Economic Principles and Business Decision-making

In this post, we'll provide an overview of managerial economics, and how it can be applied to small businesses. We'll explore topics such as opportunity cost, sunk costs, and economies of scale. By the end of this post, you should have a better understanding of how to use managerial economics to your advantage.

Managerial economics is the study of how economic principles can be applied to business decision-making. It is a relatively new field, having only emerged in the early 20th century. While managerial economics borrows from various other disciplines, such as microeconomics, game theory, and statistics, it has a distinct focus on the decision-making process of businesses.

Managerial economics is concerned with three main areas:

All businesses, whether small or large, face the same basic economic problems. These problems arise from the need to make choices in the face of scarcity. Scarcity is the condition that exists when our wants exceed the limited resources available to us. Given this, businesses must make choices about how to allocate their limited resources.

The three main economic problems businesses face are:

All businesses, regardless of size, must make choices about what products or services to offer, how to produce them, and who to produce them for. The goal of managerial economics is to help businesses make these choices in a way that maximizes their profits.

Opportunity cost is the idea that there is a cost to every decision we make.
This cost is not always monetary; it can also be opportunity cost. Opportunity cost is the value of the best alternative forgone. In other words, it is what we give up when we make a choice.

For example, if you have the opportunity to go to either a concert or a movie, and you choose to go to the concert, the opportunity cost of your decision is the movie.

The opportunity cost of any decision is the next best alternative that was not chosen.

Sunk costs are past costs that cannot be recovered. They are often irrelevant to decision-making because they cannot be changed.

For example, if you have already paid for a movie ticket, the cost is sunk and cannot be recovered. Whether or not you go to the movie is irrelevant to the sunk cost of the ticket.

Economies of scale refer to the idea that businesses can produce more goods and services at a lower cost per unit when they produce in massive quantities. This is because the fixed costs of production, such as factory rent and equipment, are spread out over a larger number of units.

The managerial economics of a small business is constrained by the limited resources available to them. Because of this, small businesses must be strategic in their decision-making in order to maximize their profits.

Opportunity cost, sunk costs, and economies of scale are all important concepts for small businesses to understand in order to make the best possible decisions.

Demand Theory

One of the most important theories in economics is demand theory. It describes how consumers make decisions about what to buy, how much to buy, and when to buy it. The theory is based on the idea that consumers have preferences and that they make decisions based on those preferences.

The theory of demand has a number of important implications for businesses.

First, it suggests that businesses need to understand the preferences of their customers. They need to know what consumers want and why they want it.

Second, businesses need to be able to forecast demand. They need to know how much of a product or service consumers are likely to demand in the future.

Third, businesses need to be able to respond to changes in demand. If demand for a product or service increases, businesses need to be able to increase production. If demand decreases, businesses need to be able to decrease production.

The theory of demand is also important for public policy. For example, the government may use demand theory to design policies that encourage people to buy more of a good that is considered to be essential, such as food or medicine. Alternatively, the government may use demand theory to design policies that discourage people from buying goods that are considered to be harmful, such as cigarettes or alcohol. In summary

Demand Curve

The demand curve is one of the most important concepts in economics. It shows the relationship between price and quantity demanded. This relationship is represented by a line on a graph. The demand curve is downward sloping, which means that as price increases, quantity demanded decreases.

Several factors can impact the demand curve.

One of the most important is income. As income increases, people have more money to spend and will demand more goods and services.

Another factor is prices of related goods. If the price of a good goes up, people will demand less of it. If the price of a good goes down, people will demand more of it.

What does this all mean for businesses and policy makers? It is important to understand the demand curve in order to make decisions about pricing, production, and other economic factors.

Law of Diminishing Returns

Production Theory

Keynesian economics is a more recent approach that focuses on the role of government in the economy. This approach is useful for understanding how to stabilize the economy in the face of shocks.

Cost Theory

In microeconomics, cost theory is the study of how costs affect the production and consumption of goods and services. Cost theory is a fundamental principle of economics that plays a major role in decision-making.

There are numerous types of costs that can be incurred in the production of goods and services. These costs can be categorized as fixed costs, variable costs, or sunk costs.

Fixed costs are costs that do not vary with the level of production. Examples of fixed costs include rent, property taxes, and insurance.

Variable costs are costs that do vary with the level of production. Examples of variable costs include raw materials, labour, and utilities.
 

Sunk costs are costs that have already been incurred and cannot be recovered.

The main objective of cost theory is to find the least-cost method of production. The least-cost method is the method of production that minimizes the total cost of production. To find the least-cost method of production, economists use the following principles:

• The principle of diminishing marginal returns: In other words, there is a point where the benefits of an activity start to decrease as the activity is continued.
  • The principle of diminishing marginal returns states that as more of a good is produced, the marginal cost of producing that good will increase.
• The principle of opportunity cost:
  • The principle of opportunity cost states that the opportunity cost of producing a good is the value of the next best alternative use of the resources used to produce the good.
    
    

Pricing Theory

Game Theory

Price discrimination theory

Finally, customers may be able to find out about the different prices being charged and may react negatively to this. Despite these challenges, price discrimination can be an effective pricing strategy for firms.