CHAPTER 1

Introduction to
Managerial Economics

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 1
 ECONOMICS AND
MANAGERIAL
DECISION MAKING

• Economics is the study of the behavior of human

beings in producing, distributing and consuming
material goods and services in a world of scarce
resources

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 2
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Management is the science of organizing and

allocating a firm’s scarce resources to achieve its
desired objectives

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 3
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Managerial economics is the use of economic

analysis to make business decisions involving the
best use (allocation) of an organization’s scarce
resources

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 4
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Questions that managers must answer:

• What are the economic conditions in our
particular market?
• market structure?
• supply and demand?
• technology?

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 5
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Questions that managers must answer:

• What are the economic conditions in our particular
market?
• government regulations?
• international dimensions?
• future conditions?
• macroeconomic factors?

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 6
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Questions that managers must answer:

• Should our firm be in this business?
• if so, at what price?
• and at what output level?

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 7
 ECONOMICS AND
MANAGERIAL DECISION
MAKING
• Questions that managers must answer:
• How can we maintain a competitive advantage over other
firms?
• cost-leader?
• product differentiation?
• market niche?
• outsourcing, alliances, mergers?
• international perspective?

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 8
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Questions that managers must answer:

• What are the risks involved?
• shifts in demand/supply conditions?
• technological changes?
• the effect of competition?
• changing interest rates and inflation rates?

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 9
 ECONOMICS AND
MANAGERIAL DECISION
MAKING

• Questions that managers must answer:

• What are the risks involved?
• exchange rates (for companies in international
trade)?
• political risk (for firms with foreign operations)?

Risk is the chance that actual future outcomes will

differ from those expected

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 10
 REVIEW OF ECONOMIC TERMS

• Microeconomics is the study of individual consumers

and producers in specific markets, especially:
• supply and demand
• pricing of output
• production process
• cost structure
• distribution of income

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 11
 REVIEW OF ECONOMIC TERMS

• Macroeconomics is the study of the aggregate

economy, especially:
• national output (GDP)
• unemployment
• inflation
• fiscal and monetary policies
• trade and finance among nations

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 12
 REVIEW OF ECONOMIC TERMS

• Resources are inputs (factors) of production :

• land: least flexible resource, factor income: Rent
• Labor: Most flexible resource
• Most abundant resource in developing countries
• Factor income: wages
• capital: Any good or service used to produce others (i.e. intermediate goods)
e.g. factories, tools, machinery and equipment
• Most abundant factor for industrial countries (e.g. United States, Japan)
• Factor income: interest
• Entrepreneur: Management (e.g. ownership control) ,e.g: business managers
factor income : profit
Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 13
 REVIEW OF ECONOMIC TERMS

• Scarcity is the condition in which resources

are not available to satisfy all the needs and
wants of a specified group of people
• The basic economic problem of any society is
the relative scarcity of resources in relation to
the unlimited needs and wants of consumers
• The Basic Economic Problem of Relative Scarcity is
illustrated by two concepts:
 Opportunity Cost,
 The Production Possibility Frontier (PPF)
Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 14
 BASIC ECONOMIC QUESTIONS?

Allocation decisions must be made because of scarcity.

Scarcity Choices must be made

1. What To Produce?
2. How To Produce?
3. For Whom To Produce?

1-
15
 REVIEW OF ECONOMIC TERMS

• Opportunity cost: The sacrifice (or alternative

forgone) in choosing to satisfy one need or want
rather than another
• Production Possibility Frontier (PPF) Theory :
A simplified economic model which portrays scarcity,
choice and opportunity cost

Copyright 2009 Pearson Education, Inc. Publishing as Prentice Hall. Chapter One 16
 PRODUCTION POSSIBILITY
FRONTIER (PPF) THEORY

The Static Production Possibility Frontier

Analyses the economy at a fixed point in time
Is based on the following assumptions:
There is a fixed quantity of resources
The economy only produces two products
Resources can be used interchangeably
All resources within the economy are used
Resources are used at maximum efficiency

1-
17
AN EXAMPLE OF THE STATIC PPF MODEL

Production Possibility Schedule

A B C D E
Tractors 0 100 200 300 400
Video recorders 800 600 400 200 0

1-
18
 THE PPF GRAPH

Tractors E
400- PPF
D
300-
C
200-
B
100-
A
0 200 400 600 800

Video recorders
1-
19
 MAXIMUM OUTPUT LEVELS

• The PPF shows the maximum output of the

economy
• If the economy devotes all of its resources to the
production of VCRs it is able to produce 800 (+
zero tractors)—Production Possibility A
• Alternatively, if the economy chooses
Production Possibility C it is able to produce 200
tractors and 400 VCRs

1-
20
 OPPORTUNITY COSTS

• The PPF shows that to produce more of one

product means producing less of another
• Opportunity costs of production can be
measured e.g. if the economy moves from
point C to D (along the PPF) it will produce
an extra 100 tractors BUT 200 VCRs must
be sacrificed
• Hence the opportunity cost is 200 VCRs
1-
21
 POINTS OUTSIDE THE STATIC PPF

• Points outside the PPF (e.g. X) are not

possible using existing technology and
resources
A
.X

PPF
B

1-
22
POINTS INSIDE THE STATIC PPF

• At point Y, the economy is

PPF satisfying fewer needs and
A
wants than is possible
• This is due to:
• Resources not being fully
employed and/or
.Y • Resources not being used
in the most efficient way
B

1-23
 THE DYNAMIC PPF MODEL

• This model differs from the static PPF in that it

incorporates changes over time
• It demonstrates the effect of changes in the
quantity and quality of productive resources e.g.
new resource discoveries, improvements in
technology
• Changes in the quantity and/or quality of
resources will SHIFT the PPF

1-
24
 DYNAMIC PPF

• When the
A quality/quantity of
resources increases
(decreases), the
economy can produce
more (less) of both
products and the
entire curve will
SHIFT outwards
(inwards)

1-25
 NOTE

• If the change in resources affects ONLY one product, the

PPF will ONLY shift on one axis e.g.:

A A

OR

B B

1-
26
 THE SIGNIFICANCE OF PPF SHIFTS

• Increased maximum output levels enable:

1. Higher levels of consumption
2. Greater satisfaction of consumer needs and
wants
• Improvements in the quality of resources
results in the more efficient use of scarce
resources

1-
27