Concepts

ConceptsofofManagerial
ManagerialEconomics
Economics

Definition of Managerial Economics

 Managerial Economics is a science applied to

decision making.
 Managerial Economics is applied Microeconomics,
making use of the tools of Statistics, Mathematics,
and Decision Science to solve managerial decision
problems.
 Managerial economics deals with the application of
the economic concepts, theories, tools, and
methodologies to solve practical problems in a
business.

Dr. Mosiur Rahman

 Concepts
ConceptsofofManagerial
ManagerialEconomics
Economics

Definition of Managerial Economics

 Managerial economics is the study of economics

theories, logic and tools of economic analysis that
are used in the process of business decision making
by managers.
 Economics theories and tools of economic analysis
are used to find out business problems, evaluate
business options and opportunities to take an
appropriate business decision.

Dr. Mosiur Rahman

 Concepts
ConceptsofofManagerial
ManagerialEconomics
Economics

Definition of Managerial Economics

 Milton H. Spencer and Lonis Siegelman define

Managerial Economics as “the integration of
economic theory with business practice for the
purpose of facilitating, decision making and forward
planning by management.”

Dr. Mosiur Rahman

 Concepts
Conceptsof
ofManagerial
ManagerialEconomics
Economics

Economic Analysis & Business Decision Making

Managerial
Managerialdecision
decisionproblems
problems
Product
Productprice
priceand
andoutput
output
Make or buy
Make or buy
Production
Productiontechnique
technique
Investment
Investment andfinancing
and financing

Economic
Economicconcepts
concepts Decision
Decisionmaking
makingtools
tools
Theory
Theory of consumerbehaviour
of consumer behaviour Numerical analysis
Numerical analysis
Theory of firm
Theory of firm Statistical
Statisticalanalysis
analysis
Theory
Theory ofmarket
of marketstructures
structuresand
and Forecasting
Forecasting
pricing Game
pricing Gametheory
theory
Optimization
Optimization

Managerial
ManagerialEconomics
Economics
Use
Useofofeconomics
economicsconcepts
conceptsand
and
decision making tools to solve
decision making tools to solve
managerial
managerialdecision
decisionproblems
problems

Optimal
Optimalsolutions
4 solutions
Dr. Mosiur Rahman
 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

Economic Analysis & Business Decision Making

Examples of Managerial Problems:

 What should we produce? (production theory)

 Where and how to get financing
 What method of production to use
 Whether or not to invest in new equipment
 What are customers buying? (demand theory)
 Which costs do I need to worry about now? (cost theory)
 What market am I in? (competition theory)
 What should we charge for it? (pricing theory)

Dr. Mosiur Rahman

 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

Economic Analysis & Business Decision Making

Managerial Decision Making Process:

1. Determining and defining the objective to be

achieved.
2. Collection and analysis of information on
economic, social, political, and technological
environment.
3. Inventing, developing and analyzing
possible course of action
4. Selecting a particular course of action from
available alternatives.
Dr. Mosiur Rahman
 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

Economic Analysis & Business Decision Making

For Launching a new product, issues to be considered:

 Product related issues-Manager required to

collect & analyze production technique & it’s cost,
supply position of input required & it’s price,
availability of foreign exchange it inputs required.
 Sales prospects & Problems- Market &
Business trend, competitors & their market share,
pricing & strategy of Competitors, market structure,
supply of complementary goods.

Dr. Mosiur Rahman

 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

ME facilitate to solve Business Problem. Ways :

First, it can give clear understanding of the various necessary

economic concepts, including demand, supply, cost, price, and
the like that are used in business analysis.
Second, it can help in ascertaining the relevant variables and
specifying the relevant data.
Third, it provides consistency to business analysis and helps in
arriving at right conclusions.

Dr. Mosiur Rahman

 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

Scope of Managerial Economics

Dr. Mosiur Rahman

 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

Scope of Managerial Economics

The scope of managerial economics extends to those

economic concepts, theories, and tools of analysis used
in analyzing the business environment, and to find
solutions to practical business problems.

The areas of business issues:

1. Operational or internal issues; and,
2. Environment or external issues.

Dr. Mosiur Rahman

 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

Scope of Managerial Economics

Microeconomic theories dealing with Operational

or internal issues include:
 Demand and Supply Analysis and Forecasting
 Cost and Production Analysis
 Product Policy, Advertising & Sales Promotion
 Pricing & Output Decision
 Profit analysis and Management
 Investment & Capital Management

Dr. Mosiur Rahman

 Nature
Nature&&Scope
ScopeofofManagerial
ManagerialEconomics
Economics

ME & Gap Between Theory & Practice

ME logic and tools of analysis guide business

decision makers in: :
1. identifying their problems in the achievement
2. collecting the relevant data and related facts;
3. processing and analyzing the facts;
4. drawing the relevant conclusions;
5. determining and evaluating the alternative means of
achieving the goal; and,
6. taking a decision.

Dr. Mosiur Rahman

 Objectives
ObjectivesofofaaBusiness
BusinessFirm
Firm

Concept of Profit

• Profit is the positive gain from an investment or

business operation.
• ‘Profit’ means the excess of revenue over all paid out
costs or expenses (Operating Expenses & Overhead
Expenses).
• For practical purposes profit or business income
refers
to profit in accounting sense.

Dr. Mosiur Rahman

 Objectives
ObjectivesofofaaBusiness
BusinessFirm
Firm

Accounting Profit VS Economic Profit

 Accounting Profit = π = TR – (w + r + i + m)
 Accounting or Business Profit = TR-Explicit Costs
 Economic profit is a return over and above the
opportunity cost.
Economic Profit= TR – Total Economic Cost
= TR– (Explicit costs + Implicit Costs)

Dr. Mosiur Rahman

 Economic Profit versus
Accounting Profit
 Business Profit = TR- Explicit costs
 Business Profit >Economic Profit
 When EP=0, then BP is normal
 When EP>0, then BP is Supernormal Above
Normal or Abnormal Profit
 Accounting profit does not subtract implicit
costs from total revenue.
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Dr. Mosiur Rahman
Total Economic Cost
 Total Economic Cost
– Sum of opportunity costs of both market-supplied
resources & owner-supplied resources.
 Explicit Costs
– Monetary payments to owners of market-supplied
resources
 Implicit Costs
– Nonmonetary opportunity costs of using owner-
supplied resources

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Dr. Mosiur Rahman
Types of Implicit Costs

 Opportunity cost of cash provided by owners

– Equity capital
 Opportunity cost of using land or capital
owned by the firm
 Opportunity cost of owner’s time spent
managing or working for the firm

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Dr. Mosiur Rahman
Theories of Profit/Role of Profit in the
Operation of a Free Economy:

The most important theories are:

a) Frictional Theory of Profit
b) Rent Theory of Profit.
c) Dynamic Theory of Profit.
d) Hawley's Risk Bearing Theory of Profit.
e) Uncertainty Theory of Profit.
f) Innovation Theory of Profit
g) Monopoly Theory of Profit.

Dr. Mosiur Rahman

Walker’s Rent Theory of Profit:

 Profits is the rent of “exceptional abilities that an

entrepreneur may possess” over others.
 Profit is rental in character. Just as superior grades
of land earn more rent than the inferior grades of
land.
 similarly superior entrepreneurs due to their
exceptional ability or opportunity earn more profits
than the inferior entrepreneurs.
 So, Profit is the difference between the earnings of
the least and the most efficient entrepreneurs.
Clark’s Dynamic Theory of Profit:

• "Profit arises only in a dynamic economy.

• The manager’s who take advantages of changing
conditions in a dynamic economy make pure profit.
• An economy is said to be dynamic when generic
change in-
• population and capital
• method of production
• Changes in the form of business organization
• The consumers wants, etc.,
Hawley's Risk Bearing Theory of Profit:

• "Profit is the reward of risk taking by the

entrepreneur of business.”
• During the conduct of any business activity,
all other factors of production have their
guaranteed incomes from the entrepreneur in
case of profit or loss.
• The greater the risk, the higher must be the
profits.

Dr. Mosiur Rahman

Hawley's Risk Bearing Theory of Profit:

According to Howley, risk in business arise due to

 obsolescence of a product,
 sudden fall in the market prices,
 non-availability of crucial raw materials,
 introduction of better substitutes by competitors
 Fire, theft, accidents etc. which are insurable.

Dr. Mosiur Rahman

 Knight’s Uncertainty Theory of Profit:

 According to Professor Knight:

"Profit is the reward for uncertainly-bearing 
and not of risk-taking in a business.”
 Knight divide risk into calculable & non-
calculable.
Schumpeter’s Innovation Theory of
Profit :

 Under conditions of stationary equilibrium, total

receipts from the business are exactly equal to
the total cost outlay, and there is no profit.
 Profit can be made only by introducing
innovations in manufacturing technique, as well
as in the methods of supplying the goods.
Schumpeter’s Innovation Theory of
Profit :

 Sources of innovation include:

1. Introduction of new commodity or a better
quality good;
2. Introduction of new method of production;
3. Opening of a new market;
4. Discovery of new sources of raw material; and,
5. Organizing the industry in an innovative manner
with the new techniques.
Monopoly Theory of Profit :
 Monopoly arises due to such factors as:
(i) economies of scale;
(ii) sole ownership;
(iii) legal sanction and protection; and,
(iv) mergers and acquisition.
 A monopolist can earn pure or ‘monopoly’ profit and
maintain it in the long run by using its monopoly powers,
including:
(i) powers to control price and supply;
(ii) powers to prevent entry of competitors by price cutting; and,
(iii) monopoly power in certain input markets.
 Objectives
ObjectivesofofaaBusiness
BusinessFirm
Firm

Objectives of a Firm

 Maximizing the value of the firm

 Possible alternative objectives
– Market share maximization
– Growth maximization
– Maximizing the benefit of the stakeholder

Dr. Mosiur Rahman

Maximizing the Value of a Firm

 Maximize firm’s value by maximizing profit in

each time period
– Cost & revenue conditions must be independent
across time periods
 Value of a firm =
1 2 T T
t
  ...  
(1  r ) (1  r ) 2
(1  r ) T
t 1 (1  r )
t

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Dr. Mosiur Rahman
Profit Maximization

Dr. Mosiur Rahman

Profit Maximization

Dr. Mosiur Rahman

Objections to Profit Maximization

 It is Vague. It Ignores the Timing of Returns. It

Ignores Risk. It assume Perfect Competition
 In new business environment profit
maximization is regarded as Unrealistic,
Difficult, Inappropriate, Immoral.

Dr. Mosiur Rahman

 Wealth Maximization

 Maximizes the net present value of a course

of action to shareholders.
 Accounts for the timing and risk of the
expected benefits.
 Benefits are measured in terms of cash flows.
 Fundamental objective—maximize the
market value of the firm.

Dr. Mosiur Rahman

Role of Profit in Business

 Above normal profits provide a signal for

expansion or entry.
 Below normal profits provide a signal for
contraction or exit.
 Allocation of scarce economic resources.
 Reward for innovation and efficiency.

Dr. Mosiur Rahman

Role of Business in Society

 Business is useful in satisfying consumer wants.

 Business contributes to social welfare
 Benefit of growth to stakeholders
 Benefit of growth of Consumer
 Accelerate Govt. services

Dr. Mosiur Rahman