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5/12/18

Olivier de Jong, Managerial Economics - Spring 2018 1

Olivier J. de Jong, LL.M., MM., MBA, CFD, CFFA, AA www.centime.biz

Valuationandpricing(November5,2013)

Lecture1

ManagersProfits,Markets

10/8/16, 2:46 AM

of 1https://targetcareers.co.uk/sites/targetcareers.co.uk/files/public/Bangor.jpg

•  I have a doctorate in international business law, a Masters in Management in service organizations, I’m a certified accountant (AA), and recently completed my executive MBA in leadership and sustainability;

•  I worked as interim CFO of a small airline in the Caribbean (part of Royal KLM) … which recently collapsed (but not because of me) I was engaged as a Venture Capitalist (Next-Flower (internet flower retail)), interim financial restructuring executive within the hospitality industry (Thomas Cook)

•  Started my carrier at a top accounting firms (senior manager EY, partner ESJ), with in South, Middle and North America, Europe and The Caribbean;

•  During my recent MBA studies I lectured at the British University Vietnam, and was an adjunct professor at Vesalius College, Brussels;

•  I’m an adjunct professor at Solvay Brussels Schools of Economics & Management, Université Libre de Bruxelles;

Something about me …

•  In a few words, •  I’m your short term guide for the Managerial Economics studies at Henan

University of Technology; •  I’m delighted to have you all in my class now;

•  When teaching all my subjects are mostly related toward

Accounting, Banking & Finance or Statistics;

•  When not teaching I’m the Chief Executive Officer of the largest private owned Financial Service organization in the Caribbean,

•  Exploring countries and enjoying taking pictures;

•  Last but not least enjoying my family when working in the Caribbean.

Something about me …

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Classroom rules •  Be on time;

•  Prepare for your lecture and tutorial hour, see you module guide;

•  No cell phone allowed;

•  I-pad and Laptop computer allowed for making notes;

•  Miss-usage of I-pad of Laptop (social media, etc., during class) will have consequences for the whole group;

Questions ??? •  I’m always a short call away;

•  E-mail •  [email protected]

• We chat •  olliefiance

• Use the our website for latest updates, other student questions

•  http://www.uwcentre.ac.cn/sbcollege/

Copyright ©2015 Pearson Education, Inc. All rights reserved. 1-6

What are we going to do?? Through our topics we will be able after our three week able to; •  Appreciate managerial economics and understand its standard

tools and techniques.

•  Provide an understanding of the tools of economics that are useful for analysis of demand, cost analysis, product price determination, and determining non-price competitive strategies.

•  Understand the economic framework used for analysis of decision-making in business, and understand the differences in the various competitive environments faced by different types of business (e.g., for profit, not-for-profit, government agency).

•  Think analytically in terms of economics theories and concepts for informing business decisions.

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Learning Objectives v  Understand why managerial economics relies on microeconomics

and industrial organization to analyze business practices and design business strategies.

v  Explain the difference between economic and accounting profit and relate economic profit to the value of the firm.

v  Describe how separation of ownership and management can lead to a principal-agent problem when goals of owners and managers are not aligned and monitoring managers is costly or impossible for owners.

v  Explain the difference between price-taking and price-setting firms and discuss the characteristics of the four market structures.

v  Discuss the primary opportunities and threats presented by the globalization of markets in business.


Managerial Economics & Theory

v  Managerial economics applies microeconomic theory to business problems ~ How to use economic analysis to make decisions to

achieve firm’s goal of profit maximization v  Economic theory helps managers understand

real-world business problems ~ Uses simplifying assumptions to turn complexity into

relative simplicity


Microeconomics

v  Microeconomics ~  Study of behavior of individual consumers, business

firms, and markets v  Business practices or tactics

~ Routine business decisions managers must make to earn the greatest profit under prevailing market conditions

~ Using marginal analysis, microeconomics provides the foundation for understanding everyday business decisions

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Microeconomics

v  Industrial organization ~ Specialized branch of microeconomics

focusing on behavior and structure of firms and industries

~ Provides foundation for understanding strategic decisions through application of game theory


Strategic Decisions

v Business actions taken to alter market conditions and behavior of rivals ~ Increase/protect strategic firm’s profit

v While common business practices are necessary for the goal of profit-maximization, strategic decisions are generally optimal actions managers can take as circumstances permit


Economic Forces that Promote Long-Run Profitability (Figure 1.1)

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Economic Cost of Resources

v Opportunity cost is: ~ What firm owners must give up to use

resources to produce goods and services v Market-supplied resources

~ Owned by others and hired, rented, or leased v Owner-supplied resources

~ Owned and used by the firm


Total Economic Cost

v Total Economic Cost ~ Sum of opportunity costs of both market-

supplied resources and owner-supplied resources

v Explicit Costs ~ Monetary opportunity costs of using market-

supplied resources v  Implicit Costs

~ Nonmonetary opportunity costs of using owner-supplied resources


Types of Implicit Costs

v Opportunity cost of cash provided by owners ~ Equity capital (money provided to businesses

by the owners) v Opportunity cost of using land or capital

owned by the firm v Opportunity cost of owner’s time spent

managing or working for the firm

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Economic Cost of Using Resources (Figure 1.2)

Explicit Costsof

Market-Supplied ResourcesThe monetary payments to

resource owners

Implicit Costsof

Owner-Supplied ResourcesThe returns forgone by not takingthe owners’ resources to market

+

=


Economic Profit vs. Accounting Profit

Economic profit = Total revenue – Total economic cost = Total revenue – Explicit costs – Implicit costs

Accounting profit = Total revenue – Explicit costs

v  Accounting profit does not subtract implicit costs from total revenue

v  Firm owners must cover all costs of all resources used by the firm ~ Objective is to maximize profit


Maximizing the Value of a Firm

v Value of a firm ~ Price for which it can be sold ~ Equal to the present value of expected future

profits v Risk premium

~ An increase in the discount rate to compensate investors for uncertainty about future profits

~ The larger the risk, the higher the risk premium, and the lower the firm’s value

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Maximizing the Value of a Firm

v Maximize firm’s value by maximizing profit in each time period ~ Cost & revenue conditions must be

independent across time periods

v Value of a firm =


Some Common Mistakes Managers Make

v Never increase output simply to reduce average costs

v Pursuit of market share usually reduces profit

v Focusing on profit margin won’t maximize total profit

v Maximizing total revenue reduces profit v Cost-plus pricing formulas don’t produce

profit-maximizing prices


Principal-Agent Relationship

v Relationship formed when a business owner (the principal) enters an agreement with an executive manager (the agent) whose job is to formulate and implement tactical and strategic business decisions that will further the objectives of the business owner (the principal).

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Separation of Ownership & Control

v Principal-agent problem ~ A manager takes an action or makes a

decision that advances the interests of the manager but reduces the value of the firm.

v Complete contract ~ An employment contract that protects owners

from every possible deviation by managers from value-maximizing decisions.


Separation of Ownership & Control

v Hidden actions ~ Actions or decisions taken by managers that

cannot be observed by owners for any feasible amount of monitoring effort.

v Moral Hazard ~ A situation in which managers take hidden

actions that harm the owners of the firm but further the interests of the managers.


Corporate Control Mechanisms

v  Internal control mechanisms ~ Require managers to hold stipulated amount

of firm’s equity ~ Increase percentage of outsiders serving on

board of directors ~ Finance corporate investments with debt

instead of equity v External mechanism

~ Corporate takeovers

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Price-Takers vs. Price-Setters

v Price-taking firm ~ Cannot set price of its product ~ Price is determined strictly by market forces of

demand & supply v Price-setting firm

~ Can set price of its product ~ Has a degree of market power, which is the

ability to raise price without losing all sales


What is a Market?

v A market is any arrangement through which buyers & sellers exchange anything of value

v Markets reduce transaction costs ~ Costs of making a transaction happen, other

than the price of the good or service itself


Market Structures

v Market characteristics that determine the economic environment in which a firm operates ~ Number and size of firms in market ~ Degree of product differentiation among

competing firms ~ Likelihood of new firms entering market when

incumbent firms are earning economic profits

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Perfect Competition

v Large number of relatively small firms v Undifferentiated product v Price takers with no market power v No barriers to entry

~ Any economic profit earned will vanish as new firms enter


Monopoly

v Single firm v Produces product with no close

substitutes v Protected by a barrier to entry

~ Allows the monopolist to raise its price without concern that economic profits will attract new firms


Monopolistic Competition

v Large number of relatively small firms v Differentiated products

~ Gives the monopolistic competitor some degree of market power

v Price setters v No barriers to entry

~ Ensures any economic profits will be bid away by new entrants

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Oligopoly

v Few firms produce all or most of market output

v Profits are interdependent ~ Actions by any one firm will affect sales and

profits of the other firms


Globalization of Markets

v 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


Summary v  Managerial economics applies concepts/theories from

microeconomics and industrial organization ~  Marginal analysis provides the foundation for everyday business

practices or tactics v  Opportunity cost of using any resource is what the firm owners

must give up to use the resource ~  Unlike economic profit, accounting profit does not subtract

implicit (opportunity) costs from total revenue v  With the separation of ownership and management, a principal-

agent problem can arise because owners cannot be certain that managers are making decisions to maximize the value of the firm

v  For price-taking firms, price is determined solely by market forces of supply and demand, while price-setters have some degree of market power to set price

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What is next •  Review your notes for this afternoon Tutorial

•  Key Elements •  Review of Present Value p34 •  What drives the value of your firm???

• Questions •  Page 31 Technical Problems 1, 2, 3, 4.

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