Lesson 1

provides the economic foundation needed by Accountancy students to understand how individuals, firms, and organizations make decisions when resources are limited.

It applies economic principles to practical business problems such as resource allocation, cost control, pricing, investment, production, and profitability.

is fundamentally concerned with choices under conditions of scarcity. Because resources such as money, labor, time, materials, capital, and technology are limited while human wants and organizational objectives are numerous, individuals and firms must make choices and accept trade-offs.

Economics is fundamentally concerned with choices under conditions of

provides important information about the financial consequences of decisions,

provides a framework for understanding choices, trade-offs, incentives, and resource allocation.

Economics has several important characteristics.

Economics studies human behavior, particularly how people and organizations make decisions about resources.

People and organizations continuously make choices because they cannot have everything they want.

Scarcity is the fundamental economic condition that creates the need for resource allocation.

People respond to incentives.

For example:
higher wages may encourage workers to supply more labor;

lower prices may encourage consumers to buy more;

tax incentives may encourage investment;

higher production costs may discourage expansion.

Economists use:

models;
graphs;
statistics;
mathematical relationships;
data analysis; and
logical reasoning

to analyze economic problems. Economic models simplify reality so that important relationships can be examined more clearly.

is the application of economic principles, concepts, and analytical methods to business and managerial decision-making. It is sometimes described as the bridge between economic theory and business practice.

While economics may ask:

Managerial economics asks:

While economics may study:

Managerial economics asks:

Managerial economics can help answer questions such as:

What product should the company produce?
How much should it produce?
What price should it charge?
Should the company expand?
Should it outsource production?
Should it hire additional workers?
Should it purchase new equipment?
Should it discontinue a product?
Should it enter a new market?
How should scarce capital be allocated?

These questions involve

Economics

Managerial Economics

examines the behavior and decisions of individual economic agents such as: consumers; households; workers; businesses; firms; and individual markets.

focuses on individual economic agents and the decisions of households, workers, and businesses.

Economics is commonly divided into

examines the economy as a whole.

three fundamental economic questions:

means that available resources are insufficient to satisfy all human wants and needs.

is central to economic reasoning because choosing one alternative generally means giving up the possibility of using the same resources for another alternative.

is the value of the next-best alternative that is forgone when a choice is made.

is the value of what is given up or forfeited when an alternative is selected.

Opportunity Cost =

Usually refers to costs recorded in the accounting system.

Refers to the value of the best alternative forgone. Therefore, an economic decision may involve costs that do not appear as conventional accounting expenses.

basic economic decision-making process

What decision needs to be made?

What does management want to accomplish?

Possible alternatives may include: expand; maintain current operations; outsource; automate; or discontinue the service.

Consider: available capital; labor; time; technology; regulations; production capacity

Management compares expected benefits with relevant costs.

What is the best alternative that will be sacrificed?

Select the alternative that best supports the organization ' s objective given its constraints.

Management should monitor the outcome and determine whether the decision achieved its objectives.

Should we do a little more or a little less of an activity?

A manager compares the: Marginal Benefit (MB) with Marginal Cost (MC) A

If MB > MC

If MB < MC

If MB = MC

Economic conditions affect: sales forecasts; operating costs; labor costs; material costs; interest expense; investment requirements.

Economic concepts help accountants understand: fixed costs; variable costs; relevant costs; incremental costs; opportunity costs; economies of scale; and cost behavior.

Accounting information can identify costs and margins. Economic analysis adds information about: demand; competition; consumers; substitutes; market conditions; and price sensitivity. Thus, accountants involved in management decision-making need both accounting and economic perspectives.

Resources are limited.

Alternatives must be selected.

Selecting one alternative means sacrificing another.

The value of the next-best alternative forgone.

Compare relevant benefits, costs, risks, and alternatives.

Select the alternative that best supports the organization ' s objective under its constraints.

Students should remember the following chain: