Matakuliah : J0434/EKONOMI MANAJERIAL
Tahun
: 2008
The Fundamentals of Managerial
Economics
Pertemuan 1-2
Chapter 1
The Fundamentals of Managerial Economics
McGraw-Hill/Irwin
Michael R. Baye, Managerial Economics and
Business Strategy
Michael ©R.2008
Baye,
Copyright
by the McGraw-Hill Companies, Inc. All rights reserved.
1-4
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
Michael R. Baye,
1-5
Managerial Economics
• Manager
– A person who directs resources to achieve a stated goal.
• Economics
– The science of making decisions in the presence of scare
resources.
• Managerial Economics
– The study of how to direct scarce resources in the way that most
efficiently achieves a managerial goal.
Michael R. Baye,
1-6
Identify Goals and Constraints
• Sound decision making involves having well-defined
goals.
– Leads to making the “right” decisions.
• In striking to achieve a goal, we often face constraints.
– Constraints are an artifact of scarcity.
Michael R. Baye,
1-7
Economic vs. Accounting Profits
• Accounting Profits
– Total revenue (sales) minus dollar cost of producing goods
or services.
– Reported on the firm’s income statement.
• Economic Profits
– Total revenue minus total opportunity cost.
Michael R. Baye,
1-8
Opportunity Cost
• Accounting Costs
– The explicit costs of the resources needed to produce
produce goods or services.
– Reported on the firm’s income statement.
•
Opportunity Cost
– The cost of the explicit and implicit resources that are
foregone when a decision is made.
• Economic Profits
– Total revenue minus total opportunity cost.
Michael R. Baye,
1-9
Profits as a Signal
• Profits signal to resource holders where resources are
most highly valued by society.
– Resources will flow into industries that are most highly valued by
society.
Michael R. Baye,
1-10
The Five Forces Framework
Entry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale
Entry
Network Effects
Reputation
Switching Costs
Government Restraints
Power of
Input Suppliers
Power of
Buyers
Supplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints
Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints
Sustainabl
e Industry
Profits
Industry Rivalry
Concentration
Price, Quantity, Quality, or
Service Competition
Degree of Differentiation
Substitutes & Complements
Switching Costs
Timing of Decisions
Information
Government Restraints
Price/Value of Surrogate Products
or Services
Price/Value of Complementary
Products or Services
Michael R. Baye,
Network Effects
Government
Restraints
1-11
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.
Michael R. Baye,
1-12
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.
Michael R. Baye,
1-13
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 interest rate is “i”:
PV 
FV
1  i 
n
Examples:
Lotto winner choosing between a single lump-sum payout of $104
million or $198 million over 25 years.
Determining damages in a patent infringement case.
Michael R. Baye,
1-14
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 – OCW
• If i = 0, note PV = FV.
• As i increases, the higher is the OCW and the lower the
PV.
Michael R. Baye,
1-15
Present Value of a Series
• Present value of a stream of future amounts (FVt) received at the
end of each period for “n” periods:
PV 
• Equivalently,
FV1
1  i 

FV2
 ...
1  i 
FV
PV  
1  i 
1
2
n
t
t 1
Michael R. Baye,
t
FVn
1  i 
n
1-16
Net Present Value
• Suppose a manager can purchase a stream of future receipts (FVt
) by spending “C0” dollars today. The NPV of such a decision is
NPV 
FV1
1  i 
If
1

FV2
1  i 
2
 ...
FVn
1  i 
Decision Rule:
NPV < 0: Reject project
NPV > 0: Accept project
Michael R. Baye,
n
 C0
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
CF
CF
CF
PVPerpetuity 


 ...
2
3
1  i  1  i  1  i 
CF

i
Michael R. Baye,
1-17
1-18
Firm Valuation and Profit Maximization
• The value of a firm equals the present value of current and future
profits (cash flows).

PVFirm   0 
1

2
1  i  1  i 
 ...  
t 1
t
1  i t
• A common assumption among economist is that it is the firm’s
goal to maximization profits.
– This means the present value of current and future profits, so the firm
is maximizing its value.
Michael R. Baye,
1-19
Firm Valuation With Profit Growth
• If profits grow at a constant rate (g < i) and current period profits
are o, before and after dividends are:
1 i
before current profits have been paid out as dividends;
ig
1 g
Ex  Dividend
PVFirm
  0 that g immediately
after current profits are paid out as dividends.
• Provided
< i.
ig
PVFirm   0
– That is, the growth rate in profits is less than the interest rate and both
remain constant.
Michael R. Baye,
1-20
Marginal (Incremental) Analysis
• Control Variable Examples:
–
–
–
–
–
Output
Price
Product Quality
Advertising
R&D
• Basic Managerial Question: How much of the control
variable should be used to maximize net benefits?
Michael R. Baye,
1-21
Net Benefits
• Net Benefits = Total Benefits - Total Costs
• Profits = Revenue - Costs
Michael R. Baye,
1-22
Marginal Benefit (MB)
• Change in total benefits arising from a change in the
control variable, Q:
B
MB 
Q
• Slope (calculus derivative) of the total benefit curve.
Michael R. Baye,
1-23
Marginal Cost (MC)
• Change in total costs arising from a change in the
control variable, Q:
C
MC 
Q
• Slope (calculus derivative) of the total cost curve
Michael R. Baye,
1-24
Marginal Principle
• To maximize net benefits, the managerial control
variable should be increased up to the point where
MB = MC.
• MB > MC means the last unit of the control variable
increased benefits more than it increased costs.
• MB < MC means the last unit of the control variable
increased costs more than it increased benefits.
Michael R. Baye,
The Geometry of Optimization:
Total Benefit and Cost
Total Benefits
& Total Costs
Costs
Slope =MB
Benefits
B
Slope = MC
C
Q*
Michael R. Baye,
Q
1-25
1-26
The Geometry of Optimization: Net Benefits
Net Benefits
Maximum net benefits
Slope = MNB
Q*
Michael R. Baye,
Q
1-27
Conclusion
• Make sure you include all costs and benefits when
making decisions (opportunity cost).
• When decisions span time, make sure you are
comparing apples to apples (PV analysis).
• Optimal economic decisions are made at the margin
(marginal analysis).
Michael R. Baye,