mba wd me pdf 01
Post on 07-Oct-2015
215 Views
Preview:
DESCRIPTION
TRANSCRIPT
-
MBA 532 Managerial Economics Lecture 1
Nature and scope of Managerial Economics
Professor H.D. Karunaratne
-
2
Why We Study Managerial Economics?
Growing complexity of business decision-making process due to changing market conditions and business Environment
Increasing use of economic logic, concepts, theories, and tools of economic analysis in the process of business decision making
Rapid increase in demand for professionally trained managerial manpower
Professor H. D Karunaratne
-
3
Definition of Managerial Economics Managerial economics is the application of
microeconomic tools and techniques to the key decisions firms need to make; e.g. pricing, output, investment, and advertising.
Managerial economics is primarily concerned with the theory of the firm, although any study of decisions at the firm level requires an understanding of the structure of the industry within which the firm is located.
Professor H. D Karunaratne
-
4
Managerial economics is the study of economic theories, logic and tools of economic analysis that are used in the process of business decision making.
Economic theories and techniques of economic analysis are applied to analyze business problems, evaluate business options and opportunities with a view to arriving at an appropriate business decision.
Managerial economics is thus constituted of that part of economic knowledge, logic, theories and analytical tools that are used for rational business decision-making
Professor H. D Karunaratne
-
5
The Nature of Managerial Economics
Economic Theory Micro/Macro
Analytical Tools Mathematics/
Statistics
Management Problems
Economic Methodology Descriptive Models Prescriptive Models
Study of functional areas Acc/Fin/Mkt/Per/Pro
Optimal Decisions
Managerial Economics
Professor H. D Karunaratne
-
6
Managerial economics applies economic theory and methods to business and administrative decision making
The role of managerial economics in management decision making;
1. Management decision problems
2. Economic Concepts
3. Decision sciences: Tools & techniques
of analysis
Professor H. D Karunaratne
-
7
Manager: A person who directs resources to achieve a stated goal.
Basically managers are confronted with two types of problems (a) decision-making (b) forward planning
Economics: The science of making decisions in the presence of
scarce resources
Managerial Economics: The study of how to direct scarce resources in the way
that most efficiently achieves a managerial goal
Basic Concepts in Managerial Economics
Professor H. D Karunaratne
-
8
Various approaches to analyze management problems Descriptive approach Quantitative approach
Functions & constraint maximization Graphs & numerical values
Revenue of the firm Costs of the firm Profit Maximization
Professor H. D Karunaratne
-
9
Managerial Economics yManagerial Economics is the study of economic
theories, logic and tools of economic analysis, used in the process of business decision making
yWhy Managerial Economics? y The growing complexity of business decision-
making processes y Changing market conditions y Globalization of business transactions. y Rapid increase in demand for professionally
trained managerial manpower.
Professor H. D Karunaratne
-
10
Nature of Managerial Economics
Managerial Decision Problem
Product selection, pricing Organization design Product development & promotion Investments Advertising Make or buy
Professor H. D Karunaratne
-
11
Nature of Managerial Economics Economic Concepts
Marginal analysis Theory of Firm Consumer demand Public Choice theory
Professor H. D Karunaratne
-
12
Quantitative Methods
Numerical analysis Statistical estimations Forecasting procedures Game-theory concepts Optimization techniques Information systems
Nature of Managerial Economics
Professor H. D Karunaratne
-
13
Managerial Economics
Optimal Solution
Use of economic concepts and quantitative methods to solve management decision problems
Nature of Managerial Economics Managerial Decision
Problem Economic Concepts Quantitative Methods
Professor H. D Karunaratne
-
14
yManagerial Economics helps to identify yhow economic forces affect organizations yways to achieve goals efficiently and
effectively
yManagerial Economics is applicable for non-profit organization
e.g. Non-profit Hospital Management problem: providing best medical care
possible given limited medical staff, equipment etc.
Managerial economics help to determine the optimal allocation of these limited resources
Professor H. D Karunaratne
-
15
Theory of the Firm What is a firm?
Series of contractual relationships that connect suppliers, inventors, workers and management in a joint effort to serve customers
Firm
Society
Inventors Suppliers
Employees Management
Customers Professor H. D Karunaratne
-
16
Theory of the Firm Theory of the firm is simply firm is thought to
have profit maximization as its primary goal Theory of the firm sometimes distinguish
between long-run motivations (sustainability) and short-run motivations (profit maximization)
Today the primary goal of the firm is long-term expected value maximization
16Professor H. D Karunaratne
-
17
Value of a Firm Value of the Firm = Present Value of
Expected Future Profits
TR-Total Revenues TC- Total Costs i- Appropriate interest t -time
Profits = Total Revenues - Total Costs
Therefore, Value =
Professor H. D Karunaratne
-
18
Constraints & Theory of the Firm Goal of Theory of the Firm is profit maximization
But there are constraints Resources are limited(skilled labor, energy, space,
funds)
Decisions are constrained by contractual requirements(labour contracts limit flexibility of work)
Constrains on out put(quality level, minimum satisfaction level)
Legal restrictions(Environment, health & safety)
Professor H. D Karunaratne
-
19
Limitations of the Theory of Firm
Competition in the capital market forces to seek value maximization
Risk of the decisions to reach the goal Should consider all relevant costs and
benefits before making a decisions
Firms need to have Social responsible behavior as well
Professor H. D Karunaratne
-
Profit Measurement
Free enterprise depend upon profits & Profit relevant motive
Efficient allocation of economic resources reflects from profit
-
21
Business Vs. Economic Profit
Accounting Profit (Business Profit) = Residual of Sales Revenue The explicit costs of doing business This is the amount available to fund Equity Capital
after payment for all other resources used by the firm
As for the cost for resources such as labour, energy, there is a price for entrepreneurial effort of a firms owner / manager & for other resources that owners bring to the firm
Professor H. D Karunaratne
-
22
To compensate inputs provided by owners, including entrepreneurial effort & capital,
have to includes an Opportunity Cost to the Nominal Rate of Return on equity capital
This enables the concept of Economic Profit
Economic Profit = Business Profit Implicit (non-cash) costs of capital & other owner provided inputs used by the firm
Specially among small business opportunity costs for owner provided inputs are often a considerable part of business profits
Professor H. D Karunaratne
-
23
Economic profits: The difference between total revenue and total
opportunity cost
Opportunity cost: The cost of the explicit and implicit resources
that are forgone when a decision is made
Present value: The amount that would have to be invested
today at the prevailing interest rate to generate the given future value.
Professor H. D Karunaratne
-
24
Determinants of the Value of a Firm
Value of Firm Inputs, legal,
and other Constraints
n
ti
tt
iTCTR
1 1
The value of i depends on
1. Risk ness of firm
2. Conditions in capital markets
Values of TR depends on 1.Demand & Forecasting 2.Pricing 3.New product development
Value of TC depends on 1. Production Techniques 2. Cost functions 3. Process Development
Professor H. D Karunaratne
-
25
Scope of Managerial Economics
The following key business areas can be considered to be the scope of managerial economics
1. Demand Analysis and Demand Forecasting 2. Resource Allocation 3. Production and Cost analysis 4. Competitive analysis 5. Pricing 6. Strategic Planning Reference: Chapter 1 & 2 of Dwivedi, D. N. (2005) Managerial
Economics, Sixth Reprint , VIKAS Publishing House Professor H. D Karunaratne
-
26
Variability of Business Profits
Normal rate of profit is typically assessed by Return on Stockholders Equity (ROE) ROE = Accounting net income/ Book value of the firm
Professor H. D Karunaratne
-
27
Lets have a look about Corporate Giants in 2007,
Company Name Return on Equity (ROE) %
Intel Corporation 13.7 HP Company 17.1 Johnson & Johnson 28.1
The Coca-Cola company 30.1
Microsoft Corporation 32.4 Proctor & Gamble 15.0 The Boeing Company 46.5
Professor H. D Karunaratne
-
28
The annual average ROE of 10% can be regarded as typical value in the market
Most of the companies shown in the chart have exceed this limit !!!
Also
Why do Profits vary among firms ?
Professor H. D Karunaratne
-
29
Explanation of economic profit or losses can be done using varies theories.
y Frictional Profit Theory Markets are sometimes in disequilibrium because of unanticipated changes in demand or cost conditions.
For example,
y New user friendly software increased demand for personal computers & boots returns for PC manufactures & software venders.
y ATMs & financial sector Professor H. D Karunaratne
-
30
Monopoly Profit Theory some firms earn above normal profits because they are sheltered from competition by high barriers to entry
High capital requirements Intel Corporation Patents Microsoft Corporation Import protection & regulations US automobile
industry
Frictional Profit Theory & Monopoly Profit Theory commonly called as Disequilibrium Profit Theories
Professor H. D Karunaratne
-
31
Compensatory Profit Theories Innovative Profit Theory - Above normal profits
that arise following successful invention or modernization
For example, Microsoft Corporation Introduced & marked Graphical User Interface, while other competitors using command based approach
In general Compensatory Profit Theory describes above normal rates of return that reward firms for extraordinary success in meeting customer needs & maintaining efficient operations
Also recognizes economic profit as an important reward to the entrepreneurial function of owners & managers
Professor H. D Karunaratne
-
32
Role of Profits in the Economy
Each of preceding theories describes economic profits obtained for different reasons. Some cases combination of theories apply.
Economic profits play an important role in any market-based economy as indicator.
Above normal profits alarms that firm output should be increased. Expansion by established firms or entry by new competitors occurs quickly in high profit period.
Below normal profits alarms firm for contraction & exit. Such profits penalize stagnation & inefficiency.
Professor H. D Karunaratne
-
1-33
Managerial Economics & Theory
Managerial economics applies microeconomic theory to business problems How to use economic analysis to make
decisions to achieve firms goal of profit maximization
Microeconomics Study of behavior of individual economic
agents
-
1-34
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
-
1-35
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
-
1-36
Economic Cost of Using Resources (Figure 1.1)
Explicit Costsof
Market-Supplied ResourcesThe monetary payments to
resource owners
Total Economic CostThe total opportunity costs of both kinds of resources
Implicit Costsof
Owner-Supplied ResourcesThe returns forgone by not takingthe owners resources to market
+
=
-
1-37
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 owners time spent managing or working for the firm
-
1-38
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
-
1-39
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 firms value
-
1-40
Maximizing the Value of a Firm Maximize firms 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
SS S S
-
1-41
Separation of Ownership & Control
Principal-agent problem Conflict that arises when goals of management
(agent) do not match goals of owner (principal)
Moral Hazard When either party to an agreement has
incentive not to abide by all its provisions & one party cannot cost effectively monitor the agreement
-
1-42
Corporate Control Mechanisms
Require managers to hold stipulated amount of firms equity
Increase percentage of outsiders serving on board of directors
Finance corporate investments with debt instead of equity
-
1-43
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
-
1-44
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
-
1-45
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
-
1-46
Perfect Competition
Large number of relatively small firms Undifferentiated product No barriers to entry
-
1-47
Monopoly
Single firm Produces product with no close substitutes Protected by a barrier to entry
-
1-48
Monopolistic Competition
Large number of relatively small firms Differentiated products No barriers to entry
-
1-49
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
-
1-50
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
-
3-51
Optimization
An optimization problem involves the specification of three things: Objective function to be maximized or
minimized
Activities or choice variables that determine the value of the objective function
Any constraints that may restrict the values of the choice variables
-
3-52
Choice Variables
Choice variables determine the value of the objective function
Continuous variables Can choose from uninterrupted span of
variables
Discrete variables Must choose from a span of variables that is
interrupted by gaps
-
3-53
Net Benefit
Net Benefit (NB) Difference between total benefit (TB) and total
cost (TC) for the activity NB = TB TC
Optimal level of the activity (A*) is the level that maximizes net benefit
-
3-54 NB
TB
TC
Optimal Level of Activity (Figure 3.1)
1,000
Level of activity
2,000
4,000
3,000
A
0 1,000 600 200
T
o
t
a
l
b
e
n
e
f
i
t
a
n
d
t
o
t
a
l
c
o
s
t
(
d
o
l
l
a
r
s
)
Panel A Total benefit and total cost curves
A
0 1,000 600 200 Level of activity
N
e
t
b
e
n
e
f
i
t
(
d
o
l
l
a
r
s
)
Panel B Net benefit curve
G
700
F
D
D
C
C
B
B
2,310
1,085
NB* = $1,225
f
350 = A*
350 = A*
M
1,225 c 1,000 d 600
-
3-55
Marginal Benefit & Marginal Cost
Marginal benefit (MB) Change in total benefit (TB) caused by an
incremental change in the level of the activity
Marginal cost (MC) Change in total cost (TC) caused by an
incremental change in the level of the activity
-
3-56
Marginal Benefit & Marginal Cost
TBMBA
' 'Change in total benefit
Change in activity
TCMCA
' 'Change in total costChange in activity
-
3-57
Relating Marginals to Totals
Marginal variables measure rates of change in corresponding total variables Marginal benefit & marginal cost are also
slopes of total benefit & total cost curves, respectively
-
3-58
MC (= slope of TC)
MB (= slope of TB)
TB
TC
Relating Marginals to Totals (Figure 3.2)
F
D D
C C
Level of activity
800
1,000
Level of activity
2,000
4,000
3,000
A
0 1,000 600 200
T
o
t
a
l
b
e
n
e
f
i
t
a
n
d
t
o
t
a
l
c
o
s
t
(
d
o
l
l
a
r
s
)
Panel A Measuring slopes along TB and TC
A
0 1,000 600 200
M
a
r
g
i
n
a
l
b
e
n
e
f
i
t
a
n
d
m
a
r
g
i
n
a
l
c
o
s
t
(
d
o
l
l
a
r
s
)
Panel B Marginals give slopes of totals
800
2
4
6
8
350 = A*
100
520
100
520
350 = A*
B
B
b
G
g
100
320
100
820
d (600, $8.20)
d (600, $3.20)
100
640
100
340
c (200, $3.40)
c (200, $6.40)
5.20
-
3-59
Using Marginal Analysis to Find Optimal Activity Levels
If marginal benefit > marginal cost Activity should be increased to reach highest net
benefit
If marginal cost > marginal benefit Activity should be decreased to reach highest net
benefit
Optimal level of activity When no further increases in net benefit are
possible
Occurs when MB = MC
-
3-60
NB
Using Marginal Analysis to Find A* (Figure 3.3)
A 0 1,000 600 200
Level of activity
N
e
t
b
e
n
e
f
i
t
(
d
o
l
l
a
r
s
)
800
c
d
100
300 100
500
350 = A*
MB = MC
MB > MC MB < MC
M
-
3-61
Unconstrained Maximization with Discrete Choice Variables
Increase activity if MB > MC Decrease activity if MB < MC Optimal level of activity
Last level for which MB exceeds MC
-
3-62
Irrelevance of Sunk, Fixed, & Average Costs
Sunk costs Previously paid & cannot be recovered
Fixed costs Constant & must be paid no matter the level of
activity
Average (or unit) costs Computed by dividing total cost by the number of
units of the activity
These costs do not affect marginal cost & are irrelevant for optimal decisions
-
3-63
Constrained Optimization The ratio MB/P represents the additional
benefit per additional dollar spent on the activity
Ratios of marginal benefits to prices of various activities are used to allocate a fixed number of dollars among activities
-
3-64
Constrained Optimization To maximize or minimize an objective
function subject to a constraint Ratios of the marginal benefit to price must be
equal for all activities
Constraint must be met
A B Z
A B Z
MB MB MB...
P P P
-
Questions
Professor H. D Karunaratne 65
top related