Managers, Profits, And Markets

Managers, Profits, and Markets

Managerial economics provides a systematic, logical way of analyzing business decisions that focuses on the economic forces that shape both day-today decisions andlong-run planning decisions. Managerial economics applies microeconomic theory—the study of the behavior of individual economic agents—to business problems in order to teach business decision makershow to use economic analysis to make decisions that will achieve the firm's goal: the maximization of profit. Economic theory helps managers understand real-world business problems by using simplifyingassumptions to abstract away from irrelevant ideas and information and turn complexity into relative simplicity. Like a road map, economic theory ignores everything irrelevant to the problem andreduces business problems to their most essential components. The opportunity cost of using resources to produce goods and services is the amount the firm's owner gives up by using these resources.Opportunity costs are either explicit opportunity costs or implicit opportunity costs. Explicit costs are the costs of using market-supplied resources, which equal the monetary payments to hire, rent, orlease resources owned by others. Implicit costs are the costs of using owner-supplied resources, which are the best earnings forgone from using resources owned by the firm in the firm's own productionprocess. Total economic cost is the sum of explicit and implicit costs. Economic profit is the difference between total revenue and total economic cost:

Economic profit = Total revenue - Totaleconomic cost = Total revenue - Explicit costs - Implicit costs

Accounting profit differs from economic profit because accounting profit does not subtract from total revenue the implicit costs of usingresources: Accounting profit = Total revenue - Explicit costs Thus accounting profit will be larger than economic profit for firms using owner-supplied resources. Since all costs matter to owners of...