Executive MBA Program, Faculty of Business Administration (FBA), Eastern University (EU)

ECN 515: Managerial Economics

Course Instructor:
Prof. Dr. M. Ashraf Hossain
Postdoc (Bus. Mgt./JSPS Fellow); UN Fellow (Regional Dev./UNCRD); PgDMC (IMCB); Ph D & M.S (Dev.
Eco/Nagoya); Research Student (Economics/Nagoya), and M. Sc & B. Sc (Hons) in Statistics, JU.
 Professor, FBA, & Director, IQAC, EU.
Cell#: 0174-114-0484 / 0195-744-6556, E-mail: [email protected]

Class Schedule: Saturday (6:30 ~9:30 pm)/ Room#: 403

Consulting Hour: Saturday (12:00~3:00 pm) &/or Thursday (4:30~6:00 pm) but always welcome, if in office.
(May not be available in office: Friday/Weekly Holiday) and Thursday/Off-day).

The Course Deal

My end of the deal Your end of the deal

Come prepared to lead an effective and Come prepared and ready to actively

engaging lecture with clearly defined goals participate (I will ask you questions!)

Provide support and feedback on Respect each others’ experiences and

 Why is understanding economics so confusing
and frustrating (sometimes…)?
 Models are abstractions from reality
 Underlying assumptions
 Ceteris Paribus assumption “all else being equal”
“hold other things constant” (S&N, 2000: 6)

Culture, religion, gender, politics, etc.

 Rationality: people, governments, teachers, (yes...even grad students)

are rational actors.
More is better

 Why is learning economics so confusing: aligning your 3 brains

 Economic Models: Word problems!
 Narrative representations
Changes, impacts, shifts
 Graphical representations
 Algebraic representations
 Primary Discussions
 Background/Overview of the Course
(Plz. read the provided “Course Outline” carefully)
 Ice-Breaking, Brain-storming and Motivation
 Teacher & Classroom Inputs
 Causation vs. Correlation
 Nature, scope and significance of Managerial Economics?;
 How it is useful to a Manager?
 Functions of a Managerial Economist?
 What role a managerial Economist plays?, etc.
 Course Coverage: Economy & Capitals, 5Es in Economics; Economics vs.
Managerial Economics; Economic Perspectives & goals; Economic systems &
problems; Production/Business factors; Production decisions (Input-Output
decisions); Efficiency & Productivity; Desire-Want & Demand, Demand-Supply and
forecasting; Investment & Pricing (Price – Output decisions); Price Ceilings &
Floorings; Inequality, Kuznets curve, Lorenz curve & Pareto efficiency; Cost
Analysis: Costs vs. Loss-Profit Analysis; Opportunity costs; Production possibility
frontiers (PPF), Market structure & functions, etc.
 ECN 515: Managerial Economics
Chapter I: Introduction to Economics & Managerial Economics
Economics (?)
•The study of how societies use scarce resources to produce valuable commodities and
distribute them among different people (Samuelson & Nordhaus, 2008).
• Reveals information about preferences, decision-making & how incentives can alter
decisions of individuals. Economics is the social science concerned with the efficient
use of scarce resources to achieve the maximum satisfaction of economic wants.
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”
•“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”

– W. Warren Haynes, V.L. Mote, S. Paul

“Integration of economic theory with business practice for the purpose of
 Resources Scarcity and Allocation
1. Resources are always scarce.
2. They are not only scarce, but also have alternative uses.
3. Optimum allocation is required
Allocation problems are faced by individuals, Organizations
(Both profit making and non- profit making) & Nations also.

Economics deals with:

1. How an individual consumer allocates his scarce resources
among alternative uses?
- in such a way that he/she always tries to get maximum
satisfaction.
- Maximization of satisfaction / utility is the goal of an
individual consumer.
2. Similarly, an individual producer aims at least cost
combination of inputs to get a given quantities of output.
 Macroeconomics vs. Microeconomics

Macroeconomics examines either the economy as a

whole or its basic sub-divisions or aggregates, e.g.
-Total output; Total employment; Total income;
Aggregate expenditures, and The general level of
prices in analyzing various economic problems.
In microeconomics we talk of an/a –
1).Individual firm, a production industry or household;
2). measurement of price of a specific product;
3). the number of workers employed by a single firm;
4).the revenue/income of a particular firm/household,
or
5). the expenditures of a specific firm, government
entity, or family.
 The Economic Perspective
Economists view things through a unique perspective. This economic perspective or
economic way of thinking has several critical and closely interrelated features.
1) Scarcity and Choice; 2) Rational Behavior; & 3) Marginalism: Benefit and Cost
 Scarcity & Choices: Since human and property resources are scarce
(limited), it follows that the goods and services we produce must also be
limited. Scarcity limits our options and necessitates that we make choices.
Because we "can't have it all," we must decide what we will have, & what
we must forgo.
Rational Behavior: Economics is grounded on the assumption of "rational
self-interest." Individuals pursue actions that will enable them to achieve
their greatest satisfaction. Rational behavior means that individuals will
make different choices under different circumstances.
Marginalism - Benefit & Cost: The economic perspective focuses largely on
marginal analysis comparisons of marginal benefits and marginal costs.
(Used this way, "marginal" means "extra," "additional," or "a change in.")
 Economic Goals
If economic policies are designed to achieve certain economic goals, then we
need to recognize a number of goals that are accepted worldwide. They
include:

 Economic growth: Produce more and better

goods & services, or more simply, develop a
higher standard of living.
 Full employment: Provide suitable jobs for all
citizens who are willing & able to work.
 Economic efficiency: Achieve the maximum
fulfillment of wants using the available
productive resources.
 Price-level stability: Avoid large upswings and
downswings in the general price level; that is,
avoid inflation and deflation.
 Economic Goals: Cont.----
 Economic freedom: Guarantee that businesses, workers, and
consumers have a high degree of freedom in their economic
activities.
 Equitable distribution of income: Ensure that no group of
citizens faces poverty while most others enjoy abundance.
 Economic security: Provide for those who are chronically ill,
disabled, laid off, aged or otherwise unable to earn minimal
levels of income.
 Balance of trade: Seek a reasonable overall balance with rest
of the world in international trade and financial transactions.
Although most of us might accept these goals as generally
stated, we might also disagree substantially on their specific
meanings.
Some of these goals are complementary; when one is achieved, some other one
will also be realized. For example, achieving full employ-ment means eliminating
unemployment, which is a basic cause of inequitable income distribution.
Economic Systems: Three practiced systems are there:
1). Capitalist System/ Market Economy /Open Economy (Democratic System);
2). Centrally-Planned /State Controlled Economy (Communist & Socialist Systems);
3). Mixed Economy
Fundamental differences between economic systems:
Capitalist/ Centrally-Planned/ Mixed
Differences Market Economy State-Controlled Economy
Economy
Ownership of Individuals & firms, The State,
Means of State
directly and/or Individuals
Production
indirectly. and firms
Coordination of Market through Budget through plant Budget and
Economic price managers market
Activities

Central Problems of Economic Systems: 1) What goods to produce and

how much of each?; 2). How to produce each good?; 3). For whom to
produce?; 4). How income is distributed?; 5). Achievement of Economic
growth? And 6). Business Fluctuations?
 Positive and Normative Economics
Positive Economics: Concerns ‘what is’.

Positive economics describes the actual observations

of the real world, which actually focuses on facts
and cause-and-effect relationships. These include
description, theory development, and theory testing
(theoretical economics). It avoids value judgments, tries
to establish scientific statements about economic
behavior, and deals with what the economy is
actually like. Such scientific-based analysis is critical
to good policy analysis.
Examples: Positive statements:
 Last year Bangladesh economy grew by 7.05
percent.
 The unemployment rate in Bangladesh is higher
than that in several Asian countries.
 Normative Economics
Normative economics embodies subjective feelings about
‘what ought to be’.
Normative economics incorporates value judgments
about what the economy should be like or what
particular policy actions should be recommended to
achieve a desirable goal. Normative economics looks
at the desirability of certain aspects of the economy.
It underlies expressions of support for particular
economic policies. Economic policy making is
essentially normative in character.
Normative statements:
 Bangladesh needs to increase/accelerate the growth
rate by another 2 to 3 percent to reduce the number
of people living under poverty line.
 If the unemployment rate is not reduced the standard
of economic life will not increase in Bangladesh in the
near future. So Bangladesh should increase public
spending to give jobs to more people.
 Positive and Normative Economics
Whenever words, such as "ought" or "should"
appear in a sentence, there is a strong chance
you are encountering a normative statement.
Conclusion: Economic policy making is essentially
normative in character. However, all important
normative questions involve positive statement.
(Theoretical economics is if "positive"; policy
economics is "normative.")
Growth as a Goal
Growth is a widely held economic goal. The expansion of total
output relative to population results in rising real wages and
incomes, and thus higher standards of living. An economy
that is experiencing economic growth is better able to meet
people's wants and resolve socioeconomic problems. A
growing economy can undertake new programs to alleviate
poverty & protect the environment without impairing existing
levels of consumption, investment and public goods
production.
In short, growth lessens the burden of scarcity. A growing
economy, unlike a static economy, can consume more today
while increasing its capacity to produce more in the future.
By easing the burden of scarcity - by relaxing society's
constraints on production - economic growth enables a
nation to attain its economic goals more readily and to
undertake new endeavors that require goods and services to
be accomplished.
 Arithmetic of Growth
The mathematical approximation called the rule of 70
provides a quantitative grasp of the effect of economic
growth. It tells us that we can find the number of years it
will take for some measure to double, given its annual
percentage increase, by dividing that percentage increase
into the number 70.
So, the approximate number of years required to double
the real GDP
70
= ------------------------------------------------------
Annual percentage rate of GDP growth
Examples: A 3 percent annual rate of growth will double real
GDP in about 23 (= 70 / 3) years. Growth of 8 percent per
year will double real GDP in about 9 (= 70/ 8) years. The
rule of 70 is generally applicable.
 Circular Flow
 In economics, the term circular flow refers to a
simple economic model which describes the
reciprocal circulation of income between producers &
consumers. In the circular flow model, the inter-
dependent entities of producer and consumer are
referred to as "firms" and "households" respectively,
and provide each other with factors in order to
facilitate the flow of income.
 Firms provide consumers with goods and services in
exchange for consumer expenditure and "factors of
production" from households.
Transactions Matrix
Buy Households Firms Government Inflows or
Sell Income

Households Domestic Labour Labour Retired Bonds, Total money

Services services Labour services inflows (TMI) to
Retired Bonds households

Firms Goods and Collective

services, New Investment Consumption TMI to
bonds goods and Investment firms
Goods

Government New money, new

bonds, Collective New None TMI to
goods & services money Government
for taxes
Outflows or Total Money TME of TME of
expenditure expenditure (TME) Firms Government TMI = TME
of households
 The Business Cycle
The term business cycle refers to alternating rises & declines
in the level of economic activity, sometimes extending over
several years. Both unemployment & inflation often are
associated with business cycles. There are 4 phases of a
generalized business cycle –
GDP
Peak
Peak
Peak GDP
Rec
Average
ry

y
Line

Re
r
ve

ess

ve
co

ce
co
ion

ss
Re

Re

io
n
Trough
Trough Trough

Time
 The Business Cycle

1.Peak
At a peak business activity' has reached a temporary maximum. Here the
economy is at full employment and the level of real output is at or very
close to the economy's capacity. The price level is likely to rise during
this phase.

2. Recession
A peak is followed by a recession— a period of decline in total output,
income, employment, and trade. This downturn, which lasts 6 months or
more, is marked by the widespread contraction of business activity in
many sectors of the economy. But because many prices are downwardly
inflexible, the price level is likely to fall only if the recession is severe and
prolonged - that is, only if a depression occurs.
 The Business Cycle

3. Trough
In the trough of the recession or depression, output
and employment "bottom out" at their lowest
levels. The trough phase may be either short-lived
or quite long.

4. Recovery
In the expansion or recovery phase, output and
employment rise toward full employment. As
recovery intensifies, the price level may begin
to rise before full employment and full capacity
production return.
Roles of the Government
 To protect the sovereignty of the state
 To enact laws and enforce them
 To maintain law and order for the citizens
 To print the legal tender/money
 To ensure distribution of income
 To present budget and monetary policy to
control price and growth in the economy,
etc.
Nature, Scope and Significance of Managerial Economics:
 Managerial Economics – Business Economics
 Managerial Economics is ‘Pragmatic’
 Managerial Economics is ‘Eclectic’
 Managerial Economics is ‘Normative’
 Universal applicability
 The roots of Managerial Economics spring 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, etc.
 BUSINESS ADMINISTRATION

DECISION PROBLEMS

TRADITIONAL ECONOMICS : DECISION SCIENCES :

THEORY AND METHODOLOGY TOOLS AND TECHNICS

MANAGERIAL ECONOMICS :
INTEGRATION OF ECONOMIC
THEORY AND
METHODOLOGY WITH TOOLS
AND TECHNICS BORROWED
FROM OTHER DECIPLINES

OPTIMAL SOLUTIONS TO
BUSINESS PROBLEMS
 Core Concepts:
 Efficiency - most effective use of a society’s
resources in satisfying people’s wants and needs:
 Pareto Efficient Allocation
 Efficient Use of Resources including timeliness,
 Productivity vs. Efficiency
 Efficiency vs. Equity

 Opportunity Cost: Cost of forgone alternative (s)*

 What are the opportunity costs?
*The value of the next best use (or opportunity) for an economic
good, or the value of sacrificed alternative…
(What is the opportunity cost of obtaining a MBA
degree with good grade?
ECN 515: Managerial Economics

William J. Baumol, “What Can Economic Theory Contribute to

Managerial Economics?” American Economic Review, 1961

Baumol concludes that “a managerial economist can become a far more

helpful member of a management group by virtue of his studies of

economic analysis, primarily because there he learns to become an
effective model builder and because there he acquires a very rich body of
tools and techniques which can help him to deal with the problems of the
firm in a far more rigorous, a far more probing, and a far deeper manner”.
Functions of a Managerial Economists:
Themain 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
 Goals of a business firm

- Single goal or multiplicity of goals

1. Profit maximization: Revenue-maximization Cost-minimization
2. Wealth maximization - Value maximization.
3. Sales revenue maximization - subject to attainment of desired
profit target.
4. Managerial utility maximization
5. Satisfying behavior theory
6. Size (growth) Maximization
7. Long run survival –
The core content of Managerial Economics :
 Theoretical foundation for demand analysis
Consumer’s equilibrium :
Cardinal Utility:
• Law of Diminishing Marginal Utility
• Law of Equi-marginal Principle
• Consumers equilibrium and derivation demand curve

Ordinal utility Analysis:

• Indifference Curve, Budget line,
• Equilibrium using indifference curves
• Changes in Equilibrium

• Due to change in Income – ICC Curve - Engel Curve

• Due to change in Price - PCC Curve – Demand Curve
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 quantities 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
Thorsten Veblen's “ Doctrine of conspicuous
consumption
Price expectations
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
 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.

Elastic Demand Unit Elastic Demand Inelastic

Demand
P Q PQ P Q PQ P Q PQ
10 1,000 units 10,000 10 1,000 units 10,000 10
1,000 units 10,000
9 2,000 units 18,000 9 1,111 units 10,000 9
1,050 units 9,450
8 3,000 units 24,000 8 1,250 units 10,000 8
1,100 units 8,800
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
2. Theory of production :
Input – Output relation

What is a production function :

Q = f (A, B, C, D)

Production function with one variable input

 Law of variable proportions
 Equilibrium of producer with one variable input (optimum
quantity of variable input)

Production function with two variable inputs

 Iso-costs, iso-quants, equilibrium - least cost combination of
inputs
 Equilibrium of producer with two variable inputs (optimum
combination of inputs)

Production function with all variable inputs

 Returns to Scale

 Increasing returns to scale

 Constant returns to scale
 Decreasing returns to scale
3. Theory of Cost : Cost - output relations
 Cost Concepts
 Opportunity Cost
 Implicit Cost
 Explicit Cost
 Cost function :
 Short run cost functions
 Fixed Cost
 Variable Cost
 AFC
 AVC
 AC
 MC
 Long run cost functions
 LAC
 LMC
4. Market structures - Price – Output Decisions

 Classification of markets: 1. No of firms 2. nature of the product

 Perfect competition
 Features of perfect competition
 Short-run equilibrium
 Long-run equilibrium
 Monopoly
 Meaning and Barriers to entry
 Short-run equilibrium
 Long-run equilibrium
 Discriminating Monopoly
 Monopolistic competition
 Oligopoly – Duopoly models
 Cournot’s Model
 Edgeworth’s Model
 Chamberlin’s Model
 Paul Sweezy’s Kinked Demand Curve
5. Profit Management :

 Concept of Profit

 Profit Theories

 Payment to factor services

 Reward for taking risk and baring uncertainty
 Result of Frictions and Imperfections and Monopoly
 Reward for successful innovations

 Cost-volume-profit Analysis

 Break even analysis

 Make or buy decisions
=
 Specific functions to be performed by a managerial Economist :

1. Production scheduling

2. Sales forecasting

3. Market research

4. Economic analysis of competing companies

5. Pricing problems of industry

6. Investment appraisal

7. Security analysis

8. Advice on foreign exchange management

9. Advice on trade

10.Environmental forecasting

- Survey of British Industry by Alexander and Kemp