1. Managerial Economics
Dr Nihal Hennayake

2. What is Microeconomics and Macroeconomics ?
Ragnor Frisch : Micro means “ Small” and Macro means “Large”
Microeconomics deals with the study of individual behaviour.
It deals with the equilibrium of an individual consumer,
producer, firm or industry.
Macroeconomics on the other hand, deals with economy wide aggregates.
Determination of National Income Output, Employment
Changes in Aggregate economic activity, known as Business
Cycles
Changes in general price level , known as inflation, deflation
Policy measures to correct disequilibrium in the economy,
Monetary policy and Fiscal policy

3. What is Managerial Economics?
“Managerial Economics is economics applied in decision making. It is a special branch of economics bridging the gap between abstract theory and managerial practice” – Willian Warren Haynes, V.L. Mote, Samuel Paul
“Integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning” - Milton H. Spencer
“Managerial economics is the study of the allocation of scarce resources available to a firm or other unit of management among the activities of that unit” Willian Warren Haynes, V.L. Mote, Samuel Paul
“ Price theory in the service of business executives is known as Managerial economics” Donald Stevenson Watson

4. BUSINESS ADMINISTRATION
DECISION PROBLEMS
TRADITIONAL ECONOMICS : THEORY AND METHODOLOGY
DECISION SCIENCES : TOOLS AND TECHNICS
MANAGERIAL ECONOMICS : INTEGRATION OF ECONOMIC THEORY AND METHODOLOGY WITH TOOLS AND TECHNICS BORROWED FROM OTHER DECIPLINES
OPTIMAL SOLUTIONS TO BUSINESS PROBLEMS

5. Nature, Scope and Significance of Managerial Economics:
Managerial Economics – Business Economics
Managerial Economics is ‘Pragmatic’
Managerial Economics is ‘Normative’
Universal applicability
The roots of Managerial Economics came from Micro Economics
Relation of Managerial Economics to Economic Theory is much like that of Engineering to Physics or Medicine to Biology. It is the
relation of applied field to basic fundamental discipline
Core content of Managerial Economics :
Demand Analysis and forecasting of demand
Production decisions (Input-Output Decisions)
Cost Analysis (Output - Cost relations)
Price – Output Decisions
Profit Analysis
Investment Decisions

6. 1. Demand Analysis :
Meaning of demand : No. of units of a commodity that customers are willing to buy at a given price under a set of conditions.
Demand function : Qd = f (P, Y, Pr W)
Demand Schedule : A list of prices and quantitives and the list is so
arranged that at each price the corresponding
amount is the quantity purchased at that price
Demand curve : Slops down words from left to right.
Law of demand : inverse relation between price and quantity
Exceptions to the law of demand :
Giffens paradox
Price expectations

7. E = percentage change in DV/ percentage change in IV
Elasticity : Measure of responsiveness - Qd = f (P, Y, Pr W)
E = percentage change in DV/ percentage change in IV
Concepts of price, income, and cross elasticity
Price Elasticity :
Ep = Percentage change in QD/Percentage change in P
Types of price elasticity :
1. Perfectly elastic demand Ep = ∞
2. Elastic demand Ep > 1
3. Inelastic demand Ep < 1
4. Unit elastic demand Ep = 1
5. Perfectly inelastic demand Ep = 0

8. Determinants of elasticity :
Elasticity and expenditure : If demand is elastic a given fall in price causes a relatively larger increase in the total expenditure.
P↓ - TR↑ when demand is elastic.
P↓ - TR↓ when demand is inelastic.
P↓ ↑ - TR remains same when demand is Unit elastic.
Measurement of elasticity :
Point and Arc elasticity
Elasticity when demand is linear
Determinants of elasticity :
(1) Number and closeness of its substitutes,
(2) the commodity’s importance in buyers’ budgets,
(3) the number of its uses.
Other Elasticity Concepts
Income elasticity
Cross elasticity

9. Functions of a Managerial Economists:
The main function of a manager is decision making and managerial Economics helps in taking rational decisions.
The need for decision making arises only when there are more alternatives courses of action.
Steps in decision making :
Defining the problem
Identifying alternative courses of action
Collection of data and analyzing the data
Evaluation of alternatives
Selecting the best alternative
Implementing the decision
Follow up of the action

10. Specific functions to be performed by a managerial Economist :
Production scheduling
Sales forecasting
Market research
Economic analysis of competing companies
Pricing problems of industry
Investment appraisal
Security analysis
Advice on foreign exchange management
Advice on trade
Environmental forecasting

11. OPTIMIZATION
Managerial economics is concerned with the ways in which managers should make decisions in order to maximize the effectiveness or performance of the organizations they manage. To understand how this can be done we must understand the basic optimization techniques.
Functional relationships:
relationships can be expressed by graphs:

12. This form can be expressed in an equation:
Q = f ( P )
Though useful, it does not tell us how Q responds to P, but this equation do.
Q = p
Marginal Analysis
The marginal value of a dependent variable is defined as the change in this dependent variable associated with a 1-unit change in a particular independent variable. e.g.

13. Total profit is maximized when marginal profit shifts from positive to negative.

14. Average Profit = Profit / Q
PROFITS
Slope of ray from the origin:
Profit / Q = average profit
Maximizing average profit doesn’t maximize total profit
MAX C B
profits
quantity Q 4

15. Marginal Profits = /Q
Q1 is breakeven (zero profit)
maximum marginal profits occur at the inflection point (Q2)
Max average profit at Q3
Max total profit at Q4 where marginal profit is zero
So the best place to produce is where marginal profits = 0.
(Figure 2.1)
max
profits Q4 Q3 Q2 Q1 Q
average
profits
marginal
profits Q 5

16. Differential Calculus in Management
A function with one decision variable, X, can be written as:
Y = f(X)
The marginal value of Y, with a small increase of X, is
My = DY/DX
For a very small change in X, the derivative is written:
dY/dX = limit DY/DX
DX  0 1

17. Marginal = Slope = Derivative
The slope of line C-D is DY/DX
The marginal at point C is DY/DX
The slope at point C is DY over DX
The derivative at point C is also this slope Y D DY DX C X

18. Quick Differentiation Review
Name Function Derivative Example
Constant Y = c dY/dX = 0 Y = 5
Functions dY/dX = 0
A Line Y = c • X dY/dX = c Y = 5X
dY/dX = 5
Power Y = cXb dY/dX = b•c•X b-1 Y = 5X2
Functions dY/dX = 10X 7

19. Quick Differentiation Review
Sum of Y = G(X) + H(X) dY/dX = dG/dX + dH/dX
Functions
example Y = 5X + 5X dY/dX = X
Product of Y = G(X) • H(X)
Two Function dY/dX = (dG/dX)H + (dH/dX)G
example Y = (5X)(5X2 )
dY/dX = 5(5X2 ) + (10X)(5X) = 75X2 8

20. Quick Differentiation Review
Quotient of Two Y = G(X) / H(X) Functions
dY/dX = (dG/dX)•H - (dH/dX)•G H2
Y = (5X) / (5X2) dY/dX = 5(5X2) -(10X)(5X) (5X2)2
= -25X2 / 25X4 = - X-2
Chain Rule Y = G [ H(X) ]
dY/dX = (dG/dH)•(dH/dX) Y = (5 + 5X)2
dY/dX = 2(5 + 5X)1(5) = X 9

21. Max of x y
Slope = 0
value of x x 10 20
dy/dx
Value of Dy/dx when y is max
Value of dy/dx which
Is the slope of y curve x 20 10
Note that this is not sufficient for maximization or minimization problems.

22. y Max value of y Min value of y x Dy/dx value of dy/dx x

23. Optimization Rules

24. Applications of Calculus in Managerial Economics
maximization problem:
A profit function might look like an arch, rising to a peak and then declining at even larger outputs. A firm might sell huge amounts at very low prices, but discover that profits are low or negative.
At the maximum, the slope of the profit function is zero. The first order condition for a maximum is that the derivative at that point is zero.
If  = 50Q - Q2,
then d/dQ = ·Q, using the rules of differentiation.
Hence, Q = 25 will maximize profits
where
50 - 2Q = 0. 10

25. More Applications of Calculus
minimization problem: Cost minimization
supposes that there is a least cost point to produce. An average cost curve might have a U-shape. At the least cost point, the slope of the cost function is zero. The first order condition for a minimum is that the derivative at that point is zero.
If TC = 5Q2 – 60Q,
then dC/dQ = 10Q - 60.
Hence, Q = 6 will minimize cost
Where:
10Q - 60 = 0. 11

26. Competitive Firm: Maximize Profits
where  = TR - TC = P • Q - TC(Q)
Use our first order condition:
d/dQ = P - dTC/dQ = 0.
Decision Rule: P = MC.
a function of Q
Max = 100Q - Q2
First order = Q = 0 implies
Q = 50 and;
 = 2,500 12

27. Second Order Condition: one variable If the second derivative is negative, then it’s a maximum.
Problem 1 Problem 2
Max = 100Q - Q2
First derivative
100 -2Q = 0
second derivative is: -2 implies
Q =50 is a MAX
Max= X2
First derivative
10X = 0
second derivative is: 10 implies
Q = 10 is a MIN 13

29. Partial Differentiation
Economic relationships usually involve several independent variables.
A partial derivative is like a controlled experiment- it holds the “other” variables constant
Suppose price is increased, holding the disposable income of the economy constant as in
Q = f (P, I )
then Q/P holds income constant. 14

30. Sales are a function of advertising in newspapers and magazines ( X, Y)
Max S = 200X + 100Y -10X2 -20Y2 +20XY
Differentiate with respect to X and Y and set equal to zero.
S/X = X + 20Y= 0
S/Y = Y + 20X = 0
solve for X & Y and Sales 15

31. 2 equations & 2 unknowns 200 - 20X + 20Y= 0 100 - 40Y + 20X = 0
Adding them, the -20X and +20X cancel, so we get Y = 0, or Y =15
Plug into one of them:
X = 0, hence X = 25
To find Sales, plug into equation:
S = 200X + 100Y -10X2 -20Y2 +20XY = 3,250 16