Managerial Economics

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Managerial Economics

• Introduction
• Managerial Economics
• Describes the economic forces that shape the
  internal and external environments of a business
  firm.
• Prescribes rules for managerial decision-making
  that furthers the objective of the firm.

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A Decision-Making Model
Objectives
Define the problem
Alternative Solutions
Evaluation
Organizational and input constraints
Social constraints
Implement and monitor the decision
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Objective of the Firm

• Not market share
• Not growth
• Not revenue
• Not empire building
• Not name recognition
• Not state-of-the-art technology

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Whats the objective of the firm?

• The objective of the firm is to maximize the
  value of the firm.
• Value of the firm is the true measure of business
  success (of course, from a for-profit
  perspective.)
• Two questions
• 1. How is the value of the firm defined and
  measured?
• 2. How do managers go about adding value to the
  firm?

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Managerial Economics

• Q1- Whats the value of the firm?
• The present value of the firms future net
  earnings.
• ?1 ?2 ?n
• V -------- -------- . . .
  --------
• (1r)1 (1r)2
  (1r)n
• ?t
• ? ------- , t 1, 2, ... ,
  N
• (1r)t

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Managerial Economics

• Q2 - How should a manager go about adding
  value?
• A good map or a travel guide to the curious
  land of the Econ should help.

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Managerial Economics

• A Useful Map
• Profit Total Rev - Total Cost
• ? P . Qd - AC . Qs

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Theories of Profits

• (Why are profits necessary?)
• Risk-Bearing Theory of Profit - Profits (normal
  profits) are necessary to compensate for the risk
  that entrepreneurs take with their capital and
  efforts
• Dynamic Equilibrium (Frictional) Theory -
  Profits, especially extraordinary profits, are
  the result of our economic systems inability to
  adjust instantaneously to unanticipated changes
  in market conditions.

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Theories of Profits

• Monopoly Theory - Profits are the result of some
  firms ability to dominate the market
• Innovation Theory - Extraordinary profits are the
  rewards for successful innovations
• Managerial Efficiency Theory - Extraordinary
  profits can result from exceptionally managerial
  skills of well-managed firms.

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Managerial Actions

• Controllable factors (internal environment)
• Productions
• Technology
• Marketing Mix
• Employment Policies
• Investment Strategies
• Capital structure

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Managerial Actions

• Non-Controllable factors(external environment)
• Level of Economic activities
• Economic Regulations
• Unions
• Global Business conditions
• BOP and Exchange rate changes

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Terminology Issues

• The Marginality analysis
• Economic Profits
• Accounting Profits
• Cash flows

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The Principle of Marginality

1,000
MC
MB
Hospital Days
1
2
3
4
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The Principle of Opportunity Cost

• Costs are opportunities sacrificed. To be
  precise, the opportunity cost of a choice or
  decision is measured by the highest valued
  alternative that will be given up.
• Cost is not always the monetary expense
• Cost is often implicit rather than explicit

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Significance of the Opportunity Cost Concept

• Accounting profits Net revenue Accounting
  costs (dollar costs of goods and services)
• Reported on the firms income statement
• Economic profits Net revenue Opportunities
  Costs
• Economic profits and opportunity costs are
  critical to decision making

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More examples of useful concepts

• The principal-agent or the agency problems
• Moral hazard

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Whats Managerial Economics?

• Managerial economics is not a separate management
  discipline
• Rather, it is a logical and useful tool for
  framing and solving management problems.

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Outline for this Course
Microeconomics Way of Thinking
Sellers, Production, Costs
Consumers, Value and Demand
Markets and Pricing
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What will we learn?

• useful economic principles for sound economic
  decision-making in a management context.
• the basics of the demand side of the market and
  which factors influence the buyers behavior.
• the fundamentals of the markets supply side
  -laws of production and how these laws impact a
  firms costs.
• how firms costs and buyers demand
  together determine the firms price
  and net profit.