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ECONOMICS 6000 Managerial Economics

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1 ECONOMICS 6000 Managerial Economics

2 1. Managerial Economics

3 Q=f(Price, Income, AD) Managerial Economics
Applies economic tools and techniques to business and administrative decision making [Hirshey, 2009] Uses decision sciences to solve managerial problems faced by private, public, and not-for-profit organizations. Q=f(Price, Income, AD)

4 2. Some Examples Management Decision Problems
Demand Analysis & Forecasting Product pricing and output decision Buy or lease decisions [vehicles] Production techniques [capital vs. labor] Inventory levels – JIT Advertising media [ TV, newspaper, radio] Labor hiring and training Investment and Financing

5 3. Managerial Economics Managerial economics deals with microeconomic reasoning on real world problems such as selecting the best strategy in different competitive environments, and making efficient choices. Should Toyota expand its capacity (S1)? In part, it must consider current and future demand and what other firms are likely to do. Capacity for making cars is a long term project, so Toyota should think in terms of the present value (PV) of future profits (S2).

6 Managerial Economics Objective Function: Decision Rule:
Max PV of profits {S1, S2} where S1 is to expand capacity and S2 is not to expand capacity yet at this time. Decision Rule: Choose S1 if PV {Profits of S1 } > PV { Profits of S2 } Choose S2 if PV { Profits of S1 } < PV { Profits of S2 } If equal profits, then flip a coin

7 4. Basic Decision Making Model
Statement of the problem => [ International competition threatens Black and Decker’s profits] Identification of objectives => [ Maintain, or gain market share ] Identify possible solutions => [ Changing production techniques, market strategies, etc. ]

8 4. Basic Decision Making Model
Select the best solution from an array of alternative solutions. Implement the decision. Evaluate performance (Sensitivity analysis) e.g. property income forecasting with varying vacancy rates (VR). When vacancy rate is 15%=> ROI= 16%; for VR =18% => expected ROI= 5%

9 5. Common Managerial Questions
What to produce?=> Consumers-Typically, the answer depends on what the consumers want Determine what price to charge. => Market forces determine the price in a market economy Determine the optimal resource use=> Firms Choice of feasible investment projects.

10 6. Management Theories of the Firm.
Value or profit maximization model-primary goal of managers (popular theory)- Road Map Sales maximization model [ Baumol, 1959 ]- managers seek to maximize sales after an adequate profit is achieved to satisfy shareholders (salaries and sales) Management Utility maximization model (Williamson, 1963) - managers may seek to maximize their compensation [salaries, fringe benefits, stock options], the size of their staff, extent of their control over the corporation =>(principal-agent problem). Management satisficing behavior (Cyert,1963; Herbert Simon, 1949)- Because of the complexity of modern corporation, managers seek to achieve satisfactory results in terms of growth in sales, profits, and market share.

11 Responsibility of Management
Managers solve problems before they become a crisis Managers select strategies to try to assure the success of the firm Managers create an organizational culture attune to the mission of the organization Senior management establishes a vision for the firm Managers motivate and promote teamwork Managers promote the profitability of the firm And many managers see it in their long-run interest to promote sustainability of their enterprise in their environment. Managers who fail at these responsibilities are reviled, be they mangers of BP, Enron, or Bernie Medoff

12 7a. The present value of the firm’s future net earnings.
The objective of the firm is to maximize the value of the firm, the true measure of business success. Two key questions are the measure of value and how managers add value to the firm   n V = [ ] + [ ] [ ] (1+r) (1+r) (1+r)n N t V =  [ ], t = 1, 2, ... , N t = 1 (1+r)t Value =  [(TRt - TCt)/(1+r)t], t = 1, 2, ... , N

13 Broad Definition of Value
Profit = Total Rev - Total Cost  = P . Qd - VC . Qs - F where  = profit, P = price, Qd = quantity demanded, VC = variable cost per unit, Qs = quantity supplied, F = total fixed costs

14 Determinants of Value of the Firm
N t N P . Qd - VC . Qs - F V = [ ] =  [ ] t=1 (1+r)t t= (1+r)t Whatever raises the price of the product and/or the quantity of the product sold Whatever lowers the variable and fixed costs Whatever lowers the “r” (discount rate or the perceived “risk” of investment) will maximize the value of the firm. Do Class Exercise # 1 and 2 in the handout

15 7b. Value maximization as a Team Effort
The marketing department has the responsibility for increasing sales by using the most effective promotional strategy [radio, TV, Newspaper ads] The production department has the responsibility for minimizing costs by using new methods of production. The finance department has a major responsibility of acquiring capital for the firm when the cost capital is low (retiring debt and expanding investment).


17 8. Major Constraints to value maximization
a. Resource scarcity or constraints i.e. limited availability of essential input such as skilled labor, raw material, energy, machinery warehouse, etc. b. Contractual Obligations Meeting nutritional requirements for feed mixture, reliability requirements. c. Legal restrictions Minimum wage laws, health and safety standards, pollution emission standards, fuel efficiency requirements, fair pricing, etc.

18 Profits (Accounting vs Economic)
9a. Business or accounting profits refer to the difference between total revenue and explicit costs. Accounting (Business) Profit = TR-Explicit costs Profit(Econ) = Total revenue - Total costs =Total Revenue - [Explicit costs + Implicit costs] Examples: Exercise #1 Problems 3 & 4 page 2 handout

19 Theories of Why Profits Exist
RISK-BEARING THEORY (Oil exploration; Investing in Stocks) TEMPORARY DISQUILIBRIUM THEORY OF PROFIT (Windfall Gains) MONOPOLY THEORY OF PROFIT INNOVATION THEORY OF PROFIT (Gates, Job, Schmidt-Page- billionaires) MANAGERIAL EFFICIENCY THEORY OF PROFIT (a reward for organizational efficiency)

20 10. Examples Multinational Production & Pricing Euro Disney
Market Entry Building an Airport A Regulatory Problem An R&D Decision Canon Texaco VS. Pennzoil 11. In a global economy, what happens in one country has a direct bearing on the economies other countries (The 2011 Flooding in Thiland and production disruption at Toyota, Honda Plants in the US; Ford Escort parts coming from global manufacturing sources)

21 Term Paper Title I. Introduction - Statement of issue(s) to be addressed - Importance of the study - Objective of the paper II. A Review of Selected Literature -Recognize previous studies related to topic -Find a niche where you make some contribution to the literature

22 III. Data and Analytical Framework
Develop a theoretical model underlying the issue IV. Analyses and Interpretations of Empirical Results Statistical test results of the theoretical model V. Summary and Conclusion References

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