Managerial Economics

Group 2B - Presentation
– Explain the central elements of the
behavioral model of the firm and consider
its strengths and weaknesses relative to
the maximizing models
– Presented by
– Thomas Leung, Angus Leung, Jeff Lee & Bonnie Chiu
Presentation Outline
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The Maximizing Models : A Glance
The Central Elements of Behavioral
Approach
A Comparison of alternative models of
the firm
Strengths & Weaknesses of Behavioral
approach
Conclusion
Maximizing Models of the Firm
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Neo classical Model
– Profit Maximizing Model
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Managerial Approaches
- Sales Revenue Maximizing Model (Baumol)
- Managerial Utility Maximizing Model (Williamson)
Profit Maximizing Model
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Objective
– To maximize profits, defined as the difference
between the firm ‘s revenues and costs
– The firm attempts to achieve the best possible
performance, rather than simply seeking “feasible”
performance which meets some sets of minimum
criteria
– Short run profit Vs Long run profit
Profit Maximizing Model
 Assumptions
– It is a holistic model
The firm is treated as a single entity which has
own objectives and makes decision.
– It optimizes
The firm is a profit-maximizer.
– Perfect Certainty
There is perfect certainty and complete
knowledge about demand and
cost conditions.
-
Profit Maximizing Model
$ Profit Max Price
MC
AC
MR = MC
Profit Max Qty
AR
Level of Output
MR

The firm aims to maximize profit by choosing the level of
output which gives the biggest difference between
revenue and costs
Managerial Approaches of a firm
 Arguments
- Firms are owned by shareholders and but
controlled by Managers; Their interests are
different
- Managers have the discretion to use the
firm ‘s resources in their own interests
- 2 models
-
Sales-Revenue Maximizing Model (Baumol)
Managerial Utility maximizing Model (Williamson)
Managerial Approaches of a firm
 Sales
Revenue Maximizing
Model (Baumol)
$
Based on the observation that
the salaries of managers, their
status and other rewards often
link to the size of the
companies which measured by
sales rather than profitability
Hence managers are more
concerned to increase sales
rather than profits
TC
TR
Level of Output
q qo
Profit
Managerial Approaches of a firm
Managerial Utility Maximizing Model
(Williamson)
Manager have “expenses preference” maximization
of utility derived from
-Amount spent on staff (S)
- Additions to managers salaries and benefits in the
form of perks (M)
-Discretionary profit (D) which exceed the min.
required to satisfy the shareholders available as a
source of finance for pet project)
Criticisms to Maximization Models

Arguments
– Firms do not attempt to maximize
– The world is an uncertain place
– Firms may not have a unified purpose
– Firm is not a single entity – not holistic
Maximizing Models really satisfying all
needs of a firm?
Behavioral Approach of a firm
Central Elements - A Glance
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The firm hardly exists - It is a shifting coalitions of
individual with multiple objectives;
Decision makers exhibit “satisficing” behavior
rather than “optimizing” behavior;
Decision maker with limited information about
the environment reduces the certainty of a decision.
Problem - oriented search using “rule - of - thumb”
is adopted to solve unmet objectives;
Dynamic behavior of aspirations of the individuals
within firm due to “organizational learning”
Behavioral Approach of a firm
The firm hardly exists - It is a shifting coalitions of
individual with multiple objectives
Investors
Employees
Distributors
Consumers
The
Firm
Creditors
Adverting Agent
Suppliers
Others
Behavioral Approach of a firm
Decision makers exhibit “satisficing” behavior
rather than “optimizing” behavior
Consider a three - person committee, suppose they
have individual goal as C1, C2 and C3, with
corresponding weights a, b and c.
Thus, company goal C is expressed as:
C = aC1+ bC2 + cC3
Instead of maximizes C1, C2 and C3 that posed conflicts,
aspiration level is specified and try to meet
Behavioral Approach of a firm
Decision makers exhibit “satisficing” behavior
rather than “optimizing” behavior
For a new Project, not all data can be available.
Thus the project is go if :
•Excepted Market Share is “sufficient”;
•Contribution of the product is “reasonable”
•Development cost is “ not too high”
This is described as “SATISFICING” in which decision
maker to the searching for a solution that meets aspiration
levels and therefore is acceptable
Behavioral Approach of a firm
Decision makers with limited information about
the environment reduces the certainty of a decision
•Information available to Marketing
•Information available to Production
•Information available to Engineering
•Information available to PPMC
All are different and different expectation of decision maker
will be included in the decision making
Behavioral Approach of a firm
Problem - oriented search using “rule - of - thumb”
is adopted to solve unmet objectives
Bargaining power of individuals come from
contribution
e.g. Marketing and Sales is more powerful
Behavioral Approach of a firm
Dynamic behavior of aspirations of the individuals
within firm due to “organizational learning”
If inducement (Salary, Retire plan and Job satisfaction)
over the aspiration level of the participant, he will stay
with the coalition.
If inducement (Salary, Retire plan and Job satisfaction)
stay long over the aspiration level of the participant, he
will increase his aspiration and dissatisfied at one day.
Behavioral Approach of a firm
Case Study - G2 Company
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HK based manufacturer with manufacturing plant
in China
Overhead is absorbed into production cost by
total absorption of 100 Million Turnover
Limited capacity of facilities and 1000 workers, no
expansion plan and budget for year 2002
Stock policy of Raw material is Two weeks in
advance of production
Stock policy of Finished goods is Zero
Behavioral Approach of a firm
The firm hardly exists - It is a shifting
coalitions of individual with multiple
objectives
Marketing
Increase 2 weeks Stock
CEO
Increase 10% Revenue
Engineering
Increase budget for 20% overtime expenses
PPMC
Increase 2 weeks safety stock of raw material
Accounting
Minimizes all costs, keep minimum stock level
Behavioral Approach of a firm
Decision makers exhibit “satisficing”
behavior rather than “optimizing” behavior
Marketing
Increase 1 week Stock
CEO
Increase 10% Revenue
Engineering
Increase budget for 10% overtime expenses
PPMC
Increase 1 week safety stock of raw material
Accounting
Minimizes all costs, keep minimum stock level
Behavioral Approach of a firm
Problem - oriented search using “rule - of thumb” is used to solve unmet objectives
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Reactive
By Past Experience
Not scientific
CEO
Increase 10% Revenue
Marketing
Increase 1 week Stock
Engineering
Increase budget for 10% overtime expenses
PPMC
Increase 1 week safety stock of raw material
Accounting
Minimizes all costs, keep minimum stock level
X
X
X
Behavioral Approach of a firm
Dynamic behavior of aspirations of the
individuals within firm due to “organizational
learning”
Marketing
Keep original stock level market slow down
CEO
Increase 10% Revenue,
But no penalty if failure
Engineering
Keep original budget of overtime expenses
PPMC
Keep original safety stock of raw material
Accounting
No additional order, no additional work
Comparison of different
approaches
Profit -max
Managerial
Behavioral
Objective
Profit maximizing
Sales - Revenue or
Managerial Utility
maximizing
Satisficing and
Feasible solutions
Ownership
Management
Same
Different
Different
Decision
Making
Optimizing
Optimizing
Rule of Thumb
Environment
Certainty
Certainty
Un-certainty
Holistic?
Yes
Yes
No
Behavioral Approach of a firm
Strengths of Behavioral Approach
1. More accurate and realistic description of what
happen inside the firm
2. Easy to understand: Qualitative approach that
good at describing the behaviour of the firm
Behavioral Approach of a firm
Weaknesses of Behavioral Approach
1. Not a good economic model: it can not make
prediction, cannot tell the firm how to respond to
environmental changes
2. Lack of an objective decision rule: using “rule of
thumb” and past experiences to solve the problem
are too subjective
3. If shareholders are a powerful group and their
aspiration level requires maximum profit making,
the firm will again behave in the same way as the
maximization model
Conclusion of the presentation
Though Behavioral approach is NOT
a good economic model, it is a useful
complement to the profitmaximizing and managerial
approaches, not a substitute for
them.
End of Presentation
Questions and Answers