ECONOMICS 6000:

Managerial Economics

Important Information

• E-mail Communication- Use mtmail, or D2L in all communications.

• Use of cellphones or other electronics gadgets are not allowed because it is a distraction for you and your neighbor. Please turn them off during class period.

• We have MA and Ph. D students who can answer most of your questions during lab hours, if you need them.

• Please complete the survey on the Global Environment

Course Overview

• Introduction ( 1&2 )• Review of the tools of analysis- optimization techniques-Appendix C,

linear programming)• Demand Theory and Estimation (3 & 4)• Demand Forecasting (Trend projections and correcting for seasonality)

(5) • TEST # 1: February 24, 2015.• Production Theory and Estimation (7)• Cost Theory and Estimation ( 8 & 9) • Test # 2 – March 31, 2015• Pricing and Output Decisions in Different Markets (Perfect

Competition, Monopoly, Monopolistic Competition, Oligopoly) (10-14) • FINAL EXAMINATION: May 5, 2015 6:00-8:00pm

1. Managerial Economics

Managerial Economics

• Managerial Economics-Integrates and applies microeconomic theory and decision sciences to solve managerial problems faced by private, public, and not-for-profit organizations.

Q=f(Price, Income, AD)

2. Some Management Decision Problems

Demand Analysis & ForecastingProduct pricing and output decision Buy or lease decisions [vehicles] Production techniques [capital vs. labor] Inventory levels – JITAdvertising media [ TV, newspaper, radio]Labor hiring and training Investment and Financing

Decision Making Process

• Objective Function: Max PV of profits {S1, S2}where S1 is to expand capacity now, or S2 expand capacity later.

• Decision Rule:– Choose S1 if PV {Profits of S1 } > PV { Profits of S2 } or– Choose S2 if PV { Profits of S1 } < PV { Profits of S2 }– If equal profits, then flip a coin

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. ]

4. Basic Decision Making Model

• Select the best solution from an array of alternative solutions.

• Implement the decision.

• Evaluate performance (Sensitivity analysis-helps to determine how one variable (the target variable) may be affected by changes in another variable

e.g. property income forecasting agency wants to determine how the ROI varies with changes in the vacancy rates (VR).

When vacancy rate is 15%=> ROI= 16%; for VR =18% => expected ROI= 5%

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.

Problem Solving Approach

You can analyze any problem by asking three questions:• Who is making the bad decision?• Does the decision maker have the information

to make good decision? • The incentive to make bad decision?Source: Froeb et al. (2014)

6. Management Theories of of the goal of the Firm

Value or profit maximization model-primary goal of managers (popular theory)- Road Map for the course

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.

Responsibility of Management

Managers solve problems before they become a crisisManagers select strategies to try to assure the success of the firmManagers create an organizational culture attune to the mission of

the organization Senior management establishes a vision for the firmManagers motivate and promote teamworkManagers promote the profitability of the firmAnd many managers see it in their long-run interest to promote

sustainability of their enterprise in their environment (CSR).

Managers who fail at these responsibilities are reviled, be they mangers of BP, Enron, or Bernie Medoff

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 short-run business success.

• Two key questions are the measure of value and how managers add value to the firm

1 2 nV = [--------] + [ --------] + . . . + [ -------- ]

(1+r)1 (1+r)2 (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

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

Determinants of Value of the Firm

N t N P . Qd - VC . Qs - FV = [ ------- ] = [---------------------- ]

t=1 (1+r)t t=1 (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 Exercises # 1 and 2 in the handout (page 2)

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)

Course Architecture

8. Major Constraints to value maximization

• Resource scarcity or constraints i.e. limited availability of essential input such as skilled labor,

raw material, energy, machinery warehouse, etc.

• Contractual Obligations Meeting nutritional requirements for feed mixture, reliability

requirements.

• Legal restrictions minimum wage laws, health and safety standards, pollution emission

standards, fuel efficiency requirements, fair pricing, etc.

9a. Profits (Accounting vs Economic)

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

9b. 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)

10. Examples

Multinational Production & Pricing Euro Disney Market Entry Building an Airport A Regulatory Problem An R&D Decision Canon Texaco VS. Pennzoil11. 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)

Term Paper Organization

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

to the literature

Term Paper Organization

III. Data and Analytical Framework Develop a theoretical model underlying the issueIV. Analyses and Interpretations of Empirical Results Statistical test results of the theoretical modelV. Summary and Conclusion References