Managerial Economics

Lecture 1 &2
PGDPM 2015-17
Poonam Singh

Why Managerial Economics?

Economic Decision Making core of
any organization
Provides theoretical foundation and
rationale to Marketing, Production,
Operation, Strategy and Finance
Important to answer why

What is Economics?
world of scarce resources
Wants are unlimited
Different people have the same want

Example: Garden of Eden

Garden of Eden

Alternative Uses
There is an accident
Red Cross reaches the spot
Alternative uses:
Different levels of injury with different
chances of survival

What is Economics?
Economics is the science which
deals with providing scarce resources
to its best alternative use
Economics is a practical science
Economicsis regarded as a social
science because it uses scientific
methods to build theories that can
help explain the behaviour of
individuals,
groups
and
organisations.

What is Managerial
Economics?
Managers or Executives typically work in an organization
Customers of the organization have limited resources.
They will invest only on something which is of value to
them : Consumer Behaviour
Organization itself works with scarce or limited resources
which it needs to utilize effectively : Production and
Cost
Different Organizations work to provide the same or
different products: Market

Stakeholders in Managerial
Economics
Managers typically work in organization which
provide goods and services
Business or Firm: for profit Organization
Applies to not for profit Organizations or
Governmental enterprises
Regulator: Manager of Economy or specific
sector

Course Structure
Lecture

Topic

1&2

Introduction & Key

concepts

3&4

Consumer Behaviour

5&6

Consumer Behaviour

7&8

Production

9&10

Cost

11&12

Mid term & Perfect

Competition

13&14

Monopoly & Price

DIscrimination

15&16

Monopolistic
Competition

17&18

Oligopoly

19&20

Oligopoly & Market

Regulation

Course Outline
Pedagogy: Lectures, cases, numericals,
presentations
Course Evaluation:
60 % : end term
20%: mid term (Date TBA)
20%: group project

KEY MEASURES AND

RELATIONSHIPS

Example
Suppose three students like spending time in the
beach
They ponder that they can work and live at the
beach at summer break
They further find out that they can lease a small
building by the beach with existing freezer
capacity and apply for a local license to sell ice
cream bars

Revenue, Cost and Profit

First question facing the students is, is it a
viable option
How do we define viability ?
Businesses are viable on a sustained basis
only when they make profit

What is Profit?
Profit is defined as Revenue - Cost
When cost exceeds revenue, it is called
negative profit or loss
Businesses are viable on a sustained
basis only when the revenue generated
by business exceeds the cost incurred in
operating business

What is Revenue?
Most businesses sell something
either a physical commodity or a
service
The total monetary value of the
goods and services sold is called
revenue

What is Cost?
Few businesses are able to sell
something
without
incurring
expenses to make the sale possible
The collective expenses incurred to
generate revenue over a period of
time, expressed in monetary value, is
cost

Example
The students in our simple venture realize they to
determine whether they can make a profit from a
summer ice cream bar business
They met the person who operated an ice cream bar
business in this building the previous year
He told them, last summer he charged $ 1.50 per ice
cream bar and sold 36,000 ice cream bars
Cost was divided into two parts:
Wholesale purchase, storage, delivery came to be
0.30 per bar : Variable cost
Lease of building, license, local business association
fee and insurance was $16,000 : Fixed cost

Was the business Viable?

Revenue = $ 54,000
Cost = $ 26,800
Profit = $ 27,200
The students feel confident that they
can run a profitable business.

The Story Ahead

They contact the building owner and pay a
non refundable deposit of $6000 to book
the space
A few weeks later, all three students were
unexpectedly offered summer internships
in a big business corporations
They would be earning $10,000 each
However, the work site is quite far from the
beach and they would have to be in office
whole day

Opportunity Cost
Now the students have two alternatives:
1. Set up business
2. Join internship
The opportunity cost of doing business is $30,000 (stipend
from internship)
Opportunity Cost is defined as thevalueof the best
alternative forgone, where a choice needs to be made
between severalmutually exclusivealternatives given
limitedresources.
It is also called as Implicit Cost

Accounting Cost and Economic Cost

Economic Fixed Cost = $30,000 + $ 16000 =
$46,000
Total Economic Cost = $ 56,800
Loss = $28,00 (Revenue = $ 54,000)
So business does not seem to be a viable option
Accounting Cost = $ 26,800

Sunk Cost
But wait a minute!
The students have made a non
refundable deposit of $6000 for the
building lease
This money is spent irrespective of
whether the students proceed for
summer business or not
This is called Sunk Cost

Accounting Profit and Economic

Profit
Assuming the fixed cost to be
$16000 as before, the accounting
fixed cost that the students need to
show for tax return is $16,000
From Economic cost perspective at
this stage it is only $10,000. Why?
Economic Profit at this stage is
$3200

Accounting Profit and Economic

Profit
Economic profit would consider
opportunity cost and ignore sunk
cost
And say, a business is viable if one
has zero economic profit or
better
Accounting profit has to be
positive
This would then be distributed to
stockholders as dividend or increased

Questions
What is Accounting Profit here?
Does it include opportunity cost?
Accounting Profit is $27,200
Defined as Revenue Explicit Cost
Opportunity Cost or Implicit Cost is not
included

Accounting and Economic

Profit

Problem
Let's say that you are running a business and incur
the following monthly expenses:
labor costs are $80,000; raw materials and business
supplies are 30,000; equipment leasing expenses are
$7,000; finance charges on loans are $3,000.
You are not paying rent, because you own the
building in which you operate the business. If you
had rented it out, however, you would have received
$12,000 in rent income. You also estimate the value
of your own time to equal $40,000.
What are your implicit, explicit, and economic costs?

Solution
Explicit costs are $80,000 + $30,000
+ $3,000 +$7,000 = $120,000.
Implicit costs are $12,000 + $40,000
= $52,000.
Your total economic costsare your
explicit plus your implicit costs, or
$120,000 + $52,000, or $172,000.

Problem
Let's say that a firm's total revenue is $180,000
What is Accounting and Economic Profit?
Solution:
Economic profits equal total revenue minus total
economic costs.
Thus, economic profits equal $180,000 - $172,000 =
$8,000.
Accounting profits equal total revenue minus total
explicit costs.
Thus, accounting profits equal $180,000 - $120,000 =
$60,000.

Road Ahead
Revenue comes from consumer
behaviour
Cost comes from Producer side
Equilibrium: Buyer meets seller, at
the market