lec 1 managerial economics
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Introduction, Basic Principles and Methodology
The central themes of Managerial Economics:
1. Identify problems and opportunities
2. Analyzing alternatives from which choices can be made
3. Making choices that are best from the standpoint of the firm or organization
• Not true that all managers must be managerial economists
• But managers who understand the economic dimensions of business problems and apply economic analysis to specific problems often choose more wisely than those who do not.
Some Economic Principles of Managers
1.Role of manager is to make decisions. Firms come in all sizes but no firm has unlimited resources so managers must decide how resources are employed
2. Decisions are always among alternatives.
3. Decision alternatives always have costs and benefits
Opportunity cost = next best alternative foregone.
Marginal or incremental approach
4. Anticipated objective of management is to increase the firm’s value
• Maximize shareholder’s wealth
• Negative impact = principal-agent problem
5. Firm’s value is measured by its expected profits
Time value of money, discount rates
6. The firm must minimize cost for each level of production
7. The firm’s growth depends on rational investment decisions
Capital budgeting decisions
8. Successful firms deal rationally and ethically with laws and regulations
Macroeconomics & Microeconomics
• Economists generally divide their discipline into two main branches:
• Macroeconomics is the study of the aggregate economy.
– National Income Analysis (GDP)
– Unemployment
– Inflation
– Fiscal and Monetary policy
– Trade and Financial relationships among nations
• Microeconomics is the study of individual consumers and producers in specific markets.– Supply and demand
– Pricing of output
– Production processes
– Cost structure
– Distribution of income and output
Microeconomics is the basis of managerial economics
• Methodology, data and application
Methodology- is a branch of philosophy that deals with how knowledge is obtained.
How can you know that you are managing efficiently and effectively?
You need some theory to do some analysis.
Without theory, there can be no good analysis
Microeconomics (probably more than other disciplines) provides the methodology for managerial economics
Managerial Economics is about both methodology and data
You need data to plug into some model to do some analysis.
This gives you the information to manage
Managerial Economics lends empirical content to the study of effective management
Review of Economic Terms
• Resources are factors of production or inputs.
– Examples:
• Land
• Labor
• Capital
• Entrepreneurship
• Managerial Economics
– The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.
• Managerial economics is the use of economic analysis to make business decisions involving the best use (allocation) of an organization’s scarce resources.
• Relationship to other business disciplines
– Marketing: Demand, Price Elasticity
– Finance: Capital Budgeting, Break-Even Analysis, Opportunity Cost, Economic Value Added
– Management Science: Linear Programming, Regression Analysis, Forecasting
– Strategy: Types of Competition, Structure-Conduct-Performance Analysis
– Managerial Accounting: Relevant Cost, Break-Even Analysis, Incremental Cost Analysis, Opportunity Cost
• Questions that managers must answer:
– What are the economic conditions in a particular market?• Market Structure?• Supply and Demand Conditions?• Technology?• Government Regulations?• International Dimensions?• Future Conditions?• Macroeconomic Factors?
• Questions that managers must answer:
– Should our firm be in this business?
– If so, what price and output levels achieve our goals?
• Questions that managers must answer:
– How can we maintain a competitive advantage over our competitors?• Cost-leader?
• Product Differentiation?
• Market Niche?
• Outsourcing, alliances, mergers,
• acquisitions?
• International Dimensions?
• Questions that managers must answer:
– What are the risks involved?
• Risk is the chance or possibility that actual future outcomes will differ from those expected today.
• Types of risk
– Changes in demand and supply conditions
– Technological changes and the effect of competition
– Changes in interest rates and inflation rates
– Exchange rates for companies engaged in international trade
– Political risk for companies with foreign operations
• Because of scarcity, an allocation decision must be made. The allocation decision is comprised of three separate choices:
– What and how many goods and services should be produced?
– How should these goods and services be produced?
– For whom should these goods and services be produced?
• Economic Decisions for the Firm
– What: The product decision – begin or stop providing goods and/or services.
– How: The hiring, staffing, procurement, and capital budgeting decisions.
– For whom: The market segmentation decision – targeting the customers most likely to purchase.
• Three processes to answer what, how, and for whom
– Market Process: use of supply, demand, and material incentives
– Command Process: use of government or central authority, usually indirect
– Traditional Process: use of customs and traditions
• Profits are a signal to resource holders where resources are most valued by society
• So what factors impact sustainability of industry profitability?
• Porter’s 5-forces framework discusses 5 categories of forces that impacts profitability
1. Entry
2. Power of input sellers
3. Power of buyers
4. Industry rivalry
5. Substitutes and Complements
Entry:
Heightens competition
Reduces margin of existing firms
Ability to sustain profits depends on the barriers to entry: cost, regulations, networking, etc.
Profits are higher where entry is low
Power of input suppliers:
Do input suppliers have power to negotiate favorable input prices?
Less power if
a. inputs are standardized,
b. not highly concentrated
c. alternative inputs available
Profits are high when suppliers power is low
Power of buyers:
High buyer power if
a. buyers can negotiate favorable terms for the good/service
b. Buyer concentration is high
c. Cost of switching to other products is low
d. perfect information leading to less costly buyer search
Industry rivalry:
Rivalry tends to be less intense
a. in concentrated industries
b. high product differentiation
c. high consumer switching cost
Profits are low where industry rivalry is intense
Substitutes and complements:
Profitability is eroded when there are close substitutes
Government policies (restrictions e.g. import restriction on drugs from Canada to US) can affect the availability of substitutes.
Sustainabl
e Industry
Profits
Power of
Input SuppliersSupplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints
Power of
BuyersBuyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints
EntryEntry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale
Network Effects
Reputation
Switching Costs
Government Restraints
Substitutes & Complements
Price/Value of Surrogate Products
or Services
Price/Value of Complementary
Products or Services
Network Effects
Government
Restraints
Industry Rivalry
Switching Costs
Timing of Decisions
Information
Government Restraints
Concentration
Price, Quantity, Quality, or
Service Competition
Degree of Differentiation
The Five Forces Framework
Market Interactions
• Consumer-Producer Rivalry
– Consumers attempt to locate low prices, while producers attempt to charge high prices.
• Consumer-Consumer Rivalry
– Scarcity of goods reduces the negotiating power of consumers as they compete for the right to those goods.
• Producer-Producer Rivalry
– Scarcity of consumers causes producers to compete with one another for the right to service customers.
• The Role of Government
– Disciplines the market process.
Overview of Lectures
Lecture 1: Demand
Lecture 2: Supply
Lecture 4: Quantitative Demand Analysis
Lecture 5: The Theory of Individual Behavior
Lecture 6:Demand Estimation & Forecasting
Lecture 7: Production
Lecture 8: Cost of Production
Lecture 9: Organizing Production
Lecture 10: Perfect Competition
Lecture 11:The Firm’s Decisions in Perfect
Competition
Lecture 12:Monopoly
Lecture 13:Price Discrimination
Lecture 14:Monopolistic Competition
Lecture 15: Oligopoly
Lecture 16: Oligopoly Games
Lecture 17: Labor and Capital Market
Lecture 18: Capital Market
Lecture 19: Economic Equations and Their
Solutions
Lecture 20: Economics Applications of
Derivatives
Lecture 21: ECONOMIC APPLICATION OF
DERIVATIVES – A
Lecture 22: ECONOMIC APPLICATION OF
DERIVATIVES - A
Lecture 23: ECONOMIC APPLICATION OF
MAXIMA AND MINIMA-A
Lecture24: MAXIMIZATION OR
MINIMIZATION (OTIMIZATION) OF
MULTI-VARIABLE FUNCTIONS OR TWO
OR MORE VARIABLE
Lecture 25: CONSTRAINED OPTIMIZATION
Lecture 26: CONSTRAINT OPTIMIZATION –
A
Lecture 27: Correlation & Regression
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