Managerial Economics

Assoc. Prof. Sven FeldmannMelbourne Business SchoolOffice 249349 8171

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GM 1Sept./Oct. 2015

What is Managerial Economics?

The job of a manager is to identify problems and opportunities, evaluate alternative courses of action, make choices, and convince others to embrace and implement these choices. Some entrepreneurs or top managers are driven by a firm vision and intuition about which choices are correct for their company. Even for these leaders, making the right decisions that guide the company along the intended path requires anticipating and evaluating the consequences of various strategic alternatives, which requires analysis.

Managerial economics provides you with a robust framework and a set of tools, collectively known as economic thinking, that help you identify and evaluate strategic business options and make better choices. To this end you learn fundamental economic tools and analytical skills that help you in managerial and strategic decision-making.

Economic decision-making focuses on the strategic aspect of decisions: actions by individuals and firms effect others, either through the market or through other forms of interaction with one another. The effect of a decision is therefore often mitigated by the response of other actors, a fact that needs to be anticipated when evaluating the options. Game theory is the formal framework that incorporates these interactions into the decision making process. Many subjects—in particular finance, business strategy, and marketing—build on tools and intuitions developed in this course.

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4. Economic Leadership

3. Critical ThinkingAbility to use economic thinking in designing and implementing solutions to management problems, processes and decision-making.

Ability to engage and influence others in their understanding, formulation, and solution of complex problems, through your actions and communication based on economic thinking.

2. Problem SolvingAbility to apply economic analysis to real-world problems.

Ability to deal with complexity, ambiguity, incomplete data, and lack of “textbook” structure.

Ability to use economic thinking in designing and implementing solutions to management problems, processes and decision-making.

Ability to engage and influence others in their understanding, formulation, and solution of complex problems, through your actions and communication based on economic thinking.

1. UnderstandingAbility to apply economic concepts to problems specifically designed to be analysed with a given concept.

Ability to apply economic analysis to real-world problems.

Ability to deal with complexity, ambiguity, incomplete data, and lack of “textbook” structure.

Ability to use economic thinking in designing and implementing solutions to management problems, processes and decision-making.

Ability to engage and influence others in their understanding, formulation, and solution of complex problems, through your actions and communication based on economic thinking.Ability to talk about

economic concepts and explain them to others.

Ability to apply economic concepts to problems specifically designed to be analysed with a given concept.

Ability to apply economic analysis to real-world problems.

Ability to deal with complexity, ambiguity, incomplete data, and lack of “textbook” structure.

Ability to use economic thinking in designing and implementing solutions to management problems, processes and decision-making.

Ability to engage and influence others in their understanding, formulation, and solution of complex problems, through your actions and communication based on economic thinking.

Four step model of learning and developing leadership in economics*

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* adapted from Accelerated Learning Lab, R.E. Wood

Learning method

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The goal of this course is to achieve the level of Critical Thinking in managerial economics. This means that you will need to be able to understand the economic concepts, learn to apply them in structured problems, and develop the ability to apply them in more complex, less structured problems exhibiting a degree of complexity and ambiguity.

Learning economics is like learning a new sport, instrument, or language: you can’t learn it by just watching it being performed! You need to participate and put in effort to practice it. Inevitably you will experience some set-backs. It is normal that you will find economics difficult and unfamiliar at first, but you will get better at it. Keep an open mind when encountering difficulties, and view challenges and mistakes as learning opportunities, not as failures.

To achieve the learning goal the course offers you the following learning structure:

TheoryLectures, reading

Practice Practice problems,

quizzes

Advanced Practice

Complex problems

ExamCombo of simple and

complex problems

To learn managerial economics you will need to put in the time and put up with some failures, just like you would when learning a new sport

Expectations

As a lecturer it is my role to help you learn managerial economics, and as a student it is your role to make the best of it. This suggests the following ground rules:

It is my responsibility tocome prepared to every class and begin and end class on timeoffer you opportunities to learn and practice new skillsprovide you with a stimulating learning environmentrespect you and your experience and backgroundtreat all students equitably, grade you fairly, and provide honest feedback on your learningrealise that it is not always your fault if you don’t understand the material.

It is your responsibility tocome prepared to every class and be ready to begin class on timebe focused and engaged in the class proceedings at all times and contribute your sharekeep distractions to a minimum. In particular this means no email, smart phone use or laptop internet browsing at any time during classbe respectful to your classmates and me. Listen actively and engageact with academic and personal integrity: uphold the Student Honour Code, do not seek an unfair advantage, and contribute your fair share to joint efforts such as group assignments and study groupcomplete all assigned work and make an effort to learn and practice the material presentedaccept fair and honest feedback. Realise that it is not always my fault if you don’t understand the material. 5

Class materials

The following text books are strongly suggested for the course:

Besanko, D. and R. Brautigam (2011), Microeconomics, 4th or 5th Edition, Wiley. (B&B) An excellent text book covering our material for weeks 3–7 and more. Available at the book store in bound copy and loose-leaf (cheaper) and as e-book from the publisher. There are several copies in the library too. I recommend you buy it.

Van Zandt, T. (2002), Firms, Prices, and Markets, INSEAD. (VZ) Downloadable for free at <http://faculty.insead.edu/vanzandt/teaching/FPM-Aug2012.pdf>

An excellent and chatty book that shows how economics and game theory apply to business strategy and the real world of business, is

Brandenburger, A. and B. Nalebuff (1997/2007), Co-opetition, Doubleday. Start reading it now! (You won’t be tested on it though.)

Class slides will be available on LMS the day before class. You are not expected to read the slides before class—in fact, I prefer it if you don’t.

Summaries of the material will be provided in due time before the exam to assist your review.

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Requirements

Preparation: There are sections and chapters assigned for reading. However, most of your time spent on managerial economics outside of the classroom will be devoted to solving practice and advanced practice problems, and reviewing prepared solutions. You need to be willing to dedicate the time necessary to complete these problems.

Maths skills: Economics is a quantitative subject and as such requires some basic maths skills. Fluency in the topics covered in Refreshing Maths during accelerator week is eminently helpful. If you are not fluent in any of the following, you should review them on your own, with a tutor, or have a word with me.

Excel: You need to be comfortable doing calculations with Excel and be able to graph a function (using Charts). You should learn how to format graphs and tables beyond the Excel defaults.

Calculator: During quizzes and exam you will not be able to use Excel and need a calculator. In addition to the basic four functions, the calculator should have exponent (xy) and a memory function. You need to know how to use the memory function. A financial calculator is OK; a smart phone calculator is not allowed during the final exam (by University of Melbourne rules).

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Assessment

Your grade will be based the following components:

Adding value to class 10%Your added value is determined by the quality, not quantity, of your participation during class. A good question enhances the learning process for everyone. Value-adding participation during a discussion entails engaging with comments others have made and building on them, not ignoring them. In addition, I may on occasion cold call students. Added value is graded by classifying students into four groups: below, at, above, and well above expectations. The majority of students will be at expectations.

Problem sets 15%A weekly problem set is due via LMS. You may solve the problems individually or in your syndicate/study group. If solved in groups, you are responsible for your own solution and submit your own answer.

Quizzes 15%Beginning with week 2 there will be a brief review quiz of the previous week’s material at the beginning of class. The quiz starts promptly at 8:30. Review and recall is critical for long-term learning.

Final exam 60%There will be an individual 3 hour final exam. You will receive sample practice questions and summaries to prepare for the exam. The exam is closed book and you can bring a 4-page, hand written, cheat sheet to the exam.

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One more thing

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It is against the rules of this class to:

1. access quizzes, problem sets or exams from previous terms

2. pass any solutions to quizzes, problem sets or exams (in whole or in part) to future students.

Typical day structure

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Time Activities

8:30 – 8:50 Quiz (except for week 1)

8:50 – 9:50 Session A

9:50 – 10:00 Break

10:00 – 10:55 Session B

10:55 – 11:10 Break

11:10 –12:00 Session C

12:00 - 14:00 Lunch and Recreation

14:00 – 15:30 Syndicates work on problem sets

15:30 – 15:45 Break

15:45 – 16:30 Session D / Review

Independent work

Topics

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Week Theme Topics/Activities Preparation

1 Creating and appropriating value

We examine how transactions create value and how a firm can appropriate some of this value. We focus on bilateral relationships which occur frequently in B2B dealings.

• Read: Course outline• Read: Note on Consumer Choice and on

Bilateral Bargaining (both on LMS)

2Bargaining with market power and multilateral negotiation

We examine how competition among multiple participants limits the range of feasible bargaining outcomes

• Read “Coopetition”, in: A. Brandenburger, B. Nalebuff, Coopetition, Chapter 2

• Read: Note on Multilateral Bargaining (LMS)

3Selling to large markets:Pricing with market power

We examine how pricing decisions affect profitability. We learn as a “benchmark” the uniform pricing model, and analyse more advanced forms of customised pricing

• Read B&B Ch. 11.1–11.3• Read B&B Ch. 12.1–12.4

4 Introduction to Game Theory

Game theory is the analysis of strategic bahavior. By examining the fundamental structure of interactions we learn to “think strategically”, analyse a strategic situation and make correct choices. This week we focus on the building blocks

• Read B&B Chapter 14

Topics

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Week Theme Topics/Activities Preparation

5 Competing in contested markets

Most firms have to decide whether to enter a market, introduce new products, choose their capacity, and design and price their products while competitors face similar choices. We examine long-run and short-run optimal behaviors and the associated competitive outcomes.

• Read B&B Ch. 13.1–13.2 (up to p.543), 13.4

6Collusion, commitment, and repeated games

Strategic commitment and trust play an important part both in the relationship with customers and suppliers and in competitive strategy. An important tool for understanding trust and credibility lies in the theory of repeated games. Application include industry collusion.

• Read B&B Ch. 13.2 (pp. 544–46), 14.2

7Dealing with incomplete information

Many of the basic economic models make unreasonably optimistic assumptions about the information available to players. We examine how incomplete and asymmetric information affects bargaining, pricing, and contractual relationships

• Reading t.b.a.