Managerial Economics
Applications, Strategy, and Tactics, 10th Edition
by McGuigan, Moyer, & Harris
PowerPoint Lecture Slides
prepared by
Richard D. Marcus
2005 South-Western Publishing
University of Wisconsin - Milwaukee
Slide 1
Chapter 1
» Introduction
»
»
»
»
»
Structure of Decision Models
Profit’s Role
Agency Problems & Solutions
Not-for-Profit Organizations
Why Corporations Have Succeeded
Over Other Organizational Forms
Slide 2
Managerial Economics
Integrates and applies microeconomic
theory and methods to decision making
problems faced by private, public, and
not-for-profit organizations.
Managerial economics deals with
microeconomic reasoning on real world
problems such as pricing decisions
selecting the best strategy in different
competitive environments.
Slide 3
MAJOR TOPICS
• Demand and Supply Analysis
and how to estimate price elasticities with regressions
• Production and Cost Analysis
and how managers can estimate these relationships
• Monopoly, Competition, and Oligopolies
and how to make good pricing decisions in the real world
• Organization Architecture
and the economic problem of motivating agents
• Risk in Economic Decisions
and ways to modify or compare risks
Slide 4
The Decision-Making Process
(Figure 1.1)
1. Establish and Identify Objectives
2. Define the Problem
3. Identify Alternative Solutions
Consider
Societal
Constraints
4. Evaluate the Alternatives
and Select the Best!
5. Implement and Monitor
the Decision
Consider
Organizational
& Input
Constraints
Slide 5
Theories of Why Profit Varies
Across Industries
1. RISK-BEARING THEORY
2. DYNAMIC EQUILIBRIUM (or
FRICTIONAL) THEORY OF PROFIT
3. MONOPOLY THEORY OF PROFIT
4. INNOVATION THEORY OF PROFIT
5. MANAGERIAL EFFICIENCY
THEORY OF PROFIT
Slide 6
Objectives of the Firm
• Profit maximization
• Shareholder wealth = value of each share (V0)
times the number of shares outstanding, or
V0 · (shares outstanding). This is the present
value of expected future profits or cash
flows, discounted at the shareholders required
rate of return, ke, ignoring taxes.

V0 (shares outstanding) =   t /(1+ke) t
t=1
Slide 7
Firm Value
(Figure 1.2)
t = REVENUE – COST = TRt – TCt = PtQt – VtQt - Ft
• Value of the Firm = the present value of discounted cash
flows
N
(t ) / (1+ke)t =
t=1
N
(PtQt – VtQt – Ft) / (1+ke)t
t =1
• Whatever lowers the perceived risk of the firm (ke) will
also raise firm value.
• Whatever raises the price of the product (Pt) or the quantity
sold (Qt ) will raise firm value.
• Whatever raises variable cost (Vt )or fixed cost ( Ft ) will
reduce firm value.
Slide 8
• To make good economic decisions,
managers need to be able to forecast &
estimate relationships
• Will be forecasting demand (both Pt & Qt)
» applies to for-profit corporations
» non-profit organizations
• Hospital Administrators -- # patients
• University Administrator -- enrollment
• Regression analysis, time series
methods, and qualitative forecasting
methods used for forecasting
Slide 9
The Role of Profits
• Economic Cost (or opportunity cost) is
the highest valued benefit that must be
sacrificed as a result of choosing an
alternative.
• Economic Profit is the difference
between revenues and total economic
cost (including the economic or
opportunity cost of owner supplied
resources such as time and capital.
Slide 10
(Figure 1.3)
Factors Affecting Stock Prices
Economic Environment Factors
1.
2.
3.
4.
5.
6.
Economic Activity
Tax Rates & Regulations
Competition
Laws and Governmental Regulation
Unionization
International Conditions & Exchange Rates
Major Policy Decisions Under Management Control
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Products or Services Offered
Production Technology
Marketing and Distribution Network Used
Investment Strategies
Employment & Compensation Policies
Ownership Form
Capital Structure Used
Working Capital Management Policies
Dividend Policies
Alliances, mergers, spin-offs
Amount, Timing, and Risk of Expected Profits
Conditions in
Financial Markets
1.
Interest Rates
2.
Investor
Sentiment
3.
Expected Inflation
Shareholder Wealth (The Market Price of the Stock)
Slide 11
Agency Problems
• Modern corporations allow managers to have
no, or limited, ownership participation in the
profitability of the firm.
• Shareholders may want profits, but managers
may wish to relax.
• The shareholders are principals, whereas the
managers are agents.
» Conflicting motivations between these
groups are called agency problems.
Slide 12
• The Principal-Agent Problem
» Shareholders (principals) want profit
» Managers (agents) want leisure &
security
• Examples
» KKR’s takeover of RJR Nabisco to
refocus on wealth-maximization
» The LBO by O.M. Scott (a lawn fertilizer
company) from ITT improved Scott’s
performance
Slide 13
Solutions to Agency Problems
• Compensation as incentive
• Extending to all workers stock options,
bonuses, and grants of stock
» It helps to make workers act more like
owners of firm
• Incentives to help the company, because
that improves the value of stock options
and bonuses.
Slide 14
What Went Right?
What Went Wrong?
• Saturn Corporation
» Different kind of
car company in 1991
» No-haggle pricing
» Sales were above expectations
• But, margin of only $400 per car to GM
» GM earned only 3% on capital
» Saturn customers wanted bigger Saturns rather than
trade up to Buick, as GM hoped.
» When the dollar appreciated, Japanese firms could
price their cars more competitively.
Slide 15
Shareholder Wealth Maximization:
Necessary Conditions
• COMPLETE MARKETS - liquid markets
for firm's inputs and by-products (including polluting
by-products).
• NO SIGNIFICANT ASYMMETRIC
INFORMATION - buyers and sellers all know
the same things.
• KNOWN RECONTRACTING COSTS
future input costs are part of the present value of
expected cash flows.
Slide 16
Goals in the Public Sector and the
Not-For-Profit (NFP) Enterprise
 Public Goods are goods that can be consumed or used by
more than one person at the same time with no extra cost
(like a flood control or national defense).
 Sometimes governments produce public goods. Other times,
they are exclusive to one person (like a free meal).
 Instead of profit, NFP organizations may have as their goals:
1. Maximization of the quantity of output, subject to a
breakeven constraint.
2. Maximization of the utility (happiness) of NFP
administrators.
3. Maximization of cash flows.
4. Maximization of the utility of contributors to the NFP
organization.
Slide 17
• Which goal a NFP manager selects affects
decisions made.
» A food shelter manager may decide to maximize
the utility of contributors by selecting only
"healthy foods"
• Public sector managers are performance
monitored.
» V.A. hospital administrators are rewarded by reducing
the cost per bed over a year. Hence, they become
efficient with respect to costs.
» The "friendliness" of the hospital staff is harder to
measure, so friendliness will tend not be a high priority
of the public sector manager.
Slide 18