Number 2
UMGC MBA 620: Financial
Decision Making
Project 2: Review and
Practice Guide
Project 2: Review and
Practice Guide
Managerial Economics
Contents Topic 1: Economics Principles ....................................................................................................................... 3
How People Make Decisions ..................................................................................................................... 3
Topic 2: Market Equilibrium.......................................................................................................................... 4
Demand Curve .......................................................................................................................................... 4
Supply Curve ............................................................................................................................................. 4
Market Equilibrium ................................................................................................................................... 5
What moves the Supply/Demand Curves ................................................................................................. 5
Topic 3: Elasticity .......................................................................................................................................... 6
What is Price Elasticity .............................................................................................................................. 6
Elasticity of Demand: Inelastic .................................................................................................................. 6
Elasticity of Demand: Unit Elastic ............................................................................................................. 7
Elasticity of Demand: Elastic ..................................................................................................................... 8
Topic 4: Market/Industry Structure .............................................................................................................. 9
Industry Structure Examples ..................................................................................................................... 9
Market Structure Comparison .................................................................................................................. 9
Perfect Competition ................................................................................................................................ 10
Topic 5: How Companies Make Decisions .................................................................................................. 11
Principle 3 ............................................................................................................................................... 11
Maximizing Profit .................................................................................................................................... 11
Problems/Exercises ..................................................................................................................................... 12
What to do .............................................................................................................................................. 12
Exercises .................................................................................................................................................. 12
............................................................................................................................................. 12
............................................................................................................................................. 12
............................................................................................................................................. 12
References .............................................................................................................................................. 12
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Topic 1: Economics Principles
How People Make Decisions • Principle 1: People face trade-offs
• Principle 2: The cost of something is what you give up to get it (opportunity cost)
• Principle 3: Rational people thing at the margin (MR=MC)
• Principle 4: People respond to incentives
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Topic 2: Market Equilibrium
Demand Curve
The market demand curve: a downward-sloping curve.
It depicts a movement along a stationary demand curve.
Based on Webster (2015, p. 22)
Supply Curve
The market supply curve: an upward-sloping curve.
It depicts a movement along a stationary supply curve.
Based on Webster (2015, p. 32)
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Market Equilibrium
A market equilibrium: determination of market price and
output.
It depicts a market equilibrium where the quantity
demanded equals the quantity supplied.
Based on Webster (2015, p. 37)
What Moves the Supply/Demand Curves
Demand:
• Price
• Income
• Price of related goods
• Tastes
• Expectations
• Number of buyers
Supply:
• Price
• Input prices
• Technology
• Expectations
• Number of sellers
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Topic 3: Elasticity
What is Price Elasticity? • Price elasticity—how sensitive demand or supply is to price changes
• Formula:
Absolute value of (% 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑖𝑒𝑠 % 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
) % change = (new value - old value) / average of new and old values
• Three Types of Elasticity
1. Inelastic: elasticity < 1
2. Elastic: elasticity > 1
3. Unit Elastic: elasticity = 1
Based on information in Mankiw (1997)
Elasticity of Demand: Inelastic
Source: Mankiw (1997)
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Elasticity of Demand: Unit Elastic
Source: Mankiw (1997)
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Elasticity of Demand: Elastic
Source: Mankiw (1997)
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Topic 4: Market/Industry Structure
Industry Structure Examples
Source: Mankiw (1997)
Market Structure Comparison Market Structure
Characteristic Perfect Competition Monopolistic Competition Oligopoly Monopoly
Type of
competition Perfect Imperfect Imperfect Imperfect
Number of firms Very many Many Few One
Type of product Homogeneous Differentiated. Many close substitutes
Homogeneous or
differentiated
Unique. No close Substitutes
Market power None; firms are “price takers”
Some; limited by availability
of close substitutes Limited; pricing
decisions
characterized
by strategic
behavior
Considerable;
firms are “price
makers.”
Barriers to entry
and exit Few to none; easy
entry and exit Few; easy entry and exit Considerable Entry impossible
Non-price
competition None Considerable,
advertising, brand-name
recognition, and trademarks
to promote customer loyalty
Considerable;
especially with
respect to
differentiated
products
None since there
is only one firm;
monopolies
frequently
advertise for
other reasons
Source: Webster (2015)
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Perfect Competition • Theoretical benchmark of market structure, six assumptions (Mankiw, 1997):
1. All companies have an identical (homogeneous) product
2. All competitors are price takers (they cannot influence the market price of their
product)
3. Market share does not influence price
4. Buyers have complete ("perfect") information at all times (past, present, future) about
the product and prices
5. Resources like labor are perfectly mobile
6. Companies can enter or exit the market without cost
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Topic 5: How Companies Make Decisions
Principle 3 Rational people thing at the margin—so do companies! (Mankiw, 2015)
Maximizing Profit Profit
𝜋 = TR – TC*
Marginal Revenue
MR = TR/Q; MC = TC/Q
Maximize (𝜋) when the following is true:
Marginal Revenue = Marginal Cost or MR – MC = 0
(Example: An empty seat on a flight at takeoff is a lost profit opportunity, because
there is almost no variable cost.)
* MR – marginal revenue, MC – marginal cost, TR – total revenue, TC – total cost, Q – quantity, --
change
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Problems/Exercises
What to do You are encouraged to complete all the practice exercises listed below. They will help you gain the
knowledge and skills needed to fully participate in the group assignment in Step 3 and complete the
final Project 2 deliverable. The answers are provided, so you can check your own work.
Exercises (in Webster, 2015)
• Solve exercises on pages 28, 31, 42, 45, 49
• Solve exercise on pages 57, 60, 68, 70, 71
• Solve exercises on pages 178, 181, 183, 184
References Mankiw, N. G. (1997). Principles of Economics (1st ed.). Harcourt.
Webster, T. J. (2015). Managerial economics: tools for analyzing business. Lexington Books.
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Now that you have read this Review and Practice Guide and completed the exercises, you are ready to participate in the group assignment in Step 3.