2. Welcome To Economics 315 Price System and resource Allocation

3. 2 Instructor: Morteza Rahmatian Office: LH 717 Phone: (714) 278-3859 E-mail: mrahmatian@fullerton.edu Web Page: Business.fullerton.edu/mrahmatian/ u Office Hours: u T and Th: 2:30 - 4:00 u Or by appointment

4. Managerial Economics: Definition: It is the application of the tools of economic theory and decision sciences to see how a firm or organization can achieve its aims and objectives most efficiently.

5. Management Economic TheoryDecision Sciences Managerial Economics Optimal Solutions a. Microeconomics b. Macroeconomics a. Mathematical Economics b. Econometrics

6. 5 Seven examples of Managerial Decisions

7. 6 1.Pricing Policies A firm can produce and sell a product in different market (local or abroad). Many factors including, price, cost, profit and market share must be taken into consideration. 1.Pricing Policies A firm can produce and sell a product in different market (local or abroad). Many factors including, price, cost, profit and market share must be taken into consideration.

8. 7 2.1987 Walt Disney Co. Signed $2 billion contract to built Euro Disney in France. Factors to consider: u Forecasting u Weather u Cost u Customer service u life style

9. 8 3.Research and Development Two choices u Enhance and improve existing products. (i.e. new and improved Tylenol) u Take a chance on creating a new product. (i.e. drug to cure AIDS)

10. 9 4. 1985 Time Inc. magazine u Approved to develop and test a new all picture magazine. u 100 personnel using 15 million testing the magazine over 13 markets. u 1986 Time Inc. decided against it. u Launching such magazine would have cost $ 100 millions.

11. 10 5.1970 Canon Inc. wanted to enter copying with Xerox Corp. having 75% of the market world wide. u Imitate and improve, risking possible patent suits. u Develop completely new copier technology aimed at avoiding Xerox patents. u License copier technology from Xerox.

12. 11 Canon needed to consider many issues u Barriers to entry u Profit potential u Degree of competition u Price u Technology u Long run growth prospect

13. 12 6.Public projects and Regulations u Government similar to the private sector is subject to similar constraint optimization. u Regulation is the methodology in which support business and to protect consumers, workers and the environment.

14. 13 7.1984-1987 dispute between Texaco and Pennzoil. The largest court award settlement. Texaco acquired Getty oil and wrecked a planned Getty-Pennzoil deal. u Pennzoil suit Texaco. u Fight it in courts and stand to lose millions in litigation. u Settle out of court and save millions in legal fees. u Use bankruptcy protection.

15. 14 Six steps in decision making:

16. 15 1.Defining the problem u In practice managerial decisions does not come neatly packaged. Rather, they are messy and poorly defined. Thus defining the problem is a key management issue.

17. 16 2.Determine the objective: What is the decision maker’s goal? u Market share u Cost minimization u Largest firm u For public sector, airport, parks, roads,…. u Cost Benefit Analysis

18. 17 3.Explore the alternatives: u What constraints limit the choice of options

19. 18 4.Predict the consequences: u What are the consequences of each alternative action. Should conditions change, how would this affect outcomes. u Sometimes simple arithmetic suffice to predict. Other times need to built a model to predict a more complicated situation

20. 19 Model is a simplified description of a process, relationship or other phenomena. Elements of a model. u Variables u Set of assumptions about other relevant variables. u Hypothesis about the way the specific variables are related. u One or more predictions

21. 20 Q = f ( P, Y, P c, P s ) Q =  +  1 P +  2 Y +  3 P c +  4 P s

22. 21 5.Make choices: u After all analysis is done, what is the preferred course of action. u Make optimal decision

23. 22 6.Perform sensitivity analysis: u Sensitivity analysis considers how optimal decision would change if key economic facts or conditions were altered. In tackling and solving a decision problem, it is important to understand and be able to explain the “why” of your decision.

24. 23 Sensitivity analysis is useful u Providing insight into the key features of the problem that affect decision. u Tracing the effect of changes in variables about which the manager may be uncertain. u Generating solutions in cases of recurring decisions under slightly modified conditions.

25. Theory of the Firm Firm: It is an organization or entity that combines and organizes resources for the purpose of producing goods and services for sale. Proprietorship PartnershipCorporation

26. Objective of the Firm: Profit Maximization Value of the Firm: It is the present value of a the firm’s expected future net cash flows

27. $100 Year One Year Two $100 Interest Rate = 5 % $100 today $105 in a year

28. So one dollar a year from now has a present value of 1234 22 11 33 44

29. Project 1: $100, $20, $10 Project 2: $40, $50, $60 Discount rate = 2%

31. Value of the Firm

32. Distinction between Accounting & Economic Profit: Total Profit = TR - TC Accounting Profit = TR - Explicit Costs Economic Profit = Accounting Profit - Implicit Costs = TR - Explicit Costs - Implicit Costs

33. 100 + 800 Problem 3: Interest rate (i) = 15%

34. Problem 12: Current Job = $30,000 New Job = $40,000 Return From Pharmacy = $200,000 Explicit Cost = 80,000+40,000+10,000+5,000 +8,000 = 143,000 Business Profit = 200,000 – 143,000 = 57,000

35. Implicit Cost = 40,000 + 2,000 = 42,000 Economic Profit = Business Profit – Implicit cost = 57,000 – 42,000 = 15,000 (b) Total Revenue now is $200,000 which includes a $15,000 economic profit. So in three years when the new pharmacy will drive down the economic profit to zero, total revenue of the pharmacy will be $200,000 - $15,000 = $185,000.

36. c. Samantha shall purchase the pharmacy if the present value of the pharmacy is positive. 15,000 – 50,000