Page 11 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes

Task Identify some quantitative techniques used in managerial decision-making.

1.4 Economic Principles Relevant to Managerial Decisions

Key economic principles that are relevant to managerial decisions are discussed in the following
sub-sections.

1.4.1 Division of Labour

I put the division of labor first mainly because Adam Smith did argue that division of labor is
the key cause of improving standards of living. Modern economics doesn’t do much with the
concept of division of labor, but two closely related concepts are important:

1. Returns to Scale: Returns to scale may be increasing, constant or decreasing. Increasing
returns to scale is the case that leads to special results, and division of labor is one cause
(arguably the main cause) of increasing returns to scale.
2. Virtuous Circles in Economic Growth: For Smith, a major consequence of division of labor
and resulting increasing productivity was a “virtuous circle” of continuing growth. Modern
“virtuous circle” theories have more dimensions, but division of labor and increasing
returns to scale are among them.

1.4.2 Opportunity Cost

The idea is that anything you must give up in order to carry out a particular decision is a cost of
that decision. This concept is applied again and again throughout modern economics.
1. Scarcity: According to modern economics, scarcity exists whenever there is an opportunity
cost, that is, where-ever a meaningful choice has to be made.
2. Production Possibility Frontier: The production possibility frontier is the diagrammatic
representation of scarcity in production.
3. Comparative Advantage: A very important principle in itself and a key to understanding
of international trade the principle of comparative advantage is at the same time an
application of the opportunity cost principle to trade.
4. Discounting of Investment Returns: Another application of the opportunity cost principle
that is very important in itself, this one tells us how to handle opportunities that come at
different times.

1.4.3 Equimarginal Principle

This is the diagnostic principle for economic efficiency. It has wide applications in modern
economics. Two of the most important are key principles of economics in themselves:
1. The Fundamental Principle of Microeconomics: This principle describes the circumstances
under which market outcomes are efficient.
2. The Externality Principle: It describes some important circumstances in which the markets
are not efficient.

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