Lecture 1 07

What is managerial economics?
 Managerial economics is the
use of economic analysis to make
business decisions involving the
best use (allocation) of an
organization’s scarce resources
 Managerial economics is (mostly)
applied microeconomics (normative
microeconomics)

Managerial economics deals with
“How decisions should be made by
managers to achieve the firm’s goals
- in particular, how to maximize
profit.”
(Also government agencies and
nonprofit institutions benefit from
knowledge of economics, i.e. efficient
recourse allocation is important for
them too...)

Relationship between Managerial
Economics and Related
Disciplines
Management
Decision Problems
Economic
Concepts
Managerial
Economics
Optimal Solutions to Managerial
Decision Problems
Management
Decision Problems
Managerial
Economics
Decision Problems
Decision Sciences

 Management Decision
Problems
 Product Price and Output
 Make or Buy
 Production Technique
 Stock Levels
 Advertising Media and Intensity
 Labor Hiring and Training
 Investment and Financing
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences

 Decision Sciences
Tools and Techniques of Analysis
 Numerical Analysis
 Statistical Estimation
 Forecasting
 Game Theory
 Optimization
 Simulation
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences

 Economic Concepts
Framework for Decisions
 Theory of Consumer Behaviour
 Theory of the Firm
 Theory of Market Structure and Pricing
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences

 Managerial Economics
 Use of Economic Concepts and
Decision Science Methodology to
Solve Managerial Decision Problems
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences
Management
Decision Problems
Economic Concepts
Managerial
Economics
Decision Problems
Decision Sciences

Ch 2 THE GOALS OF A FIRM
Economic Goals:
Maximizing or Satisficing
1. Profit
2. Market share
3. Revenue growth
4. Return on investment
5. Technology
6. Customer satisfaction
7. Shareholder value

THE GOALS OF A FIRM continued
Non-economic Objectives:
1. “A good place for our employees to
work”
2. “Provide good products/services to our
customers”
3. “Act as a good citizen in our society”

Optimal Decision:
Given the goal(s) that the firm is
pursuing, the optimal decision in
managerial economics is one that
brings the firm closest to this goal.

Roles of Managers:Making decisions and processing
information are the two primary tasks
of managers.
Examples:
• Whether or not to close down a branch
of the firm?
• Whether or not a store or restaurant
should stay open more hours a day?
• How a hospital can treat more patients
without a decrease in patient care?

Role of Managers continued
 How a government agency can be
reorganized to be more efficient?
 Whether to install an in-house
computer rather than pay for outside
computing services?

All these, as well as many other
managerial decisions require the use
of basic economics.
Economic theory helps decision
makers to know what information is
necessary in order to make the
decision and how to process and use
that information.

Questions that managers must answer:
♦ Should our firm be in this business?
♦ If so, what price and output levels achieve
our goals?
♦ How can we maintain a competitive
advantage over our competitors?
 Cost-leader?
 Product Differentiation?
 Market Niche?
 Outsourcing, alliances, mergers,
acquisitions?
 International Dimensions?

Questions that managers must answer:
♦ What are the economic conditions in a
particular market?
 Market Structure?
 Supply and Demand Conditions?
 Technology?
 Government Regulations?
 International Dimensions?
 Future Conditions?
 Macroeconomic Factors?

DMs Optimize
We should emphasize that
practically in all managerial
decisions the task of the manager
is the same!
Namely, each goal involves an
optimization problem.

The manager attempts either to
maximize or minimize some
objective function, frequently
subject to some constraint(s).
And, for all goals that involve an
optimization problem, the same
general economic principles apply!

REVIEW OF SUPPLY AND
DEMAND
“Economic analysis begins and ends
with demand and supply.”
The primary importance of demand and
supply is the way they determine prices
and quantities sold in the market.
Managers are extremely interested in
forecasting future prices and output,
both for the goods and services they sell
and for the inputs they use.

DEMAND ELASTICITY
 Elasticity measures the sensitivity of
the quantity demanded to changes in
the determinants of demand
(supply).
Some elasticity concepts:
• price elasticity of demand
• elasticity of derived demand
• cross-elasticity of demand
• income elasticity of demand
• elasticity of supply

Determinants of Price Elasticity of Demand
1. The number and availability of
substitutes
2. The expenditure on the commodity in
relation to the consumer’s budget
3. The durability of the product
4. The length of the time period under
consideration
5. Consumer’s preferences

Short-Run vs. Long-Run Elasticity
P2
P1
P
DS5 DS4 DS3 DS2
DS1
f
e
d
c b
a
DL
QQ1Q2Q3
A long-run demand curve will generally be
more elastic than a short-run curve
As the time
period
lengthens
consumers
find way to
adjust to the
price change,
via
substitution or
shifting
consumption

Elasticity of Derived Demand
 The demand for components of final
products is called derived demand
The derived demand curve will be the
more inelastic:
1. The more essential is the component in
question.
2. The more inelastic is the demand for the
final product.
3. The smaller is the fraction of total cost
going to this component.
4. The more inelastic is the supply curve of
cooperating factors.
5. The shorter the time period under
consideration.

The Relationship between Elasticity and Total
Revenue
IF DEMAND IS
P ↓ Q ↑ elastic if TR ↑ (relative ∆Q> relative ∆P)
P ↓ Q ↑ inelastic if TR ↓ (relative ∆Q< relative ∆P)
P ↑ Q ↓ elastic if TR ↓ (relative ∆Q> relative ∆P)
P ↑ Q ↓ inelastic if TR ↑ (relative ∆Q< relative ∆P)

Demand, Total Revenue, Marginal Revenue,
and Elasticity
Priceandmarginal
revenue($)
Quantity
TotalRevenue
($)
Quantity
0
p0
D E>1
E=1
E<1
D
M
R
q0
q00

The Cross-Elasticity of Demand
Cross-price elasticity measures the
relative responsiveness of the
quantity purchased of some good
when the price of another good
changes, holding the price of the
good and money income constant.

It is, therefore, the percentage
change in quantity demanded in
response to a given percentage
change in the price of another
good.
B
A
X
P
Q
E
∆
∆
=
%
%

Cross-elasticity can be either
positive or negative. In particular,
cross-elasticity is positive for
substitutes and negative for
complements.

Categories of Income Elasticity
 Income elasticity > 1: superior goods
 Income elasticity > 0, and <1: normal goods
 Income elasticity < 0: inferior goods
Superior
Normal
Inferior
Q
Y

Applications of Supply and Demand
 Interference with the Price
Mechanism:
• the effect of a price ceiling
• the effect of a price floor
• the effect of a subsidy
• the incidence of taxes

The Effect of a Price Ceiling on Quantity
of Supply and Demand
0
P1
P0
P2
P
Q1 Q0 Q2 Q
D
S

The Effect of a Price Floor on Supply and
Demand
W
0
W0
W1
Q1 Q0 Q2 Q
D
S

The Use of Price Supports
Surplus (Q2-Q1) bought Production quota Q3
by the government introduced by the
government
Q
0
P0
P1
P
Q1 Q2
D
S
Q0
P1
P
Q1 Q3
D
a) b)

 The Incidence of Taxes
 effect of demand elasticity
 effect of supply elasticity
 Imposition of a Voluntary
Export Quota
 Shift in Demand as Consumer
Tastes Change

Demand Elasticity and Tax Incidence
More elastic demand shifts the tax burden more
to the supplier.
D’
0
P
Q
D
S
D’
0
P
Q
S
S’

Supply Elasticity and Tax Incidence
P
P1
P2
P*
Q1 Q2 Q* Q
D
S
S1
S1’
S’
The more elastic the supply, the more heavily
consumers will bear the burden of the tax.

Imposition of a Voluntary Export Quota
Q
0
P0
P1
P
Q1 Q0
D
S0
S1
Q
0
P’
P’’
P
Q’ Q’’
D’
S’
D’’
a)
b) D & S of other cars
D & S of Japanese cars
in USA before 1981

The Downward Shift in Beef Demand
Q
0
P1
P0
P
Q1 Q0
D1
S0
D0
D2
S1
Decrease in the demand of beef will, over time,
shift resources out of beef production.

Lecture 1 07

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