Managerial Economics Chapter (1): The Nature and Scope of Managerial Economics February 7th, 2017 1 Course Outline Course Contents Firm Goals and Managerial Economics. Demand, Supply and Market Equilibrium. Demand and Supply Elasticity. The Theory of Production. The Theory of Cost. Perfect Competition. Pure Monopoly. Monopolistic Competition. Oligopoly. 2 Course Outline Assessment Method 3 Assignments 10% Term Paper & Presentations 10% Mid-term Exam 20% Final Exam 60% Course Outline References: Thomas, C., and Maurice, C., “Managerial Economics: Foundations of Business Analysis and Strategy,” MacGraw-Hill Publishing , 12th Ed. 2016, ISBN: 0078021909. Baye M., "Managerial Economics and Business Strategy,", MacGraw-Hill Publishing , 7th Ed. 2010, ISBN: 0073375960. 4 Course Outline 5 Definition of Managerial Economics Managerial Economics Defined The application of economic theory and the tools of decision science to examine how an organization can achieve its aims or objectives most efficiently. 6 Definition of Managerial Economics (Cont.) EXAMPLE 1: A firm may seek to maximize profits subject to limitation on the availability of essential inputs (skilled labor, capital, and raw materials) and legal constraints ( minimum wage laws, health and safety standards, and pollution emission standards). Not-for-profit organizations (such as hospitals, universities, museum) and government agencies also seek to reach some goal or objective subject to some constraints. 7 Definition of Managerial Economics (Cont.) Managerial economics studies the decision-making process, that is, the means by which an organization can achieve its objective most efficiently. 8 Definition of Managerial Economics (Cont.) Managerial Decision Problems Economic theory Microeconomics Macroeconomics Decision Sciences Mathematical Economics Econometrics MANAGERIAL ECONOMICS Application of economic theory and decision science tools to solve managerial decision problems OPTIMAL SOLUTIONS TO MANAGERIAL DECISION PROBLEMS 9 Definition of Managerial Economics (Cont.) EXAMPLE 2: • Economic theory postulates that the quantity demanded of a commodity (Q) is a function of, or depends on, the price of the commodity (P), the income of consumers (Y), and the prices of related (i.e. complementary and substitute) commodities (Pc, and Ps, respectively). • Assuming constant tastes, we may postulate the following (mathematical) model: Q = f ( P, Y, Pc, Ps ) 10 Definition of Managerial Economics (Cont.) • Collecting data on Q, P, Y, Pc, Ps , for a particular commodity, we can then estimate the empirical (econometric) relationship. • This will permit the firm to determine how much Q would change as a result of a change in P, Y, Pc, and Ps, and to forecast the future demand for the commodity. • These steps are essential in order for the management to achieve the goal, or objective, of the firm (profit maximization) most efficiently. 11 The theory of the firm Theory of the Firm Firms exists because the economies they generate in production and distribution confer great benefits to entrepreneurs, workers, and resource owners. Primary goal is to maximize the wealth or value of the firm. 12 The theory of the firm (Cont.) Value of the Firm The present value of all expected future profits: 13 The theory of the firm (Cont.) EXAMPLE 3: At a discount rate of 10 percent, the value of a firm that generates $100 of profits for each of the two years and is sold for $800 at the end of the second year is: According to the theory of the firm, it is this value (PV) that the firm seeks to maximize, 14 Profit of the firm Definitions of Profit Business Profit: Total revenue minus the explicit or accounting costs of production. Explicit costs are the actual out-of-pocket expenditures of the firm to hire labor, borrow capital, rent land and buildings, and purchase raw materials. 15 Profit of the firm (Cont.) Economic Profit: Total revenue minus the explicit and implicit costs of production. Implicit costs are the money value of the inputs owned and used by the firm in its own production processes. These include the salary that the entrepreneur could earn in managing another firm and the return that the firm could earn by investing its capital and renting its land and other inputs to other firms. Opportunity Cost: Implicit value of a resource in its best alternative use. 16 Profit of the firm (Cont.) Function of Profit Profit is a signal that guides the allocation of society’s resources. High profits in an industry are a signal that buyers want more of what the industry produces. Low (or negative) profits in an industry are a signal that buyers want less of what the industry produces. 17 Profit of the firm (Cont.) EXAMPLE 4: • • • • 18 Suppose that during a year a firm has revenues of $100,000 and explicit costs of $80,000 for hiring labor, borrowing capital, and purchasing raw materials. Suppose also that the entrepreneur could have earned $30,000 by managing another firm and an additional $5,000 by lending out the capital invested in the firm to another firm facing similar risks. The business profit of this firm is $20,000. The economic profit is -$15,000 (an economic loss). It is the concept of economic profit that provides the signal for the efficient allocation of society’s resources. Nature & Scope of Managerial Economics The End 19