1. Chapter 1 The Nature and Scope of Managerial Economics

2. Managerial Economics Defined
Salvatore - “The application of economic theory and the tools of decision science to examine how an organization can achieve its aims or objectives most efficiently.”
Pappas & Hirschey - “Managerial economics applies economic theory and methods to business and administrative decision- making.”

3. Economic Theory and Tools of Decision Sciences
Microeconomics
Macroeconomics
Tools of Decision Sciences
Mathematical Economics to express economic theory in equation form
Econometrics applies statistical tools to estimate the models, and forecasting

4. Managerial Decision Problems
Economic theory Microeconomics Macroeconomics
Decision Sciences Mathematical Economics Econometrics
MANAGERIAL ECONOMICS Application of economic theory and decision science tools to solve managerial decision problems
OPTIMAL SOLUTIONS TO MANAGERIAL DECISION PROBLEMS

5. The Process of Decision Making
Five basic process
a. Define Problem
b. Determine the objective
c. Possible solution
d. Select the best possible solution
e. Implement the decision

6. Product Markets Households Firms Factor Markets Rs Rs
Goods and Services
Goods and Services
Firms
Households
Economic Resources
Economic Resources
Income Rs
Factor Markets
Factor Payment Rs

7. Theory of the Firm
Firm Combines and organizes resources for the purpose of producing goods and/or services for sale.
Transaction and organization of productive factors are generally accomplished by the central control of managers.
Firms do not continue to grow larger and larger indefinitely
Primary goal is to maximize the wealth or value of the firm.

8. The present value of all expected future profits
Value of the Firm
The present value of all expected future profits

9. Constraints on the Operation
The primary goal of the firm is to maximize the value or wealth of the firm subject to the constraint that it faces.

10. Limitations of the Theory of the Firms
Maximization of sales
Managers seek to maximize sales after adequate profit is earned to satisfy stockholders
Maximization of management utility
The agent may be more interested in maximizing his utility than maximizing the principle’s
Satisficing behavior
Managers strive for some satisfactory goal e.g sales, profit, market share, etc.

11. Definitions of Profit
Business 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.

12. Theories of Profit Risk-Bearing Theories of Profit
Above average returns are required by the firms to remain in sectors in which there is above average risk.
Frictional Theory of Profit
Profit arises as a result of friction or disturbances from long run equilibrium.
Monopoly Theory of Profit
Firms with monopoly power restrict the output and charge higher prices

13. Contd…. Innovation Theory of Profit
A reward for the introduction of successful innovation
Managerial Efficiency Theory of Profit
Firms that are more efficient than the average will earn above normal profits.

14. Function of Profit
Profit 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.

15. Contd…
From society’s welfare point of view the profit system may not be perfect.