economics what’s economics about? ♦ science of making decisions to allocate scarce resources to...
TRANSCRIPT
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Economics
What’s Economics about?
♦ Science of making decisions to allocate scarce resources to alternative uses.
♦ Three fundamental questions: – What? – How? – To whom?
♦ Microeconomics vs Macroeconomics.
Managerial Economics vs Micro Economics
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A market economy
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• Microeconomics vs Macroeconomics
♦ Microeconomics: – Studies decision making and interactions of individual
agents; – Concentrates on Demand, Supply and Markets.
♦ Macroeconomics: – Studies the evolution of the aggregate economy, as a
result of individual decisions and interactions; – Concentrates on Product, Unemployment and Inflation. • Managerial Economics vs Micro economics
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• Managerial economics applies microeconomic theory to business problems– How to use economic analysis to make
decisions to achieve firm’s goal of profit maximization
• Microeconomics– Study of behavior of individual economic
agents
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• Why Managerial Economics?
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The Fundamentals of Managerial Economics
• Use economic profits;
• Identify objectives and constraints;
• Understand markets;
• Conduct marginal analysis;
• Consider incentives and signaling;
• Recognize time value of money
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Economic Cost of Resources
• Opportunity cost of using any resource is:– What firm owners must give up to use the
resource
• Market-supplied resources– Owned by others & hired, rented, or leased
• Owner-supplied resources– Owned & used by the firm
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Total Economic Cost
• Total Economic Cost– Sum of opportunity costs of both market-
supplied resources & owner-supplied resources
• Explicit Costs– Monetary payments to owners of market-
supplied resources
• Implicit Costs– Nonmonetary opportunity costs of using
owner-supplied resources
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Economic Cost of Using Resources
Im plic it Costsof
O w ner-S upp lied R esourcesThe re tu rns fo rgone by n o t takingthe ow ners ’ res ources to m arke t
Explicit Costso f
M arket-S u p p lied R eso u rce sT he m oneta ry paym ents to
resource o wners
Total Econom ic CostT he to ta l opportun ity cos ts o f
bo th k inds o f res ources
+
=
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Types of Implicit Costs
• Opportunity cost of cash provided by owners– Equity capital
• Opportunity cost of using land or capital owned by the firm
• Opportunity cost of owner’s time spent managing or working for the firm
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Economic Profit versus Accounting Profit
• Economic profit = Total revenue – Total economic cost
= Total revenue – Explicit costs – Implicit costs
• Accounting profit = Total revenue – Explicit costs
• Accounting profit does not subtract implicit costs from total revenue
• Firm owners must cover all costs of all resources used by the firm
– Objective is to maximize economic profit
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3. Use economic profits
♦ Accounting profits
♦ Economic profits: – Oportunity costs.
♦ Example: Operation of a small pizzeria.
♦ Objective: maximize shareholders value.
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Operation of a small pizzeria (I)
♦ Mike runs a small pizzeria in his hometown.
♦ He owns the building.
♦ Annual revenues are €100000 euros.
♦ Annual costs are €20000.
♦ Annual profit is €80000 euros.
♦ This is not the economic profit!
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Operation of a small pizzeria (II)
♦ Mike could have a job earning €30000.
♦ Mike could have rented the space for €100000.
♦ The economic profit is just:
∏ = 80000-30000-100000= -50000
♦ CONCLUSION: Mike should close the pizzeria, rent the space and get the alternative job.
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2. Identify objectives and constraints
♦ The role of objectives:
– Choices are made to achieve objectives;
– Objectives of the unit and objectives of the sub-units.
♦ Resources are scarce:
– Impose constraints;
– Limit possibilities.
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Maximizing the Value of a Firm
• Value of a firm– Price for which it can be sold– Equal to net present value of expected future
profit
• Risk premium– Accounts for risk of not knowing future profits– The larger the rise, the higher the risk
premium, & the lower the firm’s value
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Maximizing the Value of a Firm
• Maximize firm’s value by maximizing profit in each time period– Cost & revenue conditions must be
independent across time periods
• Value of a firm =
1 22
1
...(1 ) (1 ) (1 ) (1 )
TtT
T ttr r r r
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3. What is a Market?
• A market is any arrangement through which buyers & sellers exchange goods & services
• Markets reduce transaction costs– Costs of making a transaction other than the
price of the good or service
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Price-Takers vs. Price-Setters
• Price-taking firm– Cannot set price of its product – Price is determined strictly by market forces of
demand & supply
• Price-setting firm– Can set price of its product– Has a degree of market power, which is ability
to raise price without losing all sales
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Market Structures
• Market characteristics that determine the economic environment in which a firm operates– Number & size of firms in market– Degree of product differentiation– Likelihood of new firms entering market
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Perfect Competition
• Large number of relatively small firms
• Undifferentiated product
• No barriers to entry
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Monopoly
• Single firm
• Produces product with no close substitutes
• Protected by a barrier to entry
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Monopolistic Competition
• Large number of relatively small firms
• Differentiated products
• No barriers to entry
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Oligopoly
• Few firms produce all or most of market
output
• Profits are interdependent
– Actions by any one firm will affect sales &
profits of the other firms
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Globalization of Markets
• Economic integration of markets located in
nations around the world
– Provides opportunity to sell more goods &
services to foreign buyers
– Presents threat of increased competition from
foreign producers
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Recognize the time value of money ♦ Many decisions have monetary implications
throughout a long period of time (R&D is a typical example). This raises specific problems.
♦ 1€ today is worth more that 1€ one year from now.
– Opportunity cost of capital; – Use present values. ♦ Example: R&D of new drugs. •
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4. Conduct marginal analysis
♦ Why and how marginal analysis:
– Decide on the basis of marginal benefits and marginal costs.
♦ Examples:
– Discrete decisions: How many machines (Labor) to buy?
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3. Use economic profits
♦ Accounting profits
♦ Economic profits:
– Oportunity costs.