Managers rarely make decisions with perfect certainty. Demand, prices, costs and competitor actions can change. Therefore, managerial economics uses tools to make decisions under:
Common exam focus:
Risk: outcomes are uncertain, but probabilities can be assigned/estimated.
Uncertainty: outcomes are uncertain and probabilities cannot be assigned reliably.
Examples:
Managers try to evaluate alternatives using expected values and risk measures.
These basics are used to compute expected value.
Expected value is the weighted average of possible outcomes using probabilities.
Formula:
In business, we commonly use EMV (Expected Monetary Value).
EMV helps select the best alternative under risk.
Steps:
Note: EMV does not show variability/dispersion, so risk attitude matters.
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Managerial economics is a stream of management studies which emphasises solving business problems and decision-making by applying the theories and principles of microeconomics and macroeconomics. It is a specialised stream dealing with the organisation's internal issues by using various economic theories.
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Managers rarely make decisions with perfect certainty. Demand, prices, costs and competitor actions can change. Therefore, managerial economics uses tools to make decisions under:
Common exam focus:
Risk: outcomes are uncertain, but probabilities can be assigned/estimated.
Uncertainty: outcomes are uncertain and probabilities cannot be assigned reliably.
Examples:
Managers try to evaluate alternatives using expected values and risk measures.
These basics are used to compute expected value.
Expected value is the weighted average of possible outcomes using probabilities.
Formula:
In business, we commonly use EMV (Expected Monetary Value).
EMV helps select the best alternative under risk.
Steps:
Note: EMV does not show variability/dispersion, so risk attitude matters.
In exams, write these in point form.
A decision tree is a diagram showing decisions and chance events in sequence.
Common symbols:
Steps (easy):
Decision trees are useful when decisions occur in stages.
Sensitivity analysis checks how results change when one assumption changes.
Example variables:
Steps:
This helps managers focus on what matters most.
Scenario analysis considers combined changes:
It is useful under uncertainty.
BEP and MOS (from previous topic) are also risk tools:
So tools should be combined with managerial judgment.
Alternative A: profit ₹1,00,000 with p=0.6; loss ₹20,000 with p=0.4
If profit changes greatly when demand changes by ±10%, demand is a key risk driver.
EMV calculation table:
Decision tree steps:
Decision node → chance outcomes (with probabilities) → payoffs
→ compute expected values backward → choose best path
From this topic
Risk means outcomes are uncertain but probabilities are known/estimable using past data. Uncertainty means probabilities are not known reliably.
Thus, risk is measurable; uncertainty is difficult to quantify.
Expected value (EV) is the weighted average of possible outcomes using probabilities.
Formula: EV = Σ (Outcome × Probability).
Use: Under risk, EV/EMV helps compare alternatives and choose the one with highest expected payoff (especially for a risk-neutral manager).
EV is helpful but does not show risk spread.
Risk and uncertainty are common in managerial decision-making.
Thus, risk can be measured to some extent, while uncertainty is harder to quantify.