MANAGERIAL ECONOMICS & ECONOMICS THEORY

Contents
Executive Summary .................................................................................................3
Introduction ..............................................................................................................4
Managerial Economics and Economic Theory .................................................4
Functions of Managerial Economic ........................................................................5
Demand Analysis and Forecasting: ....................................................................5
Cost and Production Analysis: ...........................................................................5
Pricing Decisions, Policies and Practices: ..........................................................5
Profit Management ..............................................................................................6
Capital Management ...........................................................................................6
Optimization .........................................................................................................6
Implementation of Managerial Economics............................................................6
Managerial Economic and Decision Making.........................................................7
Principles of Managerial Economics ......................................................................7
Marginal and Incremental Principle..................................................................7
Equi-marginal Principle ......................................................................................8
Opportunity Cost Principle .................................................................................8
Time Perspective Principle..................................................................................8
Discounting Principle...........................................................................................8
Economic Profit versus Accounting Profit: ...........................................................9
Explicit and Implicit Costs ..................................................................................9
Accounting profit .................................................................................................9
Economic profit ..................................................................................................10
References ...............................................................................................................12

Executive Summary
The managerial economic deals with the managers decision regarding the business activities. In
the managerial economic managers the decisions regarding allocation of resource in order to
maximize the wealth of an organization. In this managerial economic project briefly explain the
following topic.
Managerial economic and economic theory
Economic profit versus accounting profit
Managerial Economics can be defined as merger of economic theory with business
practices so as to ease decision making and future planning by management. Managerial
Economics assists the managers of a firm in a rational solution of obstacles faced in the
firms activities. It makes use of economic theory and concepts. It helps in formulating
logical managerial decisions. The key of Managerial Economics is the micro economic
theory of the firm. It lessens the gap between economics in theory and economics in
practice. Managerial Economics is a science dealing with effective use of scarce
resources. It guides the managers in taking decisions relating to the firms customers,
competitors, suppliers as well as relating to the internal functioning of a firm. It makes
use of statistical and analytical tools to assess economic theories in solving practical
business problems.
The difference between accounting and economic profit is on the cost side. In other
word, the accountant and economist accept the revenue figure as-is. But accounting
profit does not include some costs that economic profit would. So economic profit
includes a category of costs that accounting profit completely ignores. In economics, the
goal is to maximize economic profit because doing this automatically maximizes
accounting profit. But it does not work the other way around!

Introduction
Managerial economics is a social science discipline that combines the economics theory,
concepts and known business practices in order to make the process of decision making
easy. Managerial economics as a science is useful to managers in making decisions
relating to a firms customers base, competitors and strategic future decisions.
Managerial Economics can be defined as merger of economic theory with business
practices so as to ease decision making and future planning by management. Managerial
Economics assists the managers of a firm in a rational solution of obstacles faced in the
firms activities. It makes use of economic theory and concepts. It helps in formulating
logical managerial decisions. The key of Managerial Economics is the micro economic
theory of the firm. It lessens the gap between economics in theory and economics in
practice. Managerial Economics is a science dealing with effective use of scarce
resources. It guides the managers in taking decisions relating to the firms customers,
competitors, suppliers as well as relating to the internal functioning of a firm. It makes
use of statistical and analytical tools to assess economic theories in solving practical
business problems.
The use of Managerial Economics is not limited to profit-making firms and
organizations. But it can also be used to help in decision making process of non-profit
organizations like as hospitals, educational institutions, etc. It enables optimum
utilization of scarce resources in such organizations as well as helps in achieving the
goals in most efficient manner. Managerial Economics is of great help in price analysis,
production analysis, capital budgeting, risk analysis and determination of demand.

Managerial Economics and Economic Theory

Managerial economics uses both Economic theory as well as Econometrics for rational
managerial decision making. Econometrics is defined as use of statistical tools for
assessing economic theories by empirically measuring relationship between economic
variables. It uses factual data for solution of economic problems. Managerial Economics
is associated with the economic theory which constitutes Theory of Firm. Theory of
firm states that the primary aim of the firm is to maximize wealth. Decision making in
managerial economics generally involves establishment of firms objectives,
identification of problems involved in achievement of those objectives, development of
various alternative solutions, and selection of best alternative and finally
implementation of the decision.

The following figure tells the primary ways in which Managerial Economics correlates to
managerial decision-making.

Functions of Managerial Economic

There are many function of managerial economic some are following.

Demand Analysis and Forecasting:

Effective decision making at the firm level depends on accurate estimates of demand.
Demand analysis aims at discovering the forces that determine sales. The demand
analysis mainly relates to the study of demand, determinants, demand distinctions and
demand forecasting.

Cost and Production Analysis:

Cost estimates are also essential for effective decision making and production planning
at the firm level. Profit planning, cost control and sound pricing practices call for
accurate cost and production analysis. Cost relations are production function and cost
control.

Pricing Decisions, Policies and Practices:

Pricing is an important area of managerial economics. Success of a business firm largely
depends on the accuracy of price decisions. Price determinations under different

markets, pricing methods policies, product line pricing and price forecasting are some of
the topics of this area.

Profit Management
Business firms are mainly profit hunting institutions. The success of the firm is always
measured in terms of profits. Nature and management of profit, profit policies and
techniques and profit planning are the important aspects covered in this area.

Capital Management
The most complex, troublesome problem faced by the business manager is the capital
management. Capital management implies planning and control of capital expenditure.
Cost of capital rate of return and selection of projects are the important points under
this.

Optimization
Optimization is another important concept used in economic theory and managerial
economics. Managerial economics often aims at optimizing a given objective. In recent
years, a new concept was found out called Sub-Optimization. The greatest merit of this
concept is its flexibility.

Implementation of Managerial Economics

Managerial Economics deals with allocating the scarce resources in a manner that
minimizes the cost. Managerial Economics is different from microeconomics and macro
economics. Managerial Economics has a more narrow scope it is actually solving
managerial issues using micro economics. Wherever there are scarce resources,
managerial economics ensures that managers make effective and efficient decisions
concerning customers, suppliers, competitors as well as within an organization. The fact
of scarcity of resources gives rise to three fundamental questions.
What to produce?
How to produce?
For whom to produce?
To answer these questions, a firm makes use of managerial economics principles.
The first question relates to what goods and services should be produced and in what
amount or quantities. The managers use demand theory for deciding this. The demand
theory examines consumer behavior with respect to the kind of purchases they would
like to make currently and in future; the factors influencing purchase and consumption
of a specific good or service; the impact of change in these factors on the demand of that
specific good or service; and the goods or services which consumers might not purchase

and consume in future. In order to decide the amount of goods and services to be
produced, the managers use methods of demand forecasting.
The second question relates to how to produce goods and services. The firm has now to
choose among different alternative techniques of production. It has to make decision
regarding purchase of raw materials, capital equipments, manpower, etc. The managers
can use various managerial economics tools such as production and cost analysis for
hiring and acquiring of inputs, project appraisal methods for long term investment
decisions, etc for making these crucial decisions.
The third question is regarding who should consume and claim the goods and
services produced by the firm. The firm, for instance, must decide which is its niche
market domestic or foreign? It must segment the market. It must conduct a thorough
analysis of market structure and thus take price and output decisions depending upon
the type of market.

Managerial Economic and Decision Making

Managerial economics helps in decision-making as it involves logical thinking.
Moreover, by studying simple models, managers can deal with more complex and
practical situations. Also, a general approach is implemented. Managerial Economics
take a wider picture of firm, i.e., it deals with questions such as what is a firm, what are
the firms objectives, and what forces push the firm towards profit and away from profit.
In short, managerial economics emphasizes upon the firm, the decisions relating to
individual firms and the environment in which the firm operates. It deals with key
issues such as what conditions favor entry and exit of firms in market, why are people
paid well in some jobs and not so well in other jobs, etc. Managerial Economics is a
great rational and analytical tool. Managerial Economics is not only applicable to profitmaking business organizations, but also to non- profit organizations such as hospitals,
schools, government agencies, etc.

Principles of Managerial Economics

Economic principles assist in rational reasoning and defined thinking. They develop
logical ability and strength of a manager. Some important principles of managerial
economics are:

Marginal and Incremental Principle

This principle states that a decision is said to be rational and sound if given the firms
objective of profit maximization, it leads to increase in profit, which is in either of two
scenarios.

If total revenue increases more than total cost.

If total revenue declines less than total cost.

Equi-marginal Principle
Marginal Utility is the utility derived from the additional unit of a commodity
consumed. The laws of equi-marginal utility states that a consumer will reach the stage
of equilibrium when the marginal utilities of various commodities he consumes are
equal. According to the modern economists, this law has been formulated in form of law
of proportional marginal utility. It states that the consumer will spend his moneyincome on different goods in such a way that the marginal utility of each good is
proportional to its price.

Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of alternatives required by that
decision. If there are no sacrifices, there is no cost. According to Opportunity cost
principle, a firm can hire a factor of production if and only if that factor earns a reward
in that occupation or job equal or greater than its opportunity cost. Opportunity cost is
the minimum price that would be necessary to retain a factor service in its given use. It
is also defined as the cost of sacrificed alternatives

Time Perspective Principle

According to this principle, a manger or decision maker should give due emphasis, both
to short-term and long-term impact of his decisions, giving apt significance to the
different time periods before reaching any decision. Short-run refers to a time period in
which some factors are fixed while others are variable. The production can be increased
by increasing the quantity of variable factors. While long-run is a time period in which
all factors of production can become variable. Entry and exit of seller firms can take
place easily. From consumers point of view, short-run refers to a period in which they
respond to the changes in price, given the taste and preferences of the consumers, while
long-run is a time period in which the consumers have enough time to respond to price
changes by varying their tastes and preferences.

Discounting Principle
According to this principle, if a decision affects costs and revenues in long-run, all those
costs and revenues must be discounted to present values before valid comparison of
alternatives is possible. This is essential because a rupee worth of money at a future date
is not worth a rupee today. Money actually has time value. Discounting can be defined
as a process used to transform future dollars into an equivalent number of present
dollars. For instance, $1 invested today at 10% interest is equivalent to $1.10 next year.

Economic Profit versus Accounting Profit:

Explicit costs are monetary costs a firm has. Implicit costs are the opportunity costs of a
firm's resources.

Explicit and Implicit Costs

Explicit costs are costs that involve direct monetary payment. Wages paid to workers,
rent paid to a landowner, and material costs paid to a supplier are all examples of
explicit costs. In contrast, implicit costs are the opportunity costs of factors of
production that a producer already owns. The implicit cost is what the firm must give up
in order to use its resources; in other words, an implicit cost is any cost that results from
using an asset instead of renting, selling, or lending it. For example, a paper production
firm may own a grove of trees. The implicit cost of that natural resource is the potential
market price the firm could receive if it sold it as lumber instead of using it for paper
production.

Accounting profit
Accounting profit is the monetary costs a firm pays out and the revenue a firm receives.
It is the bookkeeping profit, and it is higher than economic profit. Accounting profit =
total monetary revenue- total costs. Accounting profit is the difference between total
monetary revenue and total monetary costs, and is computed by using generally
accepted accounting principles (GAAP). Put another way, accounting profit is the same
as bookkeeping costs and consists of credits and debits on a firm's balance sheet. These
consist of the explicit costs a firm has to maintain production (for example, wages, rent,
and material costs). The monetary revenue is what a firm receives after selling its
product in the market. Accounting profit is also limited in its time scope; generally,
accounting profit only considers the costs and revenue of a single period of time, such as
a fiscal quarter or year.
In the accounting sense of the term, net profit (before tax) is the sales of the firm less
costs such as wages, rent, fuel, raw materials, interest on loans and depreciation. Costs
such as depreciation, amortization, and overhead are ambiguous. Revenue may also be
ambiguous when different products are sold as a package, or "bundled." Within US
business, the preferred term for profit tends to be the more ambiguous income.
Gross profit is profit before Selling, General and Administrative costs (SG&A), like
depreciation and interest; it is the Sales less direct Cost of Goods (or services) Sold
(COGS). Net profit after tax is after the deduction of either corporate tax (for a
company) or income tax (for an individual). Operating profit is a measure of a
company's earning power from ongoing operations, equal to earnings before the
deduction of interest payments and income taxes.
To accountants, economic profit, or EP, is a single-period metric to determine the value
created by a company in one period - usually a year. It is the net profit after tax less the

equity charge, a risk-weighted cost of capital. This is almost identical to the economist's
definition of economic profit.
There are commentators who see benefit in making adjustments to economic profit such
as eliminating the effect of amortized goodwill or capitalizing expenditure on brand
advertising to show its value over multiple accounting periods. The underlying concept
was first introduced by Schmalenbach, but the commercial application of the concept of
adjusted economic profit was by Stern Stewart & Co. which has trade-marked their
adjusted economic profit as EVA or Economic Value Added.

Economic profit
Economic profit is the monetary costs and opportunity costs a firm pays and the
revenue a firm receives. Economic profit = total revenue - (explicit costs + implicit
costs).
Economic profit is the difference between total monetary revenue and total costs, but
total costs include both explicit and implicit costs. Economic profit includes the
opportunity costs associated with production and is therefore lower than accounting
profit. Economic profit also accounts for a longer span of time than accounting profit.
Economists often consider long-term economic profit to decide if a firm should enter or
exit a market.
Profit generally is the making of gain in business activity for the benefit of the owners of
the business. The word comes from Latin meaning "to make progress", is defined in two
different ways, one for economics and one for accounting.
Pure economic profit is the increase in wealth that an investor has from making an
investment, taking into consideration all costs associated with that investment including
the opportunity cost of capital. Accounting profit is the difference between price and the
costs of bringing to market whatever it is that is accounted as an enterprise (whether by
harvest, extraction, manufacture, or purchase) in terms of the component costs of
delivered goods and or services and any operating or other expenses. A key difficulty in
measuring either definition of profit is in defining costs. Pure economic monetary
profits can be zero or negative even in competitive equilibrium when accounted
monetized costs exceed monetized price.
In economics, a firm is said to be making a normal profit when total revenues equal total
costs. These normal profits then match the rate of return that is the minimum rate
required by equity investors to maintain their present level of investment. Economically,
the "normal profit" is thus treated as a cost, and recognized as one of the two
components of the cost of capital.

References
https://www.boundless.com/economics/textbooks/boundless-economicstextbook/production-9/economic-profit-65/difference-between-economic-andaccounting-profit-245-12343/
http://www2.econ.iastate.edu/classes/econ532/hennessy/lectures/chap01/tsld00
3.htm
http://www.investopedia.com/terms/a/accountingprofit.asp
http://financial-dictionary.thefreedictionary.com/Value+Maximization
http://connect.mheducation.com/sites/0077333403/student_view0/ebook/chapt
er16/chbody1/16_2_maximizing_firm_value_versus_maximizing_stockholder
_interests.htm
http://smallbusiness.chron.com/maximizing-firm-value-vs-maximizingstockholder-interest-10314.html