Getting acquainted What is Managerial Economics Managerial Economics blends intermediate microeconom

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Getting acquaintedWhat is Managerial Economics?
Managerial Economics blends intermediate
microeconomics, game theory, and industrial
organization to help managers make profitable
decisions. It emphasizes formulating and
anticipating changes in decision problems, and so
differs from solving fully-formed, fixed decision
problems in Quantitative Analysis (BA 452).
Welcome to BA 445
Managerial
Economics
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Welcome to BA 445
Managerial
Economics

• Getting startedRead and bookmark the online
  course syllabus.
• http//faculty.pepperdine.edu/jburke2/ba445/index.
  htm
• It serves as a contract specifying our
  obligations to each other. (You may need
  Internet Explorer.) In particular, note
• Linear Algebra, Calculus, and Introduction to
  Microeconomics are prerequisites, so review as
  needed.
• Before each class meeting, download and read the
  PowerPoint lesson, as presented under the
  Schedule link.

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AcknowledgementsThe course content for Part I
is adapted from the textbook Managerial
Economics and Business Strategy
Acknowledgements
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Overview
Overview
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Part I OverviewDemand and Supply Analysis from
Part I helps managers make profitable decisions
when there are impersonal competitive markets of
large numbers of firms and customers and workers.
Game Theory in Parts II and III completes
demand and supply analysis when personal
decisions interact.
Overview
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For example, when merchants try to attract
tourist shoppers, there may be many potential
destinations and vacationers competing in a
market, with market price determined by aggregate
supply and demand. But once Carlos sets up a
stall selling Foakleys (Fake Oakleys) outside the
Tijuana Wax Museum, he becomes tied to Aleisha
and the other tourists walking by his stall, and
the merchant sets his prices separately from the
worldwide competitive market for Foakleys by
bargaining with those individual tourists.
Overview
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Overview

• Chapter 2 Market Forces Demand and Supply
• Lesson I.1 Demand and Supply
• Market Demand Curve
• The Demand Function
• Demand Shifters
• Consumer Surplus
• Market Supply Curve
• The Supply Function
• Supply Shifters
• Producer Surplus
• Competitive Market Equilibrium
• Competitive Markets verses Bargaining
• Tax Equilibrium
• Summary
• Review Questions
• Lesson I.2 Predicting the Future with Competitive
  Equilibrium

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The Demand Function
The Demand Function
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The Demand Function

• The Demand Function
• Shows the amount of a good that will be purchased
  at alternative prices, holding other factors
  constant.
• Law of Demand The demand curve is downward
  sloping.
• The Law of Demand has exceptions, like when
  poor people eat more beans when the price of
  beans increases because they cannot afford meat.
  --- Other exceptions?

Price
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The Demand Function

• The Inverse Demand Function
• Alternative reading of demand graph, with price
  as a function of quantity demanded.
• Example
• Demand Function
• Qxd 10 2Px
• Inverse Demand Function
• 2Px 10 Qxd
• Px 5 0.5Qxd

Price
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Demand Shifters
Demand Shifters
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Demand Shifters

• Demand shifters
• When demand is affected by factors other than its
  own price.
• Income
• Normal good (meat) --- other examples?
• Inferior good (beans and rice) --- other
  examples?
• Prices of Related Goods
• Prices of substitutes (Microsoft and Apple) ---
  other examples?
• Prices of complements (hardware and software) ---
  other examples?
• Consumer preferences and advertising
• Advertising can be informative or change
  preferences
• Population
• Consumer expectations or the price of future
  goods
• Gold can be hoarded today if you expect future
  price increases.

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Demand Shifters

• The Demand Function
• A general equation representing the demand curve
• Qxd f(Px , PY , M, H)
• Qxd quantity demand of good X.
• Px price of good X.
• PY price of a related good Y.
• Substitute good.
• Complement good.
• M income.
• Normal good.
• Inferior good.
• H any other variable affecting demand.

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Demand Shifters
Change in Quantity Demanded When computer demand
changes with the price of computers
A
B
D0
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Demand Shifters
Change in Demand When computer demand changes
with the price of software
D0 to D1 Increase in Demand for computers. ---
Other examples?
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Consumer Surplus
Consumer Surplus
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Consumer Surplus

• Consumer Surplus
• When you get more value than you pay for.
• Consumer surplus will prove useful in profitable
  marketing strategies like value pricing and price
  discrimination.
• Remember, shareholders and managers in the
  Disney Corporation are not directly interested in
  consumer surplus, but in how to make profit.

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Market Demand Curve

Consumer Surplus

• I got a great deal!
• That company offers a lot of bang for the buck!
• The Samsung SyncMaster monitor has awesome
  value.
• Total value greatly exceeds total amount paid.
• Consumer surplus is large.

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Market Demand Curve

Consumer Surplus

• I got a lousy deal!
• Disneyland park and Disney movies are fun, but
  they drive a hard bargain!
• I almost decided not to go!
• They tried to squeeze the very last cent from
  me!
• Each DVD has 12 minutes of commercials!
• Total amount paid is close to total value.
• Consumer surplus is low or zero. (Consumer
  surplus is negative only
  when consumers make
  mistakes.) --- Examples of mistakes?

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Market Demand Curve

Consumer Surplus
The discrete case
Price
Consumer Surplus The value received but not paid
for. Consumer surplus (8-2) (6-2) (4-2)
12.
10
8
6
4
2
D
1 2 3 4 5
Quantity
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Market Demand Curve

Consumer Surplus
The continuous case
Price
10
8
6
4
Expenditure on 4 units 2 x 4 8
2
D
1 2 3 4 5
Quantity
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The Supply Function
The Supply Function
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The Supply Function

• The Supply Function shows the amount of a good
  that will be produced at alternative prices,
  holding other factors constant.
• It applies when producers are price takers (in
  perfect competition)
• Price makers (like Monopolists) choose their
  price, and do not have supply curves.
• Law of Supply The supply curve is upward
  sloping.
• That Law has no exceptions, according to
  economic theory.

Price
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The Supply Function

• The Inverse Supply Function
• Alternative reading of the supply graph, with
  price as a function of quantity supplied.
• Example
• Supply Function
• Qxs 10 2Px
• Inverse Supply Function
• 2Px 10 Qxs
• Px -5 0.5Qxs

Price
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Supply Shifters
Supply Shifters
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Market Supply Curve

Supply Shifters

• Supply shifters
• When supply is affected by factors other than its
  own price.
• Input prices (wages) direction? --- other
  examples?
• Prices of production substitutes or complements
  (like cars and trucks) direction? --- other
  examples?
• Technology (marginal cost) or government
  regulations direction?
• Number of firms
• Entry (like coffee houses) --- other examples?
• Exit (like airlines) --- other examples?
• Taxes
• Excise tax (a fixed amount per unit) direction?
  --- examples?
• Ad valorem tax (a percentage of price, or
  according to value) direction? --- examples?
• Producer expectations of future prices or
  technology.

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Market Supply Curve

Supply Shifters

• The Supply Function
• A general equation representing the supply curve
• QxS f(Px , W, PR , T, H)
• QxS quantity supplied of good X.
• Px price of good X.
• W price of inputs (including wages).
• PR price of a production substitute.
• T taxes
• taxes reduce supply in a demand and supply graph
  where Px is the price that demanders pay, and (Px
  - tax) is the price that suppliers keep.
• you could also work out taxes as decreased demand
  where Px is the price that supplier keep, and (Px
  tax) that demanders pay.
• H other variable affecting supply.

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Market Supply Curve

Supply Shifters
Change in Quantity Supplied When computer supply
depends on the price of computers
A to B Increase in quantity supplied
B
A
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Market Supply Curve

Supply Shifters
Change in Supply When computer supply depends on
wages. Direction? --- Other examples?
S0 to S1 Decrease in supply
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Producer Surplus
Producer Surplus
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Producer Surplus

• Producer Surplus
• When producers receive more than necessary to
  induce them to produce a good.
• Producer surplus minus fixed cost (the cost of
  zero production) equals profit for firms in
  perfect competition.
• Producer surplus is one component of profit when
  firms are not in perfect competition, and engage
  in strategies like price discrimination and
  two-part pricing. Two-part pricing examples
  include
• Costco. Shopper pay a membership price plus
  (discounted) prices on goods in the store.
• Disneylands admission price that offers all
  rides at no extra cost. --- What price does
  Disneyland charge for rides in the park?
• Free refills on cokes.

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Producer Surplus
The continuous case
Price
S0
P
Q
Quantity
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Competitive Market Equilibrium
Competitive Market Equilibrium
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Competitive Market Equilibrium

• Market Equilibrium
• The Price that equates supply and demand
• Why predict that price?

Price
Quantity
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Competitive Market Equilibrium

• Market Equilibrium
• The Price (P) that equates supply and demand
• QxS Qxd
• No shortage or surplus
• It is a steady state (rest point) when shortage
  (D gt S) drives prices up, and surplus (D lt S)
  drives prices down.
• Does not occur when the government intervenes to
  change prices, like keeping child-costs low
  (through tax credits that subsidize the
  consumption of children).
• Why are children subsidized? Should they be
  subsidized?
• Are children like other commodities?
• Would everyone have the same number of children
  if the government cancelled child tax credits?
  That is, are there some parents that think the
  benefits of children are only slightly higher
  than the costs?

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Graphing the equilibrium story If price is too
low, like the initial price of hybrid cars
Other examples?
Competitive Market Equilibrium
Price
Quantity
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If price is too high, like airline prices just
after 9/11 Other examples?
Competitive Market Equilibrium
Price
Quantity
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Competitive Markets verses Bargaining
Competitive Markets verses Bargaining
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Competitive Markets verses Bargaining

• Question Suppose
• Aleisha is willing to pay up to 59 for a pair of
  shoes.
• Brad, to pay 44 Claudia, 34.01 Darren, 24
  Edwina, 10.
• Suppose
• Andrew is willing to sell down to 8 for a pair
  of shoes.
• Betty, to sell 20 Carlos, 34 Donna, 48
  Engelbert, 62.
• Compute the competitive-equilibrium price of
  shoes if all 10 people trade shoes on eBay?
  (Ignore postage costs.)
• Alternatively, suppose Aleisha and Carlos do not
  use eBay, but Aleisha walks by Carloss trading
  stall outside the Tijuana Wax Museum. Compute
  the gains if they trade a pair of shoes. Compute
  the price of shoes if they divide the gains
  50-50.

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Competitive Markets verses Bargaining

• Answer Competitive Markets have Many Independent
  Buyers ...
• Aleisha is willing to pay up to 59 for a pair of
  shoes.
• Brad, 44 Claudia, 34.01 Darren, 24 Edwina,
  10.

Aleisha
Brad
Claudia
Darren
Edwina
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Competitive Markets verses Bargaining

• and Many Independent Sellers
• Andrew is willing to sell down to 8 for a pair
  of shoes.
• Betty, 20 Carlos, 34 Donna, 48 Engelbert,
  62.

Aleisha
Engelbert
Brad
Donna
Claudia
Carlos
Darren
Betty
Edwina
Andrew
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Competitive Markets verses Bargaining

• Demand equals Supply determines Competitive Price
• At some price between 34 and 34.01, Aleisha,
  Brad and Claudia buy 1 pair each from Andrew,
  Betty and Carlos.

Aleisha
Engelbert
Brad
Donna
Claudia
Carlos
Darren
Betty
Edwina
Andrew
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Competitive Markets verses Bargaining

• Bargaining Occurs with One Buyer and One Seller
• If Aleisha and Carlos meet separate from the
  competitive market, then the gains if they were
  to trade a pair of shoes is the difference
  between willingness to pay and willingness to
  sell.
• Aleisha is willing to pay up to 59 for a pair of
  shoes.
• Carlos is willing to sell down to 34 for a pair
  of shoes.
• The gain from trade is the difference, 25
  59-34.
• If Aleisha and Carlos divided the gains from
  trade 50-50, then each gets 12.50 gain, meaning
  Aleisha pays price 46.50 59.00-12.50, and
  Carlos receives price 46.50 34.0012.50

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Tax Equilibrium
Tax Equilibrium
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How to reduce pollution?If an excise tax of 3
per gallon of gas is imposed ... Let P Price
the buyers pay, so P - 3 is the price sellers
receive after tax, and so supply shifts
vertically up by 3. --- Buyers pay 1 more, not
3 more.
Tax Equilibrium
Price
Quantity
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Summary
Summary
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Summary

• Summary
• The lesson uses supply curves, and so all results
  are only for perfectly competitive markets.
• One purpose is to help managers in competitive
  markets predict changes in equilibrium, so they
  can plan their future.
• Managers should understand how they are affected
  by government policy, and should try to predict
  changes in public policy. To that end, managers
  should understand the reasons for public policy.
  --- Which policies are more likely when Democrats
  have power? Republicans?
• Another purpose is to exercise the use of demand
  curves, which are used even when markets are not
  competitive.

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Review Questions

• Review Questions
• You should try to answer some of the following
  questions before the next class.
• You will not turn in your answers, but students
  may request to discuss their answers to begin the
  next class.
• Your upcoming Exam 1 and cumulative Final Exam
  will contain some similar questions, so you
  should eventually consider every review question
  before taking your exams.

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Review Questions

• Question about consumer surplus
• Question 5, Baye page 67.
• Answer
• The posted answer computes consumer surplus using
  the formula for the area of a right triangle
  because demand and supply are linear. If demand
  and supply were non-linear, you could compute
  surplus with calculus (but I would not ask you to
  do that).

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Review Questions

• Question about taxes
• American Tennis Shoe, Inc., is concerned because
  Congress has proposed an excise tax of 1 on each
  pair of tennis shoes sold in the United States.
  They are lobbying against the tax through an
  advertising campaign that says the tax will raise
  the price of tennis shoes by 1. Use supply and
  demand graphs to show how much of the tax will
  actually be passed on to consumers. 

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Review Questions

• Answer
• Draw a demand and supply curve with price being
  the price paid by consumers. Thus the 1 tax
  shifts the market supply curve upward by 1 for
  each quantity of shoes. This results in an
  increase in price paid by consumers, but that
  increase is less than the 1 tax.

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Review Questions

• Question about consumer surplus
• Question 1, Final Exam Version A
• http//faculty.pepperdine.edu/jburke2/ba445/FinalE
  xam/FinalaAnswers.pdf
• Answer

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End of Lesson I.1
BA 445

Managerial Economics