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Fac of English

commerce 4th

sec term 2014

Assuit university

Dominick Salvatore

Managerial economics in a global

Third edition

Dominick Salvatore

.Dominick Salvatore is Distinguished Professor of Economics and the Director of the Ph.D. Program in Economics at Fordham University in New York City
Office Address
Dealy Hall 521
Mailing Address
Fordham University
Department of Economics
5/F Dealy Hall
441 East Fordham Road
Bronx, NY 10458

Phone: (718) 817 3606
Fax: (914) 337 3355
Research Assistant
Katie Jajtner

Managerial economics in global economy

Chapter 1
The nature and the scope of managerial economics
Managerial economics
refer to the application of economic theory and tools of analysis of decision "
science to examine how an organization can achieve its aim or objective most
" efficiently

Management decision
Decision science tools

Economic theory

Mathematical economics

Micro economics


Macro economics

[notes in

economicsedited by "

Application of economic theory and decision science tools to solve

managerial decision problems

islam kobeisy "


Member at the AUC executive management alumni , American university in
Cairo " EMD "MC"

Optimal solution to managerial decision

Management decision problems "arises in any organization when it seek to
"achieve some goals or objective subject to some constraints
Relationship to the economic theory-1
"Economic theory " referes to microeconomic and macroeconomics
Microeconomics "is the study of economic behavior of individual decision making
units, such as individual consumers , resource owners and business firms in a
free-enterprise system
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Macro economics " the study of the total or aggregate level of output , income ,
employment , consumption , investment and prices for the economy viewed as a
" whole
Both microeconomic and macroeconomic theories are the most important -1
element in managerial economic
Economic theories seeks to predict and explain economic behavior -2
Economic theories usually begin with a model , this abstracts from the many -3
details surrounding an event and seeks to identify a few of the most important
determinates of the events
the firm uses the models of economic theory to maximize it's aim of " -4
maximizing profit", if this model predicts the behavior of the firm accurately
the methodology of economics is to accept a theory or model if it predicts -5
accurately and if the prediction follows logically from the assumption
relationship to the decision sciences-2
Managerial economic is also closely related to the decision science, these"
utilize the tools of mathematical economics and econometrics to construct and
estimate decision models aimed at determining the optimal behavior of the
Mathematical economics" "is used to formalize the economic models"
"postulated by economic theory
Econometrics" application of statistical tools particularly regression analysis "
"to real world data to estimate the models postulated by economic theory and
:For example
Economic theory postulates that the quantity demanded of a commodity is a
function of or depend on the price of the commodity "P" , The income of
"consumer "Y", and price of related commodities "Pc , Ps
Assuming constant tastes
Q d = f ( P , Y , Pc ,Ps )
By collecting data on Q , P , Y , Pc , Ps for a particular commodity , we can
estimate the empirical " econometric relationship, forecasting future demand
for a commodity is essential in order to achieve the goal or objective of the
"firm most efficiently " profit maximization
Managerial economics " refer to the application of economic theory and
decision science tools to find the optimal solution to managerial decision
" problems
managerial economics and relationship to the functional areas of business -3
administration studies

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functional areas of business administration include "accounting, finance, "-1

" and marketing ,personnel "human resources management and production
The business environment in which the firms operate and provide the "
"background for managerial decision making
"Managerial economic"
Can be regarded as an overview course that integrates economic theory, "
decision sciences, and the functional areas of business administration studies
and it examines how they interact with one another as the firm attempts to
"achieve its goal most efficiently
In short "managerial economics is not the study of number of topics but the
utilization of economic theory and management science tools to examine how a
firm can achieve it's objective most efficiently within the business environment
"in which it operates

The theory of the firm

" Reasons for the existence of firms and their functions " A firm
Is an organization that combines and organizes resources for the purpose of "
producing goods and services for sale
Proprietorships: firms owned by one individual
Partnerships: firms owned by two or more individuals
Corporation: firms owned by stockholders
-:Firm exist because
to enforce contracts between entrepreneurs and both workers and -1
owners of capital, land and other resources by an efficient way and
to save on transaction costs also saves on sales taxes and a voids
. price control and other government regulations
to generate economics in production and a distribution for -2
.workers, entrepreneurs and the owner of other resources
on the other, hand, firms don't continue to grow larger and larger -1
indefinitely because of limitations on management ability to
effectively control and direct the operation of the firm
firms can overcome these internal disadvantages of large size by -2
establishing a number of semiautonomous divisions "by
the increase communication traffic that is generated, coupled with -3
the further and further distancing of top management from the
operation of each division, impose sufficient diseconomies of scale to
limit the growth of the firm
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the firm will reach a point where the cost of supplying additional -4
services within the firm exceeds the cost of purchasing these
services from other firms
Function of the firm
The function of the firm is to purchase resources or inputs of labor "-1
services, capital, and raw materials in order to transform them into
"goods and services for sale
The owner of these resources use the income result from selling -2
these resources to purchase goods and services produced by firms
The objective and value of the firm
managerial economics begins by postulating a theory of the firm, -1
which is uses to analyze managerial decision making
the theory of the firm was based on the assumption that the goal -2
or objective of the firm was to maximize current or short-term profits
firms sacrifice short-term profits for the sake of increasing future-3
or long-term profits
Some examples
.expenditures on research and development-1
.new capital equipment-2
.enhanced promotional campaign-3
The theory of the firm postulates that
the primary goal or objective of the firm is to maximize the wealth "
" or value of the firm
This means that "future profits must be discounted to present
because money of profit in future is worth less than money of profit
Formally stated, the wealth or value of the firm is given by
p . v=


(1+r )


(1+r )

+ +

p . v=



(1+r )

(1+r )t

P. V", "the present value of all expected future profits"

, ,
represent the expected profits in each of the n years , 1 2 3

= the appropriate discount rate used to find the present value of future

sum or add all the (1+r )t resulting from substituting the value of 1 to n
t =1

for t
Since profits are equal to total revenue " TR" minus "TC" , equation can be
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t =1

TR t TC t
(1+ R)T

= Value of the firm

TR " depend on sales or the demand for the firms output and firms pricing
Tc"depend on the technology of production and resources
Constraints on the operation of the firm

Resources constraints
These constraints arise from
limitation on the availability of-1
essential inputs
firms mayn't able to hire as many-2
skilled worker as it wants
firms may not be able to acquire all -3
the specific raw material it demand
also face limitation on factory and-4
warehouse space
limitation in the quantity of capital-5
funds available for a given project
government agencies and not for-6
profit organizations also face similar
resource constraints

legal constraints
These constraints take the form of
minimum wage laws-1
health and safety standards-2
pollution emission standards-3
law and regulations that prevent-4
firms from employing
Society imposes these constraints on
firms in order to modify their behavior
and make it more nearly consistent
with broad social welfare goals

Constrained optimization
It means that how the firm maximizes it's wealth or values within these "
constrained", where the firm want to minimize costs and other objectives subject
to the constraints it faces
Limitation on the theory of the firm
the theory of the firm which postulates that " the goal or objective of the "
firm is to maximize wealth or the value of the firm has been criticized as
" being much too narrow and unrealistic
: Other theories postulate that the primary objective of the firm is
the maximization of sales-1
the maximization of management utility-2
the maximization of satisfying behavior-3

The nature and function of profits

Business versus economic profit

:Business profit
Refers to the total revenue of the firm minus the explicit costs "," "
"accounting costs
Are the actual expenditure of the firm to purchase or hire inputs required "
"costs production
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-:These costs include

2-interes on -1
borrowed capital
4-expenditures on -3
raw material

wages to hire labor

rent on land and building

" Economic profit "

" total revenue - " explicit costs + implicit costs =
"Implicit costs" - "opportunity cost"
Value of inputs owned and used by the firm in the production "
" process
:Implicit costs", include"
the salary that entrepreneur could earn in the best alternative business, -1
"for example he could work as a manager in other firm and charge a certain
the return on the firm's capital that is lent to other or deposited at a bank -2
.the rent of the land owned by the firm if it is rented to other firm -3
these implicit costs don't included in the total cost of the firm to calculate -4
business profit, but are counted as a part of total cost to calculate economic
busines profit is important for accounting and tax purposes; economic -5
profit is important must be used to reach correct investment decision
If total revenue of a firm = 100000$ and Explicit cost is = 70000$ , The
entrepreneur of the firm can earn = 35000$ and By managing another firm
and earns 10000 $ , and by lending his capital to another firm , do you agree
?to run this project ? Why
From the accounting point of view this firm makes business profit = 30000
= Total revenue explicit cost =
From the economic point of view this firm make economic loss equal = 15000
Economic profit = TR (explicit cost + implicit cost)
15000 - = (10000 + 35000 + 70000) - 100000=
I disagree to run this project, it is better for the entrepreneur to work in the "
"other firm and lend his capital and close his firm

Theories of profit
Risk-bearing theories of profit-1
For the firm, to enter and remain in business, above normal profit is required
in the fields such as petroleum exploration, where there are above average
frictional theory of profit-2
Profit arise as a result of friction or disturbances from long-term equilibrium
that is , in long run , perfectly competitive equilibrium , firms tend to earn
only a normal return " adjusted for risk " or zero economic profit on their
" investment " TR - ( EC + I C) = ZERO

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BUT in short run there may be economic profit or loss , on other hand when
losses are incurred , some firms leave the industry , this leads to a higher
prices and the elimination of the losses
monoploy theory of profit-3
Some firms with monopoly power can restrict output and charge higher
prices than under perfect competition monopoly power arises from
controlling the supply of raw materials, large scale production, from
ownership of patents or from government restrictions that prohibit
innovation theory of profit-4
the innovation theory of profit postulates that " economic "profit is the "
" reward for the introduction of a successful innovation

For example : steven jobs , the founder of the apple computer company , become a
millionaire in the course of a few years by introducing the apple computer in 1977

Managerial efficiency theory of profit -5

This theory rests on the observation that if the average firm tend to earn
only a normal return on its investment in the long run, firms that are more
efficient than the average would earn above normal returns and economic
Function of profit
profit serves a very crucial function in a free enterprise economy -1
high profit are the signal that consumer want more of the output of the -2
high profits provide the incentive for firms to expand output and for more -3
firms to enter the industry in the long_run
for a firm of a bove average efficiency , profit represent the reward for a -4
greater efficiency
On the other hand
lower profits or losses are the signal that consumers want less of the -1
commodity and the production methods are not efficient
profit provide the incentive for firms to increase their efficiency and -2
produce less of the commodity and for some firms to leave the industry for
more profitable ones
Profit system isn't perfect
And government in free enterprise economies often step in to modify the
operation of the profit system to make it more nearly consistent with broad
societal goals by making the following
regulating prices for electricity by public company to earn only a normal 1
, passing minimum wages laws and pollution emission control -2
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although profit system is not perfect , it is the most efficient form of

resource allocation available

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