its aims or objectives most
efficiently.
applications of economic theory
quantitative methods
statistical methods
computational methods

Economic Theory
Microeconomics
Study of the economic behavior of
individual decision-making units.
Relevance to Managerial Economics

Macroeconomics
Study of the total or aggregate level of
output, income, employment,
consumption, investment, and prices for
the economy viewed as a whole.

Decision Sciences
Mathematical Economics
Expresses and analyzes economic
models using the tools of mathematics.

Econometrics
Employs statistical methods to estimate
and test economic models using
empirical data.

Economic Methodology
Economic Models
Abstract from details
Focus on most important determinants
of economic behavior cause and effect

Evaluating Economic Models


A model is accepted if it predicts
accurately and if the predictions follow
logically from the assumptions.

THEORY OF THE FIRM


- What is a firm
- Types of Firms
- Reasons for Existence of a firm
- Value of the firm
- Constraints under which the
firm operates
- Limitations of the theory of the
firm

What is a FIRM:
Definition

FIRM is an organisation that


combines and organizes
resources for the purpose of
producing goods and/or
services for selling in the
market

Types of Firms
- Proprietorships
- Partnerships
- Corporations

Theory of the Firm


What will be the consequences for the society if the firm did not exist?

Combines 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 FIRM exists?


Firms exist becoz otherwise itll be very
inefficient & costly for entrepreneurs to
enter into & enforce contracts with
workers, owners of capital, land & other
resources for separate step of production
& distribution process. e.g. Car, PC.
Firms do not continue to grow larger and
larger indefinitely because of limitations
on management ability to effectively
control and direct the operation of the firm
as it becomes larger and larger.

Value of the Firm


The present value of all expected future profits
n
n
t
1
2
PV

1
2
n
t
(1 r ) (1 r )
(1 r )
(1

r
)
t 1

n
t
TRt TCt
Value of Firm

t
t
t 1 (1 r )
t 1 (1 r )
n

Present value (PV) of expected


future profits
n
t
TRt TCt
Value of Firm

t
t
t 1 (1 r )
t 1 (1 r )
n

where: TRt = the firms TR in year t


TCt = the firms TC in year t
r = the interest rate
and t goes from 1 (next year) to n (the last year
in the planning horizon)

Food Plus Store an example

Because the project has a negative net present value, it does not
contribute to the goal of maximizing shareholder value.
Therefore, it should be rejected.

CostoftheProject=30crores

Problem 1

1. #years Profit 1 Present


inthefuture(Rs.crores)
(1+r)t
value(PV)
1
8
.90909
7.27272
2
10
.82645
8.26450
3
12
.75131
9.01572
4
14
.68301
9.56214
5
15
.62092
9.31380
6
16
.56447
9.03152
7
17
.51316
8.72372
8
15
.46651
6.99765
9
13
.42410
5.51330
10
10
.38554 3.85540
Total77.55047
Thus,theanswerisRs.77.5504730=47.55047crores.

Discounting Examples
n

PV = (TRt-TCt)/(1+i)t

Discount rate (i) = 6%

t=0

Two courses of action: A and B


If A is

chosen, outflow of Rs. 1 million this year (t=0) and


inflows of Rs300,000 for each of next 5 years.

V = -1,000,000 + 300,000 + 300,000 + 300,000 + 300,000 + 300,000 = Rs263,709


1.060
1.06
1.062
1.063
1.064
1.065
If

B is chosen, outflow of Rs 1 million this year (t=0) and


inflows of Rs. 260,000 for each of next 6 years.

V = -1,000,000 + 260,000 + 260,000 + 260,000 + 260,000 + 260,000 + 260,000


1.060
1.06
1.062
1.063
1.064
1.065
1.066

=Rs. 278,504

Alternative Theories
Sales/Revenue maximization (W.Baumol, 1959)
Adequate rate of profit

Management utility maximization (Williamson,


1963)
Principle-agent problem

Satisficing behavior (Cyert & March)


Growth
Long Run Survival

Management Utility Maximization


Agency Costs
Stockholder and managers may have different objectives
job security or personal wealth may be pursued by
managers rather than pursuing stockholder wealth
maximization
Stockholder lack knowledge of managers
Random events may obscure managerial effectiveness and
results
Agency costs
costs to provide incentive for managers to pursue
stockholder goals
monitoring cost

3 policies that create the right


monetary incentives for CEOs to
maximize the value of their companies:
Boards can require that CEOs become

substantial owners of company stock


Salaries, bonuses, and stock options can be
structured so as to provide big rewards for
superior performance
The threat of dismissal for poor performance
can be made real

Definitions of Profit
Business Profit:
Total revenue minus the
explicit (or accounting) costs
of production[1].
[1] also called out-of-pocket expenses

Definitions of Profit
Business Profit: Total revenue minus the
explicit (or accounting) costs of production.

Mainly a concern of an Accountant


Controlling day to day operations
Detecting frauds/embezzlement
Satisfy tax and other laws
Produce records for various interest
groups - e.g. shareholders, tax authority,
regulators etc.

Definitions of Profit

Economic Profit:
Total revenue minus the explicit and implicit
costs* of production.
*refers to the value of the inputs owned and used by the firm in its own production
process e.g salary that entrepreneur could have earned for someone else in a
similar capacity, return the firm could have earned from investing its capital,
renting its land & other inputs to others .

Important for decision making


To choose rationally among the alternative projects for
investment/expansion

Opportunity Cost: Implicit value of a resource in its


best alternative use.

EXAMPLE
Violet purchased a tract of land for Rs1000,000. She
quit her Rs300,000 a year job as a postal employee and
opened a skeet shooting range on her land. The range
generates Rs300,000 in net revenue after all day-to-day
expenses have been covered. Assume that the relevant
discount rate is 10%. What is Violet's business profit?
What is her economic profit?

Solution: Business profit is Rs 300,000.


Implicit cost = 300,000 + (0.10)(1000,000) =
Rs400,000 so she has an economic loss of
Rs100,000.

For each one of the costs below, explain


whether the resource cost is explicit or
implicit. Assume the owner of the business
can invest money and earn 10% annually.
Calculate the explicit and implicit cost
wherever applicable.
A computer server to run the firms network is
leased for $6000 per year which is $1000 more
than the market rate.
The owner starts a business using $50000 of cash
from a personal savings account.
Computer programmers cost $30 per hour. The
firm will hire 200000 hours of programme
services this year.
A building for the business was purchased three
years ago which is now worth $30 million.

Theories of Profit

Risk-Bearing Theories of Profit


Frictional Theory of Profit
Monopoly Theory of Profit
Innovation Theory of Profit
Managerial Efficiency Theory of
Profit

Function of Profit
Profit is a signal that guides the
allocation of societys 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.

Constraints on Operations of
the FIRM
a)Availability of essential input/s
a)
b)
c)
d)

Skilled labour
Specific raw material
Factory and warehouse space
Credit availability etc.

Constraints on Operations of the


FIRM (contd.)
Legal constraints: to ensure that the firm
behaviour is consistent with social welfare
objectives

Wage/labour laws
Health and safety standards
Pollutions emission norms
Unfair business practices etc.

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