Chapter One The Nature and Scope of Managerial Economics Chapter Outline

1
Chapter OneThe Nature and Scope of Managerial
EconomicsChapter Outline

• The Managerial Decision-Making Process
• Theory of the Firm
• Profit
• Role of Business in Society

2
The Managerial Decision-Making Process

• Managerial Economics applies economic theory
  and methods to business and administrative
  decision making.
• Specifically managerial economics
• prescribes rules for improving managerial
  decisions.
• indicates how one can achieve organizational
  objectives efficiently
• allows one to recognize how economic forces
  affect organizations
• describes the economic consequences of managerial
  behavior.

3
Management Decision Problems
Decision Sciences Numerical Analysis Statistical
Estimation Forecasting Optimization
Economic Concepts Theory of the Consumer Theory
of the Firm Theory of Market Structure
Managerial Economics Use of economic concepts and
decision science methodology to solve managerial
decision problems
4
Managerial Decision Problems

• Product Price and Output
• Make or Buy
• Production Technique
• Inventory Level
• Advertising Media and Intensity
• Labor Hiring and Training
• Investment and Financing

5
Theory of the FirmOutline

• Defining Value
• Constraints and the Theory of the Firm
• Limitations of the Theory of the Firm

6
Theory of the FirmDefinitions

• Theory of the Firm The basic model of the
  business enterprise.
• Primary Motive Profit Maximization
• Expected Value Maximization Optimization of
  profits in light of uncertainty and the time
  value of money
• Value of the Firm The present value of the
  firms expected net cash flows.
• Present Value Worth in current dollars.

7
Constraints and Limitations

• Firms face constraints imposed by technology,
  resource scarcity, contractual obligations, and
  government laws.
• Hence the topic of constrained optimization.
• Do firms optimize or satisfice?
• Optimize seek the best solution
• Satisfice seek satisfactory rather than optimal
  results

8
ProfitsOutline

• Business vs. Economic Profit
• The Variability of Business Profit
• Frictional Theory of Economic Profits
• Monopoly Theory of Economic Profits
• Innovation Theory of Economic Profits
• Compensatory Theory of Economic Profits
• The Role of Profits in the Economy

9
Business vs. Economic Profit

• Business Profit Residual of sales revenue minus
  the explicit accounting cost of doing business.
• Business Profit TR Explicit Cost
• Normal Rate or Return Minimum profit necessary
  to attract and retain investment.
• Economic Profit Business profit minus the
  implicit costs of capital and any other
  owner-provided inputs.
• Economic Profit TR (Explicit Cost Implicit
  Cost)

10
Variability of Business Profits

• Profit Margin vs. ROE
• Profit Margin Net profit divided by sales.
• Return on Stockholders Equity (ROE) Accounting
  net income divided by the book value of total
  assets minus total liabilities
• ROE Profit / Book Value
• In perfect competition, economic profit is zero.
  In other words, the ROE would be equal across all
  firms.

11
Theories of Economic Profit

• Frictional Profit Theory Above-normal profits
  observed following unanticipated changes in
  demand and cost conditions.
• Monopoly Profit Theory Above-normal profits
  caused by barriers to entry that limit
  competition.
• Innovation Profit Theory Above-normal profits
  that follow successful invention or
  modernization.
• Compensatory Profit Theory Above-normal rates
  of return that reward efficiency.

12
Role of Business in SocietyOutline

• The Market System Has Led to the Highest Standard
  of Living the Human Race Has Ever Known!!!
• Why Firms Exist
• The Role of Social Constraints
• The Social Responsibility of Business

13
Why Firms Exist

• Firms exist by public consent to serve the needs
  of society.
• Competition between firms forces business to
  provide the goods and services consumers demand
  at the lowest possible cost.

14
The Role of Social Constraints

• Barriers to Entry and other Limits on Competition
• Exploitation of Workers
• Negative Externalities