MANAGERIAL ECONOMICS Mintarti Rahayu

Introduction to Managerial Economics

Managerial Economics The application of economic theory and the tools of analysis of decision science in the managerial decisions so that an organization can achieve its aims or objectives most efficiently

Management decision problems OPTIMAL SOLUTION TO MANAGERIAL DECISION PROBLEMS MANAGERIAL ECONOMICS Application of Economic theory and decision science tools to solve managerial decision problems Economic Theory: Microeconomics & Macroeconomics Decision Science tools Mathematics, statistics, lenear programming

Decision Making Process PACED P roblem A lternatives C riteria E valuation D ecision

The objective of Managerial Economics is…. To seek laws and principles that support achievement of the economic objectives of an organization. Profit Revenue Cost

The scope of decision making that is the concern of Managerial Economics: generating revenue & controlling cost  Decision making methods  Understanding consumer behavior: consumer reaction against change in price, promotion, product quality, etc. ; demand estimation & forecasting  Understanding cost component & behavior, relevant cost, cost estimation & forecasting  Pricing decision, product attributes, strategic decision

Positive and Normative Economic Managerial Economics is normative (about laws & principles how to achieve objectives / “how ought to” ), but based on positive perspective (based on what occur in management practices / “ what actually happened” )

certainty & uncertainty Economic theory: in certainty and perfect information Managerial Economics: in uncertainty and imperfect information.

Managerial Economics use symbolic models: verbal, graphic, mathematic  Model: the simplification of a complicated system or situation; an abstraction of reality that is done by ignoring details that are not essentially related to the objective of building a model.

 The objectives of building a model : Teaching: to show how a complicated system works Explanating: to explain the logic relationships among phenomena Predicting: to predict future behavior based on former system

Theory of Firm : 1. Definition of “Firm” ; 2. The Objective of a Firm & The Constraints in achieving it 3. “Profit” 1. Firm: an organization that organize various resources to produce and sell goods and services

Theory of the Firm Combines and organizes resources for the purpose of producing goods and/or services for sale. Internalizes transactions, reducing transactions costs. Primary goal is to maximize the wealth or value of the firm.

Next… 2. The objective of a Firm : to maximize “value” of the firm Value = PV of all “expected future profits” TR depend on Sales or Demand of Product and Pricing decision --- (Marketing Department) TC depend on Production Technology and Input Price --- (Production Department and Human Resource Dept) “r” depend on Firm Risk and Cost of Capital --- (Financial Department)

Alternative Theories Sales maximization Adequate rate of profit Management utility maximization Principle-agent problem Satisficing behavior

Constraints in achieving the firm’s objectives : Resources constraints ( e,g,: materials, HR, production capacity, fund, etc. ) legal constraints ( e.g.: minimum wages, working safety, pollution handling, etc. )

Business Ethics Identifies types of behavior that businesses and their employees should not engage in. Source of guidance that goes beyond enforceable laws.

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.

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.

Next… 3. PROFIT Accounting/Business Profit = TR – explicit costs ( useful for Taxition Accounting purposes ) Economic Profit = TR – explicit costs – implicit costs ( useful for investment decision ) “Normal Profit” : Economic Profit = 0

Profit theory: Excess Profit may take place because of: Risk Different from the long run profit ( that tend to be normal ) Monopoly Return for innovation More efficient than the other firms in general

Theory of the Firm Combines and organizes resources for the purpose of producing goods and/or services for sale. Internalizes transactions, reducing transactions costs. Primary goal is to maximize the wealth or value of the firm.

Why do firms exist? The role of transaction costs Types of transaction costs search and information costs bargaining and decision costs policing and enforcement costs Optimal economic organization minimizes transaction costs

Firms can reduce transaction costs Advantages of firms over markets Fewer transactions Information specialization Reputational concerns But firms can become large and unwieldy, foregoing advantages

The Changing Environment of Managerial Economics Globalization of Economic Activity Goods and Services Capital Technology Skilled Labor Technological Change Telecommunications Advances The Internet and the World Wide Web