Wk1 DQ - Managerial Economics
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Baye_9e_Chapter_01.pptxThe Fundamentals of Managerial Economics
Chapter 1
© 2017 by McGraw-Hill Education. All Rights Reserved. Authorized only for instructor use in the classroom. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objectives
Summarize how goals, constraints, incentives, and market rivalry affect economic decisions.
Distinguish economic versus accounting profits and costs.
Explain the role of profits in a market economy.
Apply the five forces framework to analyze the sustainability of an industry’s profits.
Apply present value analysis to make decisions and value assets.
Apply marginal analysis to determine the optimal level of a managerial control variable.
Identify and apply six principles of effective managerial decision making.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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The Manager
A person who directs resources to achieve a stated goal.
Directs the efforts of others.
Purchases inputs used in the production of the firm’s output.
Directs the product price or quality decisions.
© 2017 by McGraw-Hill Education. All Rights Reserved.
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Introduction
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Economics
The science of making decisions in the presence of scarce resources.
Resources are anything used to produce a good or service, or achieve a goal.
Decisions are important because scarcity implies trade-offs.
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Introduction
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The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.
Should a firm purchase components – like disk drives and chips – from other manufacturers or produce them within the firm?
Should the firm specialize in making one type of computer or produce several different types?
How many computers should the firm produce, and at what price should you sell them?
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Introduction
Managerial Economics Defined
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Basic principles comprising effective management:
Identify goals and constraints
Recognize the nature and importance of profits
Understand incentives
Understand markets
Recognize the time value of money
Use marginal analysis
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Economics of Effective Management
The Economics of Effective Management
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Identify Goals and Constraints
Well-defined goals
Firm’s overall goal is to maximize profits
Constraints make it difficult to achieve goals
Available technology
Prices of inputs used in production
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The Economics of Effective Management
Recognize the Nature and Importance of Profits
Accounting profit
Total amount of money taken in from sales (total revenue) minus the dollar cost of producing goods or services.
Economic profit
The difference between total revenue and cost opportunity cost.
Opportunity cost
The explicit cost of a resource plus the implicit cost of giving up its best alternative.
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The Economics of Effective Management
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The role of profits
Profits are a signal to resource holders where resources are most highly valued by society.
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The Economics of Effective Management
Recognize the Nature and Importance of Profits
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Five Forces and Industry Profitability
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The Economics of Effective Management
Understand Incentives
Changes in profits provide an incentive to how resource holders use their resources.
Within a firm, incentives impact how resources are used and how hard workers work.
One role of a manager is to construct incentives to induce maximal effort from employees.
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The Economics of Effective Management
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Two sides to every market transaction: buyer and seller
Bargaining position of consumers and producers is limited by three rivalries in economic transactions:
Consumer-producer rivalry
Consumer-consumer rivalry
Producer-producer rivalry
Government and the market
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The Economics of Effective Management
Understand Markets
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Recognize the Time Value of Money
Often a gap exists between the time when costs are borne and benefits received.
Managers can use present value analysis to properly account for the timing of receipts and expenditures.
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The Economics of Effective Management
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Present Value Analysis 1
Present value of a single future value
The amount that would have to be invested today at the prevailing interest rate to generate the given future value:
Present value reflects the difference between the future value and the opportunity cost of waiting:
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The Economics of Effective Management
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Present Value Analysis II
Present value of a stream of future values
or,
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The Economics of Effective Management
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Consider a project that returns the following income stream:
Year 1, $10,000; Year 2, $50,000; and Year 3, $100,000.
At an annual interest rate of 3 percent, what is the present value of this income stream?
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The Economics of Effective Management
The Time Value of Money in Action
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Net Present Value
The present value of the income stream generated by a project minus the current cost of the project:
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The Economics of Effective Management
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Present value of decisions that indefinitely generate cash flows:
Present value of this perpetual income stream when the same cash flow is generated :
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Economics of Effective Management
Present Value of Indefinitely Lived Assets
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Profit maximization
Maximizing profits means maximizing the value of the firm, which is the present value of current and future profits.
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Economics of Effective Management
Present Value and Profit Maximization
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Present Value and Estimating Values of Firms I
The value of a firm with current profits , with no dividends paid out and expected, constant profit growth rate of (assuming ) is:
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Economics of Effective Management
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When dividends are immediately paid out of current profits, the present value of the firm is (at ex-dividend date):
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Economics of Effective Management
Present Value and Estimating Values of Firms II
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Short-term and long-term profits
If the growth rate in profits is less than the interest rate and both are constant, maximizing current (short-term) profits is the same as maximizing long-term profits.
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Economics of Effective Management
Short-Term versus Long-Term Profits
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Given a control variable, , of a managerial objective, denote the
total benefit as .
total cost as .
Manager’s objective is to maximize net benefits:
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Economics of Effective Management
Use Marginal Analysis
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How can the manager maximize net benefits?
Use marginal analysis
Marginal benefit:
The change in total benefits arising from a change in the managerial control variable, .
Marginal cost:
The change in the total costs arising from a change in the managerial control variable, .
Marginal net benefits:
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Economics of Effective Management
Use Marginal Analysis
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Marginal principle
To maximize net benefits, the manager should increase the managerial control variable up to the point where marginal benefits equal marginal costs. This level of the managerial control variable corresponds to the level at which marginal net benefits are zero; nothing more can be gained by further changes in that variable.
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Economics of Effective Management
Use Marginal Analysis
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Marginal Analysis In Action
It is estimated that the benefit and cost structure of a firm is:
Find the and functions.
What value of makes zero?
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Economics of Effective Management
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Quantity
(Control Variable)
Total benefits
Total costs
0
Slope =
Slope =
Maximum total benefits
Maximum net
benefits
Economics of Effective Management
Determining the Optimal Level of a Control Variable
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Determining the Optimal Level of a Control Variable II
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Quantity
(Control Variable)
Net benefits
0
Maximum
net benefits
Slope =
Economics of Effective Management
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Quantity
(Control Variable)
Marginal
benefits, costs
and net benefits
0
Maximum net
benefits
Economics of Effective Management
Determining the Optimal Level of a Control Variable III
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Marginal Value Curves Are the Slopes of Total Value Curves
When the control variable is infinitely divisible, the slope of a total value curve at a given point is the marginal value at that point.
The slope of the total benefit curve at a given Q is the marginal benefit of that level of Q.
The slope of the total cost curve at a given Q is the marginal cost of that level of Q.
The slope of the net benefit curve at given Q is the marginal net benefit of that level of Q.
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Economics of Effective Management
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Marginal Value Curves Are the Slopes of Total Value Curves
A calculus alternative
Slope of a continuous function is the derivative /marginal value of that function:
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Economics of Effective Management
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Incremental revenues
The additional revenues that stem from a yes-or-no decision.
Incremental costs
The additional costs that stem from a yes-or-no decision.
“Thumbs up” decision
.
“Thumbs down” decision
.
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Economics of Effective Management
Incremental Decisions
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Learning Managerial Economics
Practice, practice, practice …
Learn terminology
Break down complex issues into manageable components.
Helps economics practitioners communicate efficiently.
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Learning Managerial Economics
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