bsp1005_01- introduction to managerial economics

INTRODUCTION TO

MANAGERIAL ECONOMICS

Dr. Gong Jie

National University of Singapore

Why Do We Study Economics?

People have to “Choose”.

♦ Resources are scarce.

♦ There is No Such Thing as Free Lunch!

Economics: the science of Rational Choice

♦ Rationality: the basic assumption

♦ Rational Choice: Economic agents use all the information

available to make decisions that most efficiently satisfy their

needs and achieve stated objectives.

♦ How do people make rational choice? This is the subject of

Economics!

Paul A. Samuelson’s definition of Economics

“Economics is the study of how men and society

choose, with or without the use of money, to employ

scarce productive resources, which could have

alternative uses, to produce various commodities over

time and distribute them for consumption, now and in

the future, among various people and groups in

society.”

Managerial Economics

Economics

♦ Micro: individual decision maker (consumers, households,

workers, firms, etc.)

♦ Marco: aggregate level

Managerial Economics

♦ The study of making decisions in allocating scarce resources to

achieve a managerial objective

♦ The application of microeconomics on effective management

♦ Managerial Economics helps managers make rational choice.

♦ Manager in “narrow” sense and in “broad” sense

After completing BSP1005, you will be able to:

♦ Thoroughly understand the function of market mechanisms

and the interaction among economic agents

♦ Understand how the interplay between cost and demand

fundamentals shape the prices that prevail in a market

♦ Master key concepts and principles of the basic market

structures

♦ Develop a set of tools to make qualitative and quantitative

analysis of real-world economic issues

Course Road Map

Managerial Economics

Determination of Prices

Demand and Supply

Consumer Theory

Producer Theory

Market Structure & Profit-Maximizing Pricing Decisions

Competitive Markets

Market Power & Monopoly

Pricing with Market Power

Game Theory&

Oligopoly Markets

Simultaneous-Move Game

Sequential-Move Game

Class Preparation

Class participation: NO WEBCAST

Course readings

Microeconomics, by Bensako and Braeutigam

Managerial Economics, by Png: optional

Assignments

Problems Sets

Presentation

Tutorial

Practice questions and selective homework problems

15-min group presentation

Tutorials

Tutorials start from week 3

♦ No tutorial in recess week

Practice problems will be assigned after each lecture

♦ Solutions to practice problems discussed in tutorials

♦ Written solutions will be posted on IVLE.

Presentation

♦ Each group presents once.

♦ The groups and topics will be announced at first tutorial

class.

Grading

Final exam

60 percent

Presentation

25 percent

Homework Problem Sets

15 percent

• Two sets of individual homework

• Due at the beginning of the

designated tutorial

• Group project

• 15-min presentation in tutorial

• Schedule to be announced in

IVLE & first tutorial

• Monday, 24 Nov

• Closed-book, covering all lecture

materials throughout the course

Important Dates and Times

Tuesdays, 2:00-3:30pm

♦ Office hours

Week 3 (25-29 Aug)

♦ First tutorial

Recess Week (20-28 Sep)

♦ no class

Deepavali (22 Oct)

♦ no class on 21&22 Oct. Tutorials meet as usual.

Monday, 24 Nov

♦ Final Exam

Mathematics Required

A Few More Things

Enrollment Matters

♦ Enrolling in module and tutorial sessions should be

addressed directly to BBA office.

Classroom Etiquette

♦ Be on time to class

♦ Switch off your cell phone

♦ No side conversations

♦ Laptops allowed ONLY for learning activities

Agenda

Essence of Economic Modeling

Opportunity cost

Economic models

Exogenous and endogenous variables

MARGINAL thinking!

How Do People Make Rational Choice?

People respond to Incentives.

♦ Incentives: carrots (benefits) and sticks (costs)

People make decisions by weighing benefits against costs.

♦ How do we measure benefits:

How much one is willing to sacrifice

♦ What is cost:

Economists are concerned about opportunity cost.

You should always have in mind your next best options.

Benefits of Studying Economics?

Tools that will better equip you to make choices

♦ How to quantify?

♦ How much are you willing to sacrifice in order to learn

economics?

An econ major may make you richer!

♦ Econ majors earn almost 20% more than degree-earners in

other social sciences.

♦ Among law school or MBA graduates, those who studies

econ as undergrads earn 35% more.

What is Opportunity Cost?

The value of the next-best alternative that is foregone

by the decision-maker

♦ Cost of purchasing a new car=price of the car+ return that

you would have earned from keeping the money

♦ Labor cost of your own business=wage paid to others +

what you could earn on the outside

♦ Cost of using your own building for office space=0?

Rental revenue!

What is your cost if you join NUS full-time MBA

Program?

Explicit Cost

♦ Tuition

♦ Textbooks

♦ Meal?

Is that all?

What is the cost if you run you own

restaurant?

Suppose that you own a house on Orchard Road, and you decide to run a restaurant, your total cost would include:

Explicit Cost: Implicit Cost

Models are simplifications, like maps.

Resemble reality

Abstract from the rich details

Help understand the fundamental forces

Economic Modeling

First, there is a goal.

♦ Basic managerial objective: to maximize net benefits

Net Benefits = Total Benefits - Total Costs

Profits = Revenue - Costs

♦ Objective function: functional relationship between the

value of the goal, and the values of variables.

Second, there is a set of options taken to achieve the

goal:

♦ How much of the variable should be used to maximize net

benefits?

Decision making has two components

Endogenous vs Exogenous Variables

Exogenous variables: Variables that have values that

are taken as given in the model.

Endogenous variables: Variables whose value is

determined within the model being studied.

Analyze the business of a lemonade stand:

Exogenous Endogenous

Find the optimal choice:

Marginal (Incremental) Analysis

Marginal Benefits (MB): Change in total benefits

arising from a unit change in the endogenous

variable, Q.

Marginal Costs (MC): Change in total costs arising

from a unit change in the endogenous variable, Q.

Example

Q Benefits MB Costs MC Net Benefits

0 0 0 0 0 0

1 30 6

2 48 14

3 60 24

4 64 40

30

18

12

4

6

8

10

16

24

34

36

24

Marginal Principle

MB > MC means the last unit of the endogenous

variable increased benefits more than it increased

costs.

MB < MC means the last unit of the endogenous

variable increased costs more than it increased

benefits.

To maximize net benefits, the managerial

control(endogenous) variable should be increased

up to the point where MB = MC.

Marginal Benefit (MB) for

Continuous Variable

Marginal Benefit from an infinitely small change in

the endogenous variable, Q:

Slope (calculus derivative) of the total benefit curve

Q

BMB

Δ

Δ=

Marginal Cost (MC) for

Continuous Variable

Marginal cost from an infinitely small change in the

endogenous variable, Q:

Slope (calculus derivative) of the total cost curve

Q

CMC

Δ

Δ=

The Geometry of Optimization

Q

Total Benefits

& Total Costs Benefits

Costs

Q*

B

C Slope = MC

Slope =MB

Economics of Effective Management

Identify objective and constraints

Objective: Specify what the economic agent cares about

Constraints: Whatever limits are placed on the resources

available to the agent

Economic modeling

Agent’s behavior can be modeled as optimizing the

objective function, subject to his various constraints.

Takeaway

Make sure that you include all costs(opportunity

cost) and benefits when making decisions.

Optimal economic decisions are made at the

margin (marginal analysis).