INTRODUCTION TO MANAGERIAL

ECONOMICS
(Module 1)

MUHAMMED
THAHIR P T
 What About Module 1
• Managerial economics: concept
definitions, scope and • Equi-marginal concept
importance
• Cost-Benefit analysis
• Business decision in
• Time perspective
managerial economics.
• Discounting principle.
• Uncertainty and Business
decisions. • Opportunity cost

• Incremental and marginal

 What is
Economics

• “Economics is the Science of wealth” Adam Smith.

• Economics, as a social science, studies human behavior as a
relationship between numerous wants and scarce means having
alternative uses.
• Dealing with Scarcity
• 3 Elements of Economics
 What Produce
 How to Produce
 Whom to Produce
Two basic branches of Economics:
• Micro Economics: Microeconomics is the study of decisions made by
people and businesses regarding the allocation of resources and prices of
goods and services. The government decides the regulation for taxes.
Microeconomics focuses on the supply that determines the price level of
the economy. Microeconomics is a worms view and considering a firm or
market or individual.
• Macroeconomics: Macroeconomics is a branch of economics that
depicts a substantial picture. It scrutinises itself with the economy at a
massive scale, and several issues of an economy are considered. The
issues confronted by an economy and the headway that it makes are
measured and apprehended as a part and parcel of Macroeconomics.
Macroeconomics considering as birds eye view and studying whole
economy or entire market.
 Why Economics in Business
Administration?
• To study consumer behaviour
• To analyse production, consumption and market
• Decision making
• Information about different Market
• To connect whole Economy to single market or firm
 Meaning of managerial economics
• Managerial economics deals with the application of economic principles and
methodologies to the decision-making process, within the firm under the given
situation.
• Study of allocation of resources available to a business firm or an organization.
• It is the economics of business or managerial decisions.
• It is a journey with continuing understanding and application of economic
knowledge
• Managerial economics is an evolutionary science, it is a journey with continuing
understanding and application of economic knowledge — theories, models,
concepts and categories in dealing with the emerging business/managerial
situations and problems in a dynamic economy.
Features and significance of Managerial
Economics
• It involves an application of economic theory — especially,
microeconomic analysis to practical problem solving in real
business life. It is essentially applied microeconomics.
• It is a science as well as art facilitating better managerial discipline.
It explores and enhances economic mindfulness and
awareness of business problems and managerial decisions.
• It is concerned with firm’s behaviour in optimal allocation of
resources. It provides tools to help in identifying the best course
among the alternatives and competing activities in any
productive sector whether private or public.
 Scope of Managerial Economics

• Economic analysis that can be helpful in solving business

problems, policy and planning.
• Microeconomic analysis is understand the business environment
in the Economy.
• It is concerned with firm’s between in optimal allocation of
resources.
 Uses/objectives of Managerial Economics
• It makes problem-solving easy in business;
• It improves the quality and preciseness of decisions;
• It helps in arriving at quick and appropriate decisions.
 7 common small business problems
• Recruitment, retention of employees, and labor quality.
• Changing operations in response to the market conditions.
• Lack of capital/cash flow.
• Administration.
• Time management.
• Marketing and advertising.
• Managing and providing benefits.
Decision-Making
 Decision-Making

The decision‐making process

1. Define the problem.
2. Identify limiting factors.
3. Develop potential alternatives.
4. Analyze the alternatives.
5. Select the best alternative.
6. Implement the decision.
7. Establish a control and evaluation
system.
 Decision-Making
The scientific method:
• The scientific method implies an analytical approach in the study of a
phenomenon.
• Managerial economists tend to rely on the scientific research method in
building and empirically testing business-oriented economic models.
This scientific approach consists of the following steps:
• Defining the problem
• Formulation of the hypothesis
• Abstraction for the model building
• Data collection
• Testing the hypothesis
• Deduction based on data analysis
• Evaluating the test results
• Conclusion for decisions
• Defining the problem:
 The starting point of business economic investigation/research
and analysis is the statement of the problem to be solved in the
concerned business. The problem needs to be clearly defined by
isolating the exact business phenomenon of economic interest
and application. It involves framing the relevant questions to be
explored in specific terms.
• Formulation of hypothesis:
 A hypothesis in a business enquiry is a tentative/largely untested
explanation of the behavior, assumption about the course of
behavioral tendency and discovering the cause effect
relationships among the governing factors/variables of the
concerned business phenomenon.
• Abstraction/model building:
Abstraction and model building were essential in
framing up the enquiry to a manageable proportion by
eliminating complexities and unnecessary or
insignificant details. The process involves distillation
and restrictions for choosing variables and selecting
relevant informations.
• Data collection:
As per the model specification of the variables such as
price, demand, sales, advertising expenditure, and so
on relevant data have to be collected. Data may be
time series, crosssectional or pooled.
• Testing the hypothesis:
 The hypothesis need to be verified on empirical basis by
using the relevant data. Furthermore, the significance of
statistical coefficient should be determined.
• Deduction based on data analysis:
If properly formulated hypothesis indicates not only cause
effect relationship, but also serves as the basis for
predictions on empirical results. Predictions, forecasts or
conclusions are derived from logical deductive reasoning.
• Evaluating the test results
When real world events confirm a hypothesis — (cause-
effect relationship) — it is accepted. This, however, does
not, mean that the hypothesis is proved. What it simply
means is that the investigated events have failed to
disprove the hypothesis. Hypothesis can only be tested; it
can never be proved.
• Conclusion for decisions:
 when a hypothesis is accepted — having passed various
statistical tests, it can be useful for making inferences or
drawing conclusions about a business situation for
decision-making.
 Introduction To Uncertainty In
Business
• Uncertainty is an inevitable part of business decision-
making.
• It arises due to unpredictable external factors such as
market conditions, economic changes, technological
disruption, or political instability.
• The goal is not to eliminate uncertainty but to make
informed decisions that balance risk and opportunity.
• Example: the 2008 financial crisis, covid-19 pandemic
—both drastically altered business landscapes.
 Types of uncertainty
• Strategic uncertainty: involves unpredictable long-term
changes in industry or market trends. Example: emergence of
AI in various sectors.
• Operational uncertainty: short-term risks related to day-to-
day operations. Example: supply chain disruptions.
• Market uncertainty: unpredictability in consumer behavior
or demand. Example: fluctuations in consumer confidence
due to economic downturns.
• Environmental uncertainty: unpredictable changes in
political, legal, or social frameworks. Example: regulatory
 Decision-making Models In Uncertainty

• Classical approach:
• Assumes complete information is available.
• Utilizes rational decision-making frameworks like cost-benefit
analysis.
• Rarely applicable in high uncertainty due to lack of perfect
information.
• Modern approaches:
• Scenario planning: develop different future scenarios and
strategies for each.
• Real options approach: treat strategic decisions as a
series of options to adapt over time.
• Adaptive strategies: create flexible strategies that evolve
Definition of Risk:
• Quantifiable threats with probabilities attached.
• Risk can be managed using statistical tools, forecasting
models, and historical data.
• Definition of Uncertainty:
• When outcomes are unknown and not easily quantifiable.
• Uncertainty requires strategic judgment and decision-
making without full information.
• Key Concept: "All risks are uncertainties, but not all
uncertainties are risks."
 Framework For Decision-making Under Uncertainty

• Key steps:
• Gather data: utilize both quantitative and qualitative data,
including market research, financial reports, and trend analysis.
• Develop scenarios: prepare for multiple potential outcomes
(best-case, worst-case, and most likely scenarios).
• Evaluate risk appetite: understand the organization’s
tolerance for risk.
• Create flexible strategies: design strategies that allow for
mid-course adjustments as situations evolve.
• Make decisions: use a combination of data, intuition, and
experience to make decisions under uncertainty.
 Tools for managing uncertainty
• Key tools:
• SWOT analysis (strengths, weaknesses, opportunities,
threats): helps in identifying key internal and external factors
affecting the business.
• Pestle analysis (political, economic, social, technological,
legal, environmental): examines the macro-environmental factors
that might impact decisions.
• Decision trees: visual tools to evaluate decisions based on possible
outcomes, risks, and rewards.
• Monte carlo simulations: uses random sampling to assess the
impact of uncertainty on complex systems or processes.
• Sensitivity analysis: assesses how sensitive a decision is to
changes in key assumptions.
 Strategies For Managing Uncertainty In Your Business

• Best practices:
• Diversify investments: don’t put all resources in one basket—
diversify products, markets, and revenue streams.
• Agility and adaptability: foster an organizational culture that
can pivot quickly when needed.
• Continuous monitoring: keep track of trends, market
conditions, and emerging risks to adapt strategies accordingly.
• Scenario planning: plan for various future states and be ready
with contingencies.
• Invest in innovation: uncertainty can be turned into
opportunity by investing in new technologies, products, or
 Incremental Analysis
• Incremental analysis differs from marginal analysis only in that it
analysis the change in the firm's performance for a given
managerial decision, whereas marginal analysis often is generated
by a change in outputs or inputs.
• Incremental analysis is generalization of marginal concept. It refers
to changes in cost and revenue due to a policy change.
For example - adding a new business, buying new inputs,
processing products, etc.
• Change in output due to change in process, product or investment
is considered as incremental change. Incremental principle states
that a decision is profitable if revenue increases more than costs; if
costs reduce more than revenues;
 Concept of Marginalism
• Microeconomic theories are based on the principle of
Marginalism.
• Marginal changes are assumed in the relevant phenomena.
• Marginal change refers to the addition of just a single unit more.
Thus, these are concepts like marginal utility, marginal cost,
marginal product, marginal revenue, etc.
• It, refers to a bit by bit change in the total variation. The
theories, imply equilibrium conditions in terms of margin, such
as a consumer equating marginal utility with price for the
maximisation of total satisfaction, a producer equating marginal
cost with marginal revenue for maximisation of profits, etc.
 • Marginalism focuses on the additional or incremental changes
resulting from a decision.
• It helps firms make decisions by analyzing the marginal cost
(MC) and marginal benefit (MB) of an action.

Marginal Cost (MC): Marginal Benefit (MB):

•The additional cost incurred by •The additional benefit or utility
producing one more unit of a gained from consuming or
good or service. producing one more unit.
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕 𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑻𝒐𝒕𝒂𝒍 𝑩𝒆𝒏𝒊𝒇𝒊𝒕
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝑸𝒖𝒂𝒏𝒕𝒊𝒕𝒚
 Marginal utility:

• The additional satisfaction or value

derived from consuming one more
unit of a good or service.

• Consumers make decisions based

on the marginal utility derived
from their next unit of
consumption.
 • Application of Marginalism in decision making

1.Profit maximization:
1.Rule: A firm maximizes profit where MC = MB or MC = MR
(marginal revenue).
2.If MC < MB, the firm should increase production.
3.If MC > MB, the firm should decrease production.
2.Pricing decisions:
1.Marginal analysis helps firms set optimal prices by balancing
production costs with the potential revenue from additional
units.
3.Resource allocation:
1.Firms allocate resources efficiently by comparing the
 Law of Equi-marginal Utility
• Law of equi-marginal utility explains the relation between the consumption of
two or more products and what combination of consumption these products
will give optimum satisfaction. Marginal utility is the additional satisfaction
gained by consuming one more unit of a commodity.
• Marshal introduced law of Equi Marginal Utility.
• MUX / PX = MUY / PY = MUZ / PZ
 Introduction to cost-benefit analysis (CBA)

• Definition: CBA is a systematic process for calculating

and comparing the benefits and costs of a
decision, project, or policy.
• Purpose: helps managers evaluate whether a decision is
worthwhile by weighing its costs against its benefits.
• Applications: used in capital budgeting, project
evaluation, investment decisions, and public policy
analysis.
 Key components of CBA
• Costs:
• Explicit costs: direct monetary expenses (e.g., Labor,
raw materials, equipment).
• Implicit costs: opportunity costs (e.g., Foregone income
from alternative investments).
• Benefits:
• Tangible benefits: direct revenues or cost savings.
• Intangible benefits: non-monetary gains (e.g., Customer
satisfaction, brand reputation).
Steps in conducting a cost- possible.
benefit analysis 4.Discount future values:
1.Identify the project or 1.Use net present value (NPV)
decision: to account for the time value of
1.Define the scope of the money.
decision or investment. 5.Compare total costs vs. Total
2.List all costs and benefits: benefits:
1.Both direct and indirect, as 1.Make a decision based on the
well as short-term and long- net benefit or net cost.
term. 6.Sensitivity analysis:
3.Quantify costs and benefits: 1.Analyze how changes in key
1.Assign monetary values to all assumptions affect the
Limitations of CBA
• Valuing intangible benefits: difficult to assign monetary
values to intangibles (e.g., Social impact, environmental
benefits).
• Bias in estimates: over-optimistic estimates can skew results.
• Time-consuming: complex projects may require extensive
data collection and analysis.
• Discount rate selection: a wrong discount rate can distort
the analysis, especially for long-term projects.
 Time Perspective
• Time is an important factor in business decision-making. A
timely decision is always effective and rewarding, if appropriate.
• In business decisions, in relation to time-period, thus, there are
short-term and long-term perspectives.
Short run analysis:
Short-term time perspectives are based on the short-run
analysis of the business data and performance. Eg: during
Diwali season, fireworks producers/sellers have to keep a
larger stock than otherwise.
Long run analysis:
• In long-run, the perception is towards growth, development
and expansion. It is related to the long-run business planning
 Short run:
• A period in which at least one factor of production is fixed (e.G., Plant size,
capital).
• Firms can adjust variable factors like labor or raw materials but cannot change
fixed factors.
Focus: operational decisions, pricing adjustments, and output levels based on
current capacity.
Characteristics:
• Fixed costs exist and cannot be altered.
• Firms can respond to changes in demand or market conditions by
adjusting variable inputs.
• Limited flexibility for capacity expansion.
Example: a factory can hire more workers but cannot expand its building in the
short run.
 Long run
• A period where all factors of production are variable, allowing firms to
change capital, labor, and even enter or exit markets.
• Focus: strategic decisions such as capacity expansion, investment in
technology, or market entry.
Characteristics:
• No fixed costs; all costs are variable.
• Firms can make significant adjustments in response to shifts in market
demand, technology, or competition.
• Economies of scale can be realized, reducing average costs over time.
Example: a company building a new factory to increase production
capacity.
 Discounting Principle

• According to this principle, if a decision affects costs and revenues in

long-run, all those costs and revenues must be discounted to present
values before valid comparison of alternatives is possible.
• This is essential because a rupee worth of money at a future date is not
worth a rupee today.
• Money actually has time value. Discounting can be defined as a process
used to transform future dollars into an equivalent number of present
dollars. For instance, $1 invested today at 10% interest is equivalent to
$1.10 next year.
FV = PV*(1+r)t
Where, FV is the future value (time at some future time), PV is the present
value (value at t0, r is the discount (interest) rate, and t is the time
between the future value and present value.
Importance of discounting in CBA
• Time value of money: future benefits and costs need
to be discounted to their present values.
• Discount rate: reflects the opportunity cost of capital
or risk associated with the project.
• Net present value (NPV): a decision is favorable if the
NPV (total benefits – total costs) is positive.
NPV rule: choose projects with a positive NPV.
Benefit-cost ratio (BCR):
• BCR > 1: benefits outweigh costs; proceed
with the project.
• BCR < 1: costs outweigh benefits; reject the
project.
Internal rate of return (IRR): the discount rate at
which NPV becomes zero. If IRR exceeds the cost of
capital, the project is accepted.
 Opportunity Cost Analysis
• “Opportunity cost is the value of the next-best alternative when a decision is
made; it's what is given up,”
• According to opportunity cost principle, a firm can hire a factor of production
if and only if that factor earns a reward in that occupation/job equal or
greater than it’s opportunity cost.

• Eg: Assume that, given $20,000 of available funds, a business must

choose between investing funds in securities or using it to purchase new
machinery. No matter which option the business chooses, the potential
profit that it gives up by not investing in the other option is the
opportunity cost.