Managerial Economics Chapter 1 the McGraw-Hill

7/28/2019 Managerial Economics Chapter 1 the McGraw-Hill

1/50

MANAGERIAL ECONOMICS

CLASS-01 TERM 13-1


2/50

GY005 MANAGERIAL ECONOMICS:

Course InformationTeaching Team:

1. Dr. Ir. Leonard Tampubolon, MA ([email protected])

2. Ir. Tarcius Sunaryo,MA., Ph.D. ([email protected])

Text :

1. Baye. M (2010). Managerial Economics, and Business Strategy,(7th edition). McGraw-Hill.In

2. Besanko, D., Dranove, D., Schaefer, S. and Ark Shanley (2007).

Economics of Strategy (4th edition). John Wiley & Sons.

Assessment Description:1. Class Paticipation 10%

2. Quizzess 20%

3. Mid Term Exam 30%

4. Final Exam 40%
mailto:[email protected]:[email protected]


3/50

MANAGERIAL ECONOMICS &

BUSINESS STRATEGYChapter 1:

The Fundamentals of ManagerialEconomics

McGraw-Hill/IrwinMichael R. Baye, Managerial Economics andBusiness Strategy Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.


4/50

OVERVIEW

I. Introduction

II. The Economics of Effective Management Identify Goals and Constraints

Recognize the Role of Profits

Five Forces Model

Understand Incentives

Understand Markets

Recognize the Time Value of Money

Use Marginal Analysis

1-4


5/50

MANAGERIAL ECONOMICS

ManagerA person who directs resources to achieve a stated goal.

EconomicsThe science of making decisions in the presence of scare resources.

Managerial Economics

The study of how to direct scarce resources in the way that mostefficiently achieves a managerial goal.

Efective Manager must:1. Identify goals and constraints

2. Recognize the nature and imprtance of profits3. understand incentives4. understand markets5. recognize the time value of money6. use marginal anaysis

1-5


6/50

IDENTIFY GOALS AND CONSTRAINTS:

Sound decision making involves havingwell-defined goals. Leads to making the right decisions.

In striking to achieve a goal, we oftenface constraints.

Constraints are an artifact of scarcity.

1-6


7/50

RECOGNIZE THE NATURE AND IMPRTANCE OF PROFITS:

Accounting Profits

Total revenue (sales) minus dollar cost of producing goods orservices.

Reported on the firms income statement.

Economic Profits

Total revenue minus total opportunity cost.

Accounting Costs The explicit costs of the resources needed to produce produce goods or

services.

Reported on the firms income statement.

Opportunity Cost The cost of the explicit andimplicit resources that are foregone when a

decision is made.

1-7

ECONOMIC VS. ACCOUNTING PROFITS


8/50

The Five Forces Framework

1-8

Sustainable

Industry

Profits

Power of

Input Suppliers

Supplier Concentration

Price/Productivity of Alternative

Inputs

Relationship-Specific Investments

Supplier Switching CostsGovernment Restraints

Power of

Buyers

Buyer Concentration

Price/Value of Substitute

Products or Services

Relationship-Specific Investments

Customer Switching CostsGovernment Restraints

EntryEntry Costs

Speed of Adjustment

Sunk Costs

Economies of Scale

Network Effects

Reputation

Switching Costs

Government Restraints

Substitutes & Complements

Price/Value of Surrogate Products or

Services

Price/Value of Complementary

Products or Services

Network Effects

Government

Restraints

Industry Rivalry

Switching Costs

Timing of Decisions

Information

Government Restraints

Concentration

Price, Quantity, Quality, or Service

Competition

Degree of Differentiation

PROFITS AS A SIGNALProfits signal to resource holders where resources are most highlyvalued by societyResources will flow into industries that are mosthighly valued by society.


9/50

UNDERSTANDING FIRMS INCENTIVES:

Incentives play an important role within the

firm.

Incentives determine: How resources are utilized.

How hard individuals work.

Managers must understand the role

incentives play in the organization. Constructing proper incentives will enhance

productivity and profitability.

1-9


10/50

UNDERSTAND MARKETS:

Market Interactions:

Consumer-Producer Rivalry Consumers attempt to locate low prices, while producers attempt to

charge high prices.

Consumer-Consumer Rivalry Scarcity of goods reduces the negotiating power of consumers as they

compete for the right to those goods.

Producer-Producer Rivalry Scarcity of consumers causes producers to compete with one another for

the right to service customers.

The Role of Government Disciplines the market process.

1-10


11/50

RECOGNIZE THE TIME VALUE OF MONEY:

Present value (PV) of a future value (FV) lump-sum amount to be received at the end of n

periods in the future when the per-period interestrate is i:

PVFV

i

n

1

Examples:

Lotto winner choosing between a single lump-sum payout of $104million in the 1st year or $198 million in the 25th year.

Determining damages in a patent infringement case.

1-11

THE TIME VALUE OF MONEY


12/50

PRESENT VALUE VS. FUTURE VALUE The present value (PV) reflects the difference between the

future value and the opportunity cost of waiting (OCW).

Succinctly, PV = FV

OCWIfi= 0, note PV= FV.

As i increases, the higher is the OCWand the lower the PV.

1-12

PRESENT VALUE OF A SERIES Present value of a stream of future amounts (FVt) received

at the end of each period for n periods:

Equivalently,

PV

FV

i

FV

i

FV

i

n

n

1

1

2

21 1 1...

n

t

t

t

i

FVPV

1 1


13/50

NET PRESENT VALUE

Suppose a manager can purchase a stream of future receipts (FVt) by

spending C0 dollars today. The NPVof such a decision is

NPV

FV

i

FV

i

FV

iC

n

n

1

1

2

2 0

1 1 1...

Decision Rule: If NPV < 0: Reject project ---If NPV > 0: Accept project

1-13

PRESENT VALUE OF A PERPETUITY

An asset that perpetually generates a stream of cash flows (CFi) at the

end of each period is called a perpetuity.

The present value (PV) of a perpetuity of cash flows paying the same

amount (CF= CF1= CF2= ) at the end of each period is

i

CF

i

CF

i

CF

i

CFPVPerpetuity

...111

32


14/50

FIRM VALUATION AND PROFIT MAXIMIZATION

The value of a firm equals the present value of

current and future profits (cash flows).

A common assumption among economist is that it is

the firms goal to maximization profits. This means the present value of current and future profits, so the firm

is maximizing its value.

1

21

0

1...

11 tt

t

Firm

iiiPV

1-14


15/50

Control Variable Examples: Output Price Product Quality Advertising R&D

Basic Managerial Question: How much of the controlvariable should be used to maximize net benefits?

USE MARGINAL ANAYSIS:1-15

NET BENEFITS

Net Benefits = Total Benefits - Total Costs

Profits = Revenue - Costs

MARGINAL (INCREMENTAL) ANALYSIS


16/50

1-16MARGINAL BENEFIT (MB)

Change in total benefits arising from a change in the

control variable, Q:

Slope (calculus derivative) of the total benefit curve.

Q

BMB

MARGINAL COST (MC)

Change in total costs arising from a change in the

control variable, Q:

Slope (calculus derivative) of the total cost curve

Q

CMC


17/50

MARGINAL PRINCIPLE

To maximize net benefits, the managerial

control variable should be increased up to

the point whereMB =MC.

MB >MCmeans the last unit of the control

variable increased benefits more than it

increased costs.

MB


18/50

THE GEOMETRY OF OPTIMIZATION:TOTAL BENEFIT AND COST

Q

Total Benefits& Total Costs

Benefits

Costs

Q*

B

CSlope = MC

Slope =MB

1-18


19/50

THE GEOMETRY OF OPTIMIZATION:NET BENEFITS

Q

Net Benefits

Maximum net benefits

Q*

Slope =MNB

1-19


20/50

Conclusion

Make sure you include all costs and benefits

when making decisions (opportunity cost).

When decisions span time, make sure youare comparing apples to apples (PV

analysis).

Optimal economic decisions are made at themargin (marginal analysis).

1-20


21/50

MANAGERIAL ECONOMICS &

BUSINESS STRATEGYChapter 2

Market Forces: Demand and Supply

McGraw-Hill/IrwinMichael R. Baye, Managerial Economics andBusiness Strategy Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.


22/50

OVERVIEW

III. Market Equilibrium

IV. Price Restrictions

V. Comparative Statics

II. Market Supply Curve

The Supply Function Supply Shifters

Producer Surplus

I. Market Demand Curve The Demand Function

Determinants of Demand

Consumer Surplus

2-22


23/50

MARKET DEMAND CURVE

Shows the amount of a

good that will be purchasedat alternative prices,holding other factorsconstant.

Law of Demand The demand curve is

downward sloping.

Quantity

D

Price

2-23

DETERMINANTS OF

DEMAND

Income Normal good Inferior good

Prices of RelatedGoods Prices of substitutes Prices of complements

Advertising andconsumer tastes Population

Consumer

expectations


24/50

THE DEMAND FUNCTION

A general equation representing the demand curve

Qxd = f(Px ,PY , M, H,)

Qxd = quantity demand of good X. Px = price of good X.

PY = price of a related good Y.

Substitute good.

Complement good.

M = income.

Normal good.

Inferior good.

H = any other variable affecting demand.

2-24


25/50

INVERSE DEMAND FUNCTION

Price as a function of quantity

demanded.

Example: Demand Function

Qxd = 102Px

Inverse Demand Function: 2Px = 10Qx

d

Px = 50.5Qxd

2-25


26/50

CHANGE IN QUANTITY DEMANDED

Price

Quantity

D0

4 7

6

A to B: Increase in quantity demanded

B

10A

2-26


27/50

Price

Quantity

D0

D1

6

7

D0 to D1: Increase inDemand

CHANGE IN DEMAND

13

2-27


28/50

CONSUMER SURPLUS

The value consumers get from a good but

do not have to pay for.

Consumer surplus will prove particularlyuseful in marketing and other disciplines

emphasizing strategies like value pricing

and price discrimination.

2-28


29/50

Price

Quantity

D

10

8

6

4

2

1 2 3 4 5

Consumer Surplus:

The value received but not

paid for. Consumer surplus =

(8-2) + (6-2) + (4-2) = $12.

CONSUMER SURPLUS:THE DISCRETE CASE

2-29


30/50

Consumer Surplus

1 2 3 4 5

5

6

7

8

9

10

Market Price = 5

The 1st good:

The Value for consumer = 9

The consumer surplus = 9-5 = 4

The 2nd good:



The 3rd good:

The Value for consumer =7


The 4th good:



Q

P

D

S

CS= (5X5)/2 =12.5

C N MER RPL


31/50

CONSUMER SURPLUS:THE CONTINUOUS CASE

Price $

Quantity

D

10

8

6

4

2

1 2 3 4 5

Value

of 4 units = $24ConsumerSurplus =

$24 - $8 =

$16

Expenditure on 4 units =

$2 x 4 = $8

2-31


32/50

MARKET SUPPLY CURVE

The supply curve shows the amount of a good

that will be produced at alternative prices.

Law of Supply The supply curve is upward sloping.

Price

Quantity

S0

2-32


33/50

SUPPLY SHIFTERS

Input prices

Technology or

government regulations

Number of firms Entry

Exit

Substitutes in production

Taxes Excise tax

Ad valorem tax

Producer expectations

2-33


34/50

THE SUPPLY FUNCTION

An equation representing the supply curve:

QxS = f(Px ,PR,W, H,)

QxS = quantity supplied of good X.

Px = price of good X.

PR= price of a production substitute.

W = price of inputs (e.g., wages).

H = other variable affecting supply.

2-34


35/50

INVERSE SUPPLY FUNCTION

Price as a function of quantity

supplied.

Example: Supply Function

Qxs = 10 + 2Px

Inverse Supply Function: 2Px = 10 + Qx

s

Px = 5 + 0.5Qxs

2-35


36/50

CHANGE IN QUANTITY SUPPLIED

Price

Quantity

S0

20

10

B

A

5 10

A to B: Increase in quantity supplied

2-36

2 37


37/50

Price

Quantity

S0

S1

8

75

S0 to S1: Increase in supply

CHANGE IN SUPPLY

6

2-37

2 38


38/50

PRODUCER SURPLUS

The amount producers receive in excess of the amountnecessary to induce them to produce the good.

Price

Quantity

S0

Q*

P*

2-38


39/50

Producer Surplus

1 2 3 4 5

5

1

2

3

4

P

Q

D

S

Market Price = 5

The 1st good:

The cost for Producer = 1

The producer surplus = 5-1 = 4

The 2nd good:

The cost for producer = 2


The 3rd good:

The cost for producer =3


The 4th good:

The cost for producer = 4


PS= (5X5)/2 =12.5

2 40


40/50

MARKET EQUILIBRIUM

The Price (P) that Balances

supply and demand Qx

S = Qxd

No shortage or surplus

Steady-state

2-40

2 41


41/50

Price

Quantity

S

D

5

6 12

Shortage

12 - 6 = 6

6

If price is too low

7

2-41

2 42


42/50

Price

Quantity

S

D

9

14

Surplus

14 - 6 = 8

6

8

8

If price is too high

7

2-42

2 43


43/50

PRICE RESTRICTIONS

Price Ceilings The maximum legal price that can be charged.

Examples:

Gasoline prices in the 1970s.

Housing in New York City. Proposed restrictions on ATM fees.

Price Floors

The minimum legal price that can be charged. Examples:

Minimum wage.

Agricultural price supports.

2-43

2 44


44/50

Price

Quantity

S

D

P*

Q*

P Ceiling

Q s

PF

IMPACT OF A PRICE CEILING

Shortage

Q d

2-44

Suppose the equilibrium

price for the product is $5

1. What will be happened if

government determined

the ceiling price for thisproduct is $3?



the ceiling price for this

product is $7?

2 45


45/50

FULL ECONOMIC PRICE

The dollar amount paid to a firm under a price

ceiling, plus the nonpecuniary price.

PF = Pc + (PF - PC) PF = full economic price

PC = price ceiling

PF - PC = nonpecuniary price

2-45

2-46


46/50

AN EXAMPLE FROM THE 1970S

Ceiling price of gasoline: $1.

3 hours in line to buy 15 gallons of gasoline

Opportunity cost: $5/hr.

Total value of time spent in line: 3 $5 = $15.

Non-pecuniary price per gallon: $15/15=$1.

Full economic price of a gallon of gasoline:

$1+$1=2.

2-46

2-47


47/50

IMPACT OF A PRICE FLOOR

Price

Quantity

S

D

P*

Q*

Surplus

PF

Qd QS

2-47

Suppose the equilibrium

price for the product is $5



the price floor for this

product is $3?



the price floor for this

product is $7?

2-48


48/50

COMPARATIVE STATIC ANALYSIS

How do the equilibrium price and quantitychange when a determinant of supply and/ordemand change?

Comparative static analysisshows how the

equilibrium price and quantity will changewhen a determinant of supply or demandchanges.

2-48

2-49


49/50

Priceof

PCs

Quantity of PCs

S

D

S*

P0

P*

Q0 Q*

SUPPLY CHANGE

2 49

2-50


50/50

Priceof Software

Quantity of

S

D

Q0

D*

P1

Q1

DEMAND CHANGE

P0

Managerial Economics Chapter 1 the McGraw-Hill

Documents

Transcript of Managerial Economics Chapter 1 the McGraw-Hill