BEPMC 311: MANAGERIAL ECONOMICS

MODULE 1: FUNDAMENTALS OF
ECONOMICS, MANAGEMENT AND
MANAGERIAL ECONOMICS
This introductory module introduces you to the basic concepts of managerial economics. This
unit begins by outlining the definition, origins and methods of managerial economics analysis. This
subsequent sections of this unit give a detailed discussion on the link between managerial economics
and other disciplines as well as the usefulness of economics to business management and decision
making. Overall, this unit establishes the nature and scope of managerial economics.

At the end of this module, you should have achieved the following topic or unit learning outcomes.

UNIT LEARNING OUTCOMES

Define managerial economics.

Understand the origins and methods of managerial economics analysis.
Explain the link between managerial economics and other disciplines.
Describe the scope of managerial economics.

To test your understanding of the topics presented in this module, there are two activities you
need to accomplish, one is an assessment activity which is not graded and the other one is a
graded activity.
TOPIC 1: FUNDAMENTAL ECONOMIC THEORIES, PRINCIPLES
AND CONCEPTS RELEVANT TO MANAGERS AND BUSINESSES

Managerial economics, meaning the application of economic methods to the managerial

decision-making process, is a fundamental part of any business or management course. It has
been receiving more attention in business as managers become more aware of its potential as
an aid to decision-making, and this potential is increasing all the time.

The main branch of economic theory with which managerial economics is related is
microeconomics, which deals essentially with how markets work and interactions between
the various components of the economy. In particular, the following aspects of
microeconomic theory are relevant

1. Theory of the Firm

Behavior of a firm in a pursuit of profit maximization, analyzed in terms of (1) what are
its inputs, (2) what production techniques are employed, (3) what is the quantity
produced, and (4) what prices it charges. The theory suggest that firms generate good to
a point where marginal cost equal marginal revenue, and use factors of production to the
point where their marginal revenue product is equal to the costs incurred in employing
the factors.

2. Demand Analysis
Demand analysis helps in analyzing the various types of demand which enables he
manager to arrive at reasonable estimates of demand for a product or his company.
Managers not only assess current demand, but have to consider the future demand also.

3. Production Function
Conversion of inputs into output is known as production function. Factors of production
are combined in a particular way to get maximum output.

4. Cost Analysis
Costs analysis is helpful in understanding the cost of a particular product. It takes into
account all costs incurred while producing a particular product. Under costs analysis, we
will consider determinants of costs, method of estimating costs, the relationship between
costs and output, the forecast of costs and profit.

5. Market Structures
Market structures provide a way of understanding the extent of competition faced by
firms. Here we study the model of perfect competition and move on to imperfect models.

These theories provide the broad conceptual framework of ideas involved. Economics is
essentially an approach that treats the individual elements within the economy (consumers,
firms and workers) as rational agents with objectives that can be expressed as quantitative
functions (utilities and profits) that are to be optimized, subject to certain quantitative
constraints.
TOPIC 2: FUNDAMENTALS OF BUSINESS MANAGEMENT AND
DECISION-MAKING

BUSINESS MANAGEMENT

Having a true passion for the business one is managing is very important for success. But
passion alone is not enough. A manager also needs core business skills to properly launch the
organization and survive over the long term. A manager needs to understand business
planning, strategy, finance, and marketing. If a manager plans to hire people to help run
things, communication skills, leadership skills and an understanding of how to motivate and
reward employees are needed. One needs a clear strategic vision for the company and an
ability to make informed management decisions based on research and analysis of the market,
the competition and any other internal or external forces that can impact your business.

1. People
Human resources are your company’s greatest asset and how you lead, motivate and inspire your
employees can have a huge impact on the success of your company. Key leadership and
communication skills are necessary to be a successful leader and build a strong organization.

2. Operations
Have you ever wondered what happens behind the scenes of a major new product launch such as
a new iPhone or the latest version of a popular video game? Managing a supply chain and
making sure production meets demand under tight deadlines can be incredibly complex and is
critical to business success. Understanding key aspects of business operations including capacity
planning, productivity analysis and improvement and quality assurance.

3. Accounting
Proper management of the day to day accounting and finances of a business is critical to
operations and learning how to read, analyze and prepare financial statements is an essential skill
if you plan to start or run a business.

4. Strategy
How does your business compete in the industry? How can you create a competitive advantage?
Are you able to adapt to a changing business environment? The ability to take a high-level,
strategic view of a business is necessary to identify opportunities and to stay ahead of external
forces such as new competition and changing consumer demand.

5. Finance
The growth and maintenance of your business may require making major purchases, investments,
mergers and acquisitions and more. Smart financial planning and decision-making create value
for your organization and ensure its growth into the future.

6. Marketing and PR
Marketing is much more than simply advertising a product or service. You must identify and
interact with your customer, stay on top of their changing needs and desires and deliver a strong
value proposition. Learning core concepts of marketing including segmentation, targeting,
differentiation, product positioning and much more are essential.

DECISION MAKING
Decision making process is more than simply following a list of steps, it even combines
subjective and objective evaluation of certain conditions. Nevertheless, the manager must be
as rational as possible, drawing upon all available techniques and guidelines in choosing
among the various alternatives. Let us look at some of the basics of decision making.

 Decision-Making Environment

The quality of the decisions made in an organization will dictate the success or failure of
the said business. So, all the available information and alternatives must be studied
before arriving at an important decision.

Another factor that affects these decisions is the environment in which they are taken.
There are a few different types of environments  in which these decisions are made. And
the type of decision-making environment has an impact on the way the decision is taken.
Broadly there are three basic types of decision making environment. Let us take a brief
look at each of them.

1. Certainty

Such type of environment is very sure and certain by its nature. This means that all
the information is available and at hand. Such data is also easy to attain and not very
expensive to gather. So, the manager has all the information he may need to make an
informed and well thought out decision. All the alternatives and their outcomes can
also be analyzed and then the manager chooses the best alternative.

Another way to ensure an environment of certainty is for the manager to create a

closed system. This means he will choose to only focus on some of the alternatives.
He will get all the available information with respect to such alternatives he is
analyzing. He will ignore the other factors for which the information is not available.
Such factors become irrelevant to him altogether.

2. Uncertainty

In the decision making environment of uncertainty, the information available to the

manager is incomplete, insufficient and often unreliable. In an uncertain
environment, everything is in a state of flux. Several external and random forces
mean that the environment is most unpredictable. In these times of chaos, all the
variables change fast. But the manager has to make sense of this mayhem to the best
of his ability. He must create some order, obtain some reliable data and make the
best decision as per his judgment.

3. Risk

Under the condition of risk, there is the possibility of more than one event taking
place. Which means the manager has to first ascertain the possibility and probability
of the occurrence or non-occurrence of the event. The manager will generally rely on
past experiences to make this deduction. In this scenario too, the manager has some
information available to him. But the availability and the reliability of the
information is not guaranteed. He has to chart a few alternative courses of actions
from the data he has.
 Components of Decisions

Every decision that managers make (or don't make) therefore shapes the future of the
firm. Every manager tries to make good decisions. However, it is easy to overlook an
important factor, miss a desirable option, or base the decision on unreliable information.
In addition, fear of making a wrong choice can cause to postpone decisions, leading to
missed opportunities. A structured decision-making process ensures that important
decisions are made on time and are based on facts, research, and analysis.

The most important aspect of structured decision-making is to recognize and analyze the
basic components of decisions.

1. Context - The context describes the situation surrounding the decision. For example,
the deadline and who needs to be involved to ensure a successful result.

2. Objectives - A clear understanding of desired outcomes guides decision-making and

makes it easier, logical, and less stressful. (People often avoid making decisions
because of a lack of clear objectives.)

3. Options - Significant effort must be spent uncovering all available options, studying
how each may be implemented and what results they will produce. Too often, people
limit themselves to a few obvious choices, and do not explore unusual (breakthrough)
ideas.

4. Criteria - The criteria used to select the best possible options are determined by the
context and objectives. Hard criteria are conditions which must be satisfied in order
to have a useful decision, such as budget or time constraints. Soft criteria are
conditions which require subjective assessment, and therefore can be more difficult
to apply. Examples are level of organizational disruption and employee satisfaction.

 Decision-Making Process

An effective decision-making process ensures that all four components are analyzed.
Templates are used to simplify the work and remind us of important aspects of each
component. The steps are normally completed in a sequential manner. However, it is
acceptable to skip ahead and quickly jot down some information while it is fresh in one's
memory, or to jump back and fill in new information that was overlooked initially.

Step 1: Determine the importance and the context of the decision

Use a worksheet to analyze the context. On the worksheet, list the following:

1. By when does the decision need to be made?

2. What is the time period for implementation of this decision?
3. What will be the outcome in the case of a successful decision? What will be
outcome for a wrong decision? What will be the consequences of not
deciding?
4. Who will be impacted by the decision? Who are the key people that will
help to make the decision successful?
 5. What type of activities and changes in the environment and behaviors will
be needed?
6. If the decision will impact a large number of individuals or entities, what
resources and actions will be needed to manage this impact?
7. Can early feedback through polling or other methods help in understanding
the impact on the individuals or entities?
8. Who are the key individuals who will need to support the decision with
respect to funding or human resources in order to make it succeed?

The context determines the possible consequences of the decision, the time
period involved, and who needs to be involved in the decision process.
Significant time and effort should be invested for important decisions.

Step 2: Determine the objectives for the decision

Draft an objectives worksheet and list the primary and secondary goals for the
decision. This worksheet should include the desired outcomes and indicate
which outcomes are to be avoided.

Step 3: List all options

Develop an options worksheet by listing all available options. Use

brainstorming or other methods to identify as many additional options as you
can. Make special effort to identify impossible, wild or unrealistic options, as
these may lead to outstanding 'out of the box' solutions. Find ways to uncover
new options that may not be obvious. To encourage creativity, all options
should be listed without critique.

Once all available options have been listed, clarify each option and select the
most promising ones for further analysis. (Be careful not to discard options too
early in the process.)

Step 4: Explore promising options

The most promising options should be discussed and analyzed to determine how
they may be applied and what results they will produce. Consider how options
relate to one another, and whether some options have common components or
make implementation of other options easier. In parallel with this analysis,
identify options that need more research or clarification.

Several techniques are available for analyzing the options in order to understand
their implications.

1. Interpretive Structural Modeling or Concept Mapping can be used to

analyze the inter-relationships of the options.
2. Implementation analysis can provide a clear view of resource requirements,
people and groups affected, and any cautions to exercise when
implementing the option.
3. A SWOT analysis can be used to determine the Strengths, Weaknesses,
Opportunities, and Threats for each option.
 The options are analyzed to gain a clear understanding of their implications
before applying the decision-making criteria. This is to ensure that options are
not discarded prematurely and that an accurate analysis takes place.

Step 5: Establish decision-making criteria

Review your objectives as you develop the set of criteria that will be used to
rate the options. Criteria may be clear conditions, which must be met in order to
have a useful decision, or soft criteria, which require subjective or qualitative
analysis. Assign an importance rating to each criteria.

Step 6: Evaluate the options against the criteria

When options and criteria have been established, a table is drawn with the
options listed in the rows and the criteria listed in the columns. Each option is
rated for each criteria and the value written in the corresponding cell of the
table. Then, each criteria is given a numerical importance rating. The final
matrix is generated by multiplying each option's rating for a criteria by the
criteria's importance rating. An option's overall evaluation is then determined by
the sum of this weighted rating for all the criteria.

Step 7: Select the options to pursue

Examine the Options and Screening Matrix to determine if some of the options
can be combined to create a better solution. Summarize the options selected for
implementation and their implications.

Step 8: Analyze the risks

All decisions involve an element of risk. Managers need to uncover the risks
involved or difficulties which need to be overcome when implementing the
options. Strategies can then be developed to manage those risks.

TOPIC 3: THE NATURE AND SCOPE OF MANAGERIAL

ECONOMICS

MANAGERIAL ECONOMICS DEFINED

Managerial Economics is the application of economic theory and the tools of decision
science to examine how an organization can achieve its aims or objectives (Salvatore,

Core Components:

1. Manager – a person who directs resources to achieve a stated goal.

2. Economics – the science of making decisions in the presence of scarce resources.
3. Managerial Economics - the study of how to direct scarce resources in the way
that most efficiently achieves a managerial goal.
Managerial economics is viewed as a special branch of economics bridging the gap between
pure economic theory and managerial practice. It involves the application of economic theory
and methodology to decision-making process by the management of the business firms.

1. Managerial economics is the application of economic analysis to business problems (V.

Sibanda).
2. Managerial economics consists of the use of economic models of thought to analyze
business situations (McNair and Marrian).
3. Managerial economics is the integration of economic theory with business practices for
the purpose of facilitating decision making and forward planning by the management.

In a simple diagram, we see how managerial economics is used to provide optimal solutions
to managerial decision problems.

Figure 1: Managerial Economics and Its Role to Managerial Decision

Problems

Problems arise in any organization, be it firm, not-for-profit organization (hospital,

government agency, university). Mathematical economics and econometrics are tools used to
construct and estimate decision models aimed at determining optimal behavior of the firm.
The goals and constraints may differ from case to case, but the decision-making process is the
same. Economic theories seek to predict and explain economic behavior.

Most of economic analysis to be found in managerial economics has its origins in theoretical
microeconomics. Topics like the theory of demand and supply, the profit maximization
model of the firm, optional prices and expenditures and the impact of the market structure on
firms’ behavior are all approached using the economist’s standard intellectual “tool-kit”,
which consists of building and testing models. The following theories, concepts, or principles
are considered in this course:
RELATIONSHIP WITH DECISION SCIENCES

The decision sciences provide the tools and techniques of analysis used in managerial
economics. The most important aspects are as follows:

 numerical and algebraic analysis

 optimization
 statistical estimation and forecasting
 analysis of risk and uncertainty
 discounting and time-value-of-money techniques

RELATIONSHIP WITH BUSINESS FUNCTIONS

All firms consist of organizations that are divided structurally into different departments or
units, even if this is not necessarily performed on a formal basis. Typically, the units involved
are:

1. production and operations

2. marketing
3. finance and accounting
4. human resources

All of these functional areas can apply the theories and methods mentioned earlier, in the
context of the particular situation and tasks that they have to perform. Thus a production
department may want to plan and schedule the level of output for the next quarter, the
marketing department may want to know what price to charge and how much to spend on
advertising, the finance department may want to determine whether to build a new factory to
expand capacity, and the human resources department may want to know how many people
to hire in the coming period and what it should be offering to pay them. It might be noted that
all the above decisions involve some kind of quantitative analysis; not all managerial
decisions involve this kind of analysis. There are some areas of decision-making where the
tools and techniques of managerial economics are not applicable. For example, a sales
manager may want to motivate a salesperson to achieve a higher level of performance. In this
case an understanding and application of behavioral and psychological principles is relevant.
That is not to say that economists can ignore these, but managerial economics tends to focus
more on behavioral aspects when they concern consumers rather than when they concern the
behavior of employees. A more detailed discussion of the scope of managerial economics
follows in the next section.

REFERENCES

Michael R. Baye (2010) Managerial Economics and Business Strategy 7 th ed. Massachusetts: Irwin
McGraw-Hill.

Paul G. Keat and Philip K.Y. Young (2000) Managerial Economics: Tools for Today’s Decision
Makers. Upper Saddle River, New Jersey: Prentice Hall International.

Dominick Salvatore (2014) Managerial Economics in a Global Economy, 8 th ed. Singapore: Oxford
University Press.