ECO121 MANAGERIAL ECONOMICS

Module 1 Notes – Economic decisions thus involve the

allocation of scarce resources, and a
Economic Decision Making
manager’s task is to allocate resources so as to
Introduction best meet the manager’s goals.

“Why should I study managerial economics” Managerial Economics – a sub-focus of

business economics that focuses on the
Managerial Economics provides useful microeconomic factors pertinent to the
insights into every facet of the business and decision-making process with an
nonbusiness world in which we live, including organization.
household decision making.
• Management (Managerial)
“Why is managerial economics so valuable to
✓ Business Management
such a diverse group of decision makers?”
✓ Decision Problems
The answer to this question lies in the meaning • Economics
of the term managerial economics. ✓ Economic Theories and
Methodologies
Manager – a person who directs resources to
• Application of Economics in Analyzing
achieve a stated goal.
and Solving business problems.
• Person – all individuals who: ✓ Optimal Solutions to Business
1) Direct the efforts of others, Problems.
including those who delegate
Basic Steps in Decision Making
tasks within an organization (e.g.
firm, a family, a club); ➢ Define the Problem
2) Purchase inputs to be used in the ▪ What is the problem the manager
production of goods and services faces?
such as the output of a firm, food ▪ Who is the decision maker?
for the needy, or shelter for the ▪ What is the decision setting or
homeless; or context, and how does it influence
3) Are in charge of making other managerial objective or options?
decisions, such as product price
– A key part of the problem definition
or quality.
involves identifying the context.
– A manager generally has responsibility for his Many come about as part of the firm’s
or her own actions as well as for the actions of planning process. Others are
individuals, machines, and other inputs under prompted by new opportunities or
the manager’s control. new problems.
Economics – the science of making decisions ➢ Determine the Objective
in the presence of scarce resources.
– In most private-sector decisions,
• Decisions are important because profit is the principal objective of the
scarcity implies that by making one firm and the usual barometer of its
choice, you give up another. performance.
• Resources are anything used to produce – Thus, among alternative courses of
a good or service, more generally, to action, the manager will select the
achieve a goal. one that will maximize the profit of the
firm.
 ECO121 MANAGERIAL ECONOMICS

– In practice, profit maximization often rely on a model to describe how

and cost benefit analysis are not options translate into outcomes.
always unambiguous guides to
o Model – a simplified
decision making. One difficulty is
description of a process,
posed by the timing of benefits and
relationship, or other
costs.
phenomenon.
➢ Explore the Alternatives
▪ What are the alternative courses ➢ Make a Choice
of action? ▪ After all the analysis are done,
▪ What are the variables under the what is the preferred course of
decision maker’s control? action?
▪ What constraints limit the choice – In the majority of decisions we take
of options? up, the objectives and outcomes are
– Given human limitations, decision directly quantifiable.
makers cannot hope to identify and – Thus, a company can compute the
evaluate all possible options. Still, profit results of alternative price and
one would hope that attractive options output plans.
would not be overlooked or, if
discovered, not mistakenly – The decision maker could
dismissed. determine a preferred course of
action by enumeration, that is, by
– Moreover, a sound decision testing a number of alternatives and
framework should be able to uncover selecting the one that best meets the
options in the course of the analysis. objective.
➢ Predict the Consequences – A variety of methods can identify
▪ What are the consequences of and cut directly to the best, or optimal
each alternative action? decision. These methods rely to
▪ Should conditions change, how varying extents on marginal analysis,
would this affect outcomes? decision trees, game-theory, cost-
▪ If outcomes are uncertain, what is benefit analysis, and linear
the likelihood of each? programming.
▪ Can better information be
acquired to predict outcomes? ➢ Perform Sensitivity Analysis

– Depending on the situation, the task – In tackling and solving a decision

of predicting the consequences may problem, it is important to understand
be straightforward or formidable. and be able to explain to others the
“why” of your decision.
– Sometimes elementary arithmetic
suffices. For instance, the simplest – The solution, after all, did not come
profit calculation requires only out of thin air. It depended on your
subtracting costs from revenues. stated objectives, the way you
structured the problem (including the
– In more complicated situations, set of options you considered), and
however, the decision maker must your method of predicting outcomes.
 ECO121 MANAGERIAL ECONOMICS

– Thus, sensitivity analysis Public Decisions: Economic View

considers how an optimal decision is
Managerial economics can also be applied to
affected of key economic facts.
the decision-making process of non-profit
– Sensitivity analysis might also seeking and public sector enterprises.
include assessing the
Economists in various government departments
implementation of the chosen
and public sector organizations are also
decision to see whether it achieved
concerned with project evaluation and cost-
the desired solution.
benefit analysis.
Optimal Decisions
Governments should try to obtain the maximum
A Simple model of the Firm health benefit for tax payers in spending
The decision setting we will investigate can be their revenues; government agencies can
described as follows: measure their efficiency through cost-benefit
analysis.
• A firm produces a single good or service
for a single market with the objective of Decision-Making Principles
maximizing profit.
• Decision-making lies at the heart of the
✓ Specifies the Setting and
most important problems managers face.
Objectives
Managerial economics applies the
• Its task is to determine the quantity of the
principles of economics to analyze
good to produce and sell and to set a
business and government decisions.
sales price.
• The prescription for sound managerial
✓ Possible Decision Alternatives
decisions involves six steps and this
• The firm can predict the revenue and cost
framework is flexible. The degree to
consequences of its price and output
which a decision is analyzed is itself a
decisions with certainty.
choice to be made by the manager.
✓ Link Between Action and
• Experience, judgement, common sense,
Objective
intuition, and rules of thumb all make
✓ These 3 statements fulfill the first potential contributions to the decision-
4 fundamental decision-making making process. However, none of
steps described in Module 1. these can take the place of a sound
analysis.
– It remains for the firm’s manager to “solve” and
explore this decision problem using demand Why Problems of Decision Making Arises?
and supply analysis.
• Scarcity of Resources
– The firm uses the • Unlimited Needs & Wants
demand curve as • Satisfaction of One to Another
the basis for • Uncertainty that Involves Risks
predicting the • Behavior of Market Forces
revenue cons. of
alternative output – To implement the identified course of
and pricing action that achieves the objectives in the
policies. economically most efficient way.