FUNDAMENTALS OF

MANAGERIAL ECONOMICS
Prepared by: Prof. Rebecca T. Gorospe
MANAGER
�An individuals who direct the effort of others,
including those who delegate tasks within an
organization such as a firm, a family or a club.
�An individuals who purchase inputs to be used in the
production of goods and services such as the output
of a firm, food for the needy, or shelter for the
homeless.
�An individuals who are in charge of making other
decisions, such as product price or quality.
MANAGER
�Manager generally has responsibility for his own
actions as well as for the actions of individuals,
machines,, and other inputs under the manager’s
control.
ECONOMICS
�Is the science of making decisions in the presence of
scarce resources.
RESOURCES
�Anything used to produce a good or service or, more
generally, to achieve a goal.

�(NOTE: Decisions are important because scarcity

implies that by making one choice, you give up
another.)
MANAGERIAL ECONOMICS
�Is the study of how to direct scarce resources to the
way that most efficiently achieves a managerial goal.
6 PRINCIPLES OF MANAGERIAL FUNCTION
THAT COMPRISE EFFECTIVE
MANAGEMENT
1. Identify goals and constraints;
2. Recognize the nature and importance of profits;
3. Understand incentives;
4. Understand markets;
5. Recognize the time value of money;
6. Use marginal analysis.
1. IDENTIFY GOALS AND
CONSTRAINTS
� The first step in making sound decisions is to have well-
defined goals because achieving different goals entails
making different decisions.
� If your goal is to maximize your grade in this course rather
than maximize your overall grade point average, your study
habits will differ accordingly.
� Constraints make it difficult for managers to achieve goals
such as maximizing profits or increasing market share.
� Constraints include such as the available technology and the
prices of inputs used in production.
ECONOMIC VERSUS ACCOUNTING
PROFITS
ACCOUNTING PROFIT – is the total amount of money
taken from sales (total revenue, or price times quantity
sold) minus the dollar cost of producing goods or
services.
ECONOMIC PROFITS – are the difference between the
total revenue and total opportunity cost of producing
the firm’s goods or services.
OPPORTUNITY COST – The cost of the explicit and
implicit resources that are forgone when a decision is
made
Example:
�What does it cost you to read this book?
�The price you paid the bookstore for the book is an
explicit (or accounting) cost, while the implicit cost is
the value of what you are giving up by reading the
book.
- Studying some other subject.
- Watching TV
- Your date with your boyfriend or girlfriend.
2. RECOGNIZE THE NATURE AND
IMPORTANCE OF PROFITS/THE ROLE OF
PROFITS
�Misconception to the firm’s goal of maximizing profits.
Individuals who want to maximize profits often
considered self-interested.
�Book of Adam Smith’s “The Wealth of Nations”. He is
saying that by pursuing its self-interest-the goal of
maximizing profits-a firm ultimately meets the needs
of society.
�When firms in a given industry earn economic profits,
the opportunity cost to resource holders outside the
industry increases.
5 FORCES FRAMEWORK
PIONEERED BY MICHAEL PORTER
�FIVE CATEGORIES OR FORCES THAT IMPACT
THE SUSTAINABILITY OF INDUSTRY PROFITS:
1. Entry
2. Power of input suppliers,
3. Power of buyers
4. Industry rivalry
5. Substitutes and complements
3. UNDERSTAND INCENTIVES
� The key is to design a mechanism such that if the manager
does what is in his own interest, he will indirectly do what
is best for your employees.
� Ex. Mr. O – opened a restaurant and hired a manager to run
the business so he could spend time doing the things he
enjoys. When ask if his business was doing well, he said
that he had been losing money. When asked whether he
thought the manager was doing a good job, he said For the
P3,750,000 salary I pay the manager each year, the manager
should be doing a job.
� Mr. O believes the manager “should be doing a good job.” But
individuals often are motivated by self-interest. This is not to say
that people never act out of kindness or charity, but rather that
human nature is such that people naturally tend to look after their
own self-interest.
� Since Mr. O is not physically present at the restaurant to watch
over the manager, he has no way of knowing what the manager is
up to. The manager receives 3,750,000 per year regardless
whether he puts in 12 hours or 2 hours a day. The manager
receives no reward for working hard and incurs no penalty if he
fails to make sound managerial decisions. The manager receives
the same 3,750,000 regardless of the restaurant’s profitability.
4. UNDERSTAND MARKETS
�Two sides to every transactions in the market. For
every buyer of a good there is a corresponding seller.
�The final outcome of the market process, depends on
the relative power of buyers and sellers in the
marketplace.
THREE SOURCES OF RIVALRY THAT
EXIST IN ECONOMIC TRANSACTIONS:
1. CONSUMER-PRODUCER RIVALRY – occurs because of
competing interests of consumers and producers. Consumers
attempt to negotiate or locate low prices, while producers
attempt to negotiate high prices.
2. CONSUMER-CONSUMER RIVALRY – arises because of the
economic doctrine of scarcity. When limited quantities of
goods are available, consumers will compete with one another
for the right to purchase the available goods.
3. PRODUCER-PRODUCER RIVALRY – functions only when
multiple sellers of a product compete in the marketplace.
Given that customers are scarce, producers compete with one
another for the right to service the customers available.
5. RECOGNIZE THE TIME VALUE
OF MONEY
�The timing of many decisions involves a gap between
the time when the costs of a project are borne and the
time when the benefits of the project are received.
�To properly account for the timing of receipts and
expenditures, the manager must understand present
value analysis.
PRESENT VALUE ANALYSIS
(PV)
�The amount that would have to be
invested today at the prevailing interest
rate to generate the given future value.
Formula (Present Value). The present value (PV) of a future
value (FV) received n years in the future is:

Where i is the rate of interest

For example, the present value of $100 in 10
years if the interest rate is at 7 percent is:
NET PRESENT VALUE
�The present value of the income stream generated by a
project minus the current cost of the project.
�Formula (Net Present value). Suppose that by
sinking Co dollars into a project today, a firm will
generate income of FV1 one year in the future, FV2
two years in the future, and so on for n years. If the
interest rate is I, the Net Present Value of the project is
� ex. The manager of Automated product is contemplating the purchase of a
new machine that will cost $300,000 and has a useful life of five years.
The machine will yield (year-end) cost reductions to Automated Products
of $50,000 in year 1, $60,000 in year 2, $75,000 in year 3, and $90,000 in
year 4 and 5. What is the present value of the cost savings of the machine
if the interest rate is 8 percent? Should the manager purchase the machine?
� By spending $300,000 today on a new machine, the firm will reduce costs
by $365,000 over five years. The present value of the cost savings is only:

The Net Present value of the new

machine :
NPV = PV – Co = $284,679-$300,000
= -$15,321
6. MARGINAL ANALYSIS
�States that optimal managerial decisions involve
comparing the marginal (incremental)benefits of a
decision with the marginal (incremental) costs.
�INCREMENTAL BENEFITS – means amounts saved
through avoiding costs.
�INCREMENTAL COST –is the total cost incurred due
to an additional unit of product being produced.
Discrete decisions
� More generally, let B(Q) denote the total benefits derived from Q
units of some variable that is within the manager’s control. This
is a very general idea: B(Q) may be the revenue a firm generates
from producing Q units of output; it may be the benefits
associated with distributing Q units of food to the needy; or, in
the context of our previous example, it may represent the benefits
derived by studying Q hours for an exam. Let C(Q) represent the
total cost of the corresponding level of Q. Depending on the
nature of the decision problem, C(Q) may be the total cost to a
firm of producing Q units of output, the total cost to a food bank
of providing Q units of food to the needy, or the total cost to you
of studying Q hours for an exam.
Determining the Optimal level of a Control
Variable: the Discrete Case
(1) (2) (3) (4) (5) (6) (7)
Control Marginal
Variable Q Total Total Net Marginal Marginal Net Benefit
Benefits Costs Benefits Benefit Cost MNB(Q)
B(Q) C(Q) N(Q) MB(Q) MC( Q)
GIVEN GIVEN GIVEN (2)-(3) ∆(2) ∆(3) ∆(4) or (5)-(6)

0 0 0 0 - - -

1 90 10 80 90 10 80

2 170 30

3 240 60

4 300 100

5 350 150

6 390 210

7 420 280

8 440 360

9 450 450

10 450 550
MARGINAL BENEFIT
�the additional benefit arising from a unit increase in a
particular activity.
�Is the advantage of enjoyment that is obtained by
consuming one additional unit of a product.
�Is a maximum amount a consumer is willing to pay for
an additional good or services.
MARGINAL COST
�The cost of producing one more unit of a good.
�Is the change in the total cost that arises when the
quantity produced is incremented by one unit; that is, it
is the cost of producing one more unit of a good.
�NOTE: MARGINAL PRINCIPLE
To maximize net benefits, the manager should increase
the managerial control variable to the point where
marginal benefits equal marginal costs.
INCREMENTAL DECISIONS
�Sometimes managers are faced with proposals that
require a simple thumbs up or thumbs down decisions;
�INCREMENTAL REVENUES – the additional
revenues that stem from a yes-or-no decision.
�INCREMENTAL COSTS – the additional costs that
stem from a yes-or-no decision.
�Ex. If you are the CEO of Slick Drilling Inc. and you
must decide whether or not to drill for crude oil around
the Twin Lakes area in Michigan. Note that your
revenues increase by $183,200 if you adopt the
project . To earn these additional revenues, however,
you must spend an additional $90,000 for drill augers
and $75,000 for additional temporary workers. The
sum of these costs - $165,000. Are you going to give
your thumbs up or thumbs down to the new project.