Managerial EconomicsApplied Economic Theory by Microeconomic Analysis of Business

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 2

Abstract of Presentation

Key points discussed in presentation:

1. What is managerial economics?

2. Economics tools, Methods and Approaches used by managers.

3. Theory of the firm and Demand theory

4. Production and Cost analysis

5. Pricing analysis

6. Capital budgeting

7. Game theory

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 3

What is Managerial Economics?

“Managerial economics is ultimately a short-hand for applying microeconomic theory to business problems.”

• Managerial economics is one of the most applied fields of economic theory.

• Managers and Economist, both are concerned about Money and Profit.

• Business decisions are based on non-transactional data or data collected in advance to market transactions.

• Business managers rely on applied economics to inform their decision making process.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 4

What is Managerial Economics?

• Managerial analysis uses techniques such as regression and correlation analyses to optimize business decisions based on the business' stated goals and objectives and available resources.

• Managerial economics is one of the strongest tools of financial management and managerial decision-making.

• It includes numerous tools and techniques for managers to achieve optimization under constraints and satisfy the objectives of the firm.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 5

Applications of Managerial Economics

Managerial economics is an economic tool kit for business leaders and managers. The following theories, techniques, and approaches are used by business managers to optimize firm profits and market share.

• Theory of the firm

• Demand theory

• Production and cost analysis

• Capital budgeting

• Game theory

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 6

The Theory of Firm

Managerial economics builds on the theory of the firm. The theory of the firm is a microeconomic approach to business analysis of inputs, production methods, output, and prices.

• Focuses on profit maximization, demand and price, production and factor utilization, and cost minimization.

• Emphasizes the optimization of quantity, price, costs and profits in a single time period for a single kind of product produced in a single facility.

• With its focus on optimization, remains relevant for small farms, small natural resource producers, or small factories serving local markets

• Not useful for mid to large size businesses with multiple products, production facilities, and markets.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 7

Demand Theory

Demand theory refers to the amount of product that a buyer is willing and able to buy at a specified price.

• Business managers are responsible for forecasting and estimating the demand for a product within the marketplace and producing the product in appropriate volume.

• Customers who once demanded a single, easily-produced product are increasingly demanding a combination of physical units and bundles of associated support services and quality attributes.

• Managerial economics offers tools to create a demand forecast that represents the quantity of both units and support services demanded as a function of price.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 8

Production & Cost Analysis

• Production and cost analysis refers to the microeconomic techniques used to analyse production efficiency, optimum factor allocation, economies of scale, and cost function.

• Production and cost analysis incorporates the expenses associated with raw materials, components, subassemblies, communications, transportation, and customer support services. Business managers work to add more value to the products that their companies produce.

• Business managers often face transfer pricing problems as they determine product price points.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 9

Capital Budgeting

• Capital budgeting refers to the branch of managerial economics that is concerned with investment decisions and capital purchasing decisions.

• Capital budgeting is the analytical process of determining the optimal investment of scarce capital so as to realize the greatest profit from that investment.

• Capital budgeting ranks proposed investments in order of their potential profitability.

There are two main criteria for selecting potential business investments:

1) Business managers, engaged in capital budgeting, generally have a minimum desired rate of return specified as the cut-off point to determine whether or not a project should be accepted or rejected.

2) Business managers, engaged in capital budgeting, generally experience constraint from top management regarding the total amount of potential investment.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 10

Capital Budgeting

The postponability method1)• when business managers purchase new equipment and replacements based

on their level of urgency. Investments are not made if they can be postponed until a later point.

The payback method2)• The payback method is used to measure the worth of an investment

project.• The payback method focuses primarily on profitable near-future earnings

rather than long-term profits with uncertain profits.

Business managers, engaged in capital budgeting, take hold of stockholders' funds and work to maximize their earning potential through four main strategies:

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 11

Capital Budgeting

Financial statement method3)• Based on the accounting information and book values.• Business managers hope that the figures they generate will eventually match the

accounts after the project is completed.

Discounted cash flow technique4)• The discounted cash flow technique recognizes that the use of money has a cost.• Money spent or received today has a different value than money spent or received

in the future.

Business managers, engaged in capital budgeting, take hold of stockholders' funds and work to maximize their earning potential through four main strategies:

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 12

Game Theory

Game theory is a decision-making tool for business managers. Game theory refers to a mathematical method for analysing a conflict.

• The opposing interests in the game are called players. The alternative is not between two decisions to be made but between two or more strategies to be used against the opposing interest. The value of the game is called the average gain. Each player supports a strategy that maximizes his or her average gain.

• Game theory allows capital budgeters to consider all possible forecasts for proposed investment projects.

• Game theory is potentially limited by the inputs used in analysis, and is limited by the facts utilized in the game. Incorrect or misleading information will result in inaccurate analysis of the potential gains of a project.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 13

Morden Development In Managerial Economics

• Managerial economics is, in many ways, geared to the business managers and decision-making needs of traditional firms.

• Corporations are increasingly part of global net- works of product research and design, production, and distribution.

• Firms are moving from linear, centralized, hierarchical structures to decentralized, cooperative, and team-based structures.

• Customer support services are increasingly critical to winning market segments or shares and serves to differentiate one competitor from another.

• These customer support services factor into the expense and profit forecasts made by business managers.

Prepared by: Jay H. Shah, Department of Technology Management, CSPIT, CHARUSAT 14

Concluding

• Managerial Economics, which applies economic theory and methods to business and administrative decision-making and managerial problems, is a vital tool for effective economic forecasting and profit optimization.

“Management without economics has no roots.”

&

“Economics without management bears no fruits.”