Chapter 1: - - - - - - Managerial economics: the application of economic theory and decision science tools to find the optimal solution to managerial decision problems. Economic theory helps managers understand real-world business problems Microeconomics: study of behavior of individual economic agents. Business practices or tactics: using marginal analysis, microeconomics provides the foundation for understanding everyday business decisions Industrial organization: specialized branch of microeconomics focusing on behavior & structure of firms & industries. It provides foundation for understanding strategic decisions through application of game theory. Strategic decisions seek to shape or alter the conditions under which a firm competes with its rivals. Increase/protect firm’s long-run profit. They are generally optimal actions managers can take as circumstances permit. Economic forces that promote long-run profitability: few close substitutes, strong entry barriers, weak rivalry within market, low market power of suppliers, low market power of consumers, abundant complementary products, and limited government intervention. Opportunity cost: what firm owners must give up to use the resource. Market-supplied resources: owned by others & hired, rented, or leased. Owner-supplied resources: owned & used by the firm. Total Economic Cost: sum of opportunity costs of both market-supplied resources & ownersupplied resources Explicit Costs: monetary payments to owners of market-supplied resources. Implicit Costs: nonmonetary opportunity costs of using owner-supplied resources. Types of Implicit costs: • Equity capital: cash provided by owners. • Using land or capital owned by the firm • Owner’s time spent managing or working for the firm Economic profit = Total revenue – Explicit costs – Implicit costs Accounting profit = Total revenue – Explicit costs Value of a firm: price for which it can be sold. (Equal to net present value of expected future profit.) Risk premium: accounts for risk of not knowing future profits. The larger the rise, the higher the risk premium, & the lower the firm’s value Maximize firm’s value by maximizing profit in each period. Manager mistakes: producing constant output, pursuit of market share, focusing on profit margin, maximizing total revenue, using cost-plus pricing formulas. Principal-agent problem: conflict that arises when goals of management (agent) do not match goals of owner (principal). Moral Hazard: when either party to an agreement has incentive not to abide by all its provisions & one party cannot cost effectively monitor the agreement Corporate 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. Price-taking vs price-setting firms. A market is any arrangement through which buyers & sellers exchange goods & services. Markets reduce transaction costs. Market characteristics that determine the economic environment in which a firm operates: number and size of firms, degree of product differentiation, and likelihood of new firm entry. Perfect competition: large number of relatively small firms, undifferentiated product, and no barriers to entry. Monopoly: single firm, produces product with no close substitutes, protected by a barrier to entry. Monopolistic Competition: large number of relatively small firms, differentiated products, no barriers to entry. Oligopoly: Few firms produce all or most of market output, and profits are interdependent. Globalization of Markets: economic integration of markets located in nations around the world. It provides opportunity to sell more goods & services to foreign buyers. It presents threat of increased competition from foreign producers. Chapter 2: - - - Quantity demanded (Qd): amount of a good or service consumers are willing & able to purchase during a given period of time. Six variables that influence Qd: • Price of good or service (P) • Incomes of consumers (M) • Prices of related goods & services (PR) • Taste patterns of consumers (T) • Expected future price of product (Pe) • Number of consumers in market (N) General demand function: Qd = f(P, M, PR, T, Pe , N) Demand: shows how quantity demanded is related to product price, P, when all other variables are held constant. Law of Demand Qd increases when P falls, all else constant Qd decreases when P rises, all else constant Qd/P must be negative Price (P) is plotted on the vertical axis & quantity demanded (Qd) is plotted on the horizontal axis. Change in quantity demanded: occurs when price changes and causes movement along demand curve. Change in demand: occurs when one of the other variables, or determinants of demand, changes and demand curve shifts rightward or leftward. Quantity Supplied (Qs): amount of a good or service offered for sale during a given period of time. Six variables that influence Qs: • Price of good or service (P) - - - • Input prices (PI ) • Prices of goods related in production (Pr) • Technological advances (T) • Expected future price of product (Pe) • Number of firms producing product (F) General supply function: Qs = f(P, PI, Pr, T, Pe, F) Supply: shows how quantity supplied is related to product price, P, when all other variables are held constant. Price (P) is plotted on the vertical axis & quantity supplied (Qs) is plotted on the horizontal axis. Change in quantity supplied: occurs when price changes and causes movement along supply curve. Change in supply: occurs when one of the other variables, or determinants of supply, changes and supply curve shifts rightward or leftward. Equilibrium: price & quantity are determined by the intersection of demand & supply curves. Economic value: maximum amount any buyer in the market is willing to pay for the unit, which is measured by the demand price for the unit of the good Consumer surplus: difference between the economic value of a good (its demand price) & the market price the consumer must pay. Producer surplus: for each unit supplied, difference between market price & the minimum price producers would accept to supply the unit (its supply price). Social surplus: Sum of consumer & producer surplus. The area below demand & above supply over the relevant range of output. Changes in market equilibrium: Qualitative forecast: predicts only the direction in which an economic variable will move. Quantitative forecast: predicts both the direction and the magnitude of the change in an economic variable. When demand & supply shift simultaneously: • Can predict either the direction in which price changes or the direction in which quantity changes, but not both. • The change in equilibrium price or quantity is said to be indeterminate when the direction of change depends on the relative magnitudes by which demand & supply shift • (D, S) Price may rise or fall; Quantity rises. • (D, S) Price falls; Quantity may rise or fall. • (D, S) Price rises; Quantity may rise or fall. • (D, S) Price may rise or fall, Quantity falls. Ceiling price: Maximum price government permits sellers to charge for a good. When ceiling price is below equilibrium, a shortage occurs. Floor price: Minimum price government permits sellers to charge for a good. When floor price is above equilibrium, a surplus occurs. Chapter 3: Marginal Analysis for Optimal Decision - - - - - An optimization problem involves the specification of three things: • Objective function to be maximized or minimized. • Activities or choice variables that determine the value of the objective function. • Any constraints that may restrict the values of the choice variables. Unconstrained optimization: an optimization problem in which the decision maker can choose the level of activity from an unrestricted set of values. Constrained optimization: an optimization problem in which the decision maker chooses values for the choice variables from a restricted set of values. Choice variables determine the value of the objective function. • Continuous variables: Can choose from uninterrupted span of variables. • Discrete variables: Must choose from a span of variables that is interrupted by gaps. Net Benefit (NB) = Total Benefit (TB) – Total Cost (TC) Optimal level of the activity (A*) is the level that maximizes net benefit. Marginal benefit (MB): change in total benefit (TB) caused by an incremental change in the level of the activity. Marginal cost (MC): change in total cost (TC) caused by an incremental change in the level of the activity. Marginal variables measure rates of change in corresponding total variables. Marginal benefit & marginal cost are also slopes of total benefit & total cost curves, respectively. If marginal benefit > marginal cost Activity should be increased to reach highest net benefit. If marginal cost > marginal benefit Activity should be decreased to reach highest net benefit MB = MC optimal level of activity Unconstrained Maximization with Discrete Choice Variables: • Increase activity if MB > MC • Decrease activity if MB < MC • Optimal level of activity - Last level for which MB exceeds MC Sunk costs: previously paid & cannot be recovered. Fixed costs: constant & must be paid no matter the level of activity. Average (or unit) costs: computed by dividing total cost by the number of units of the activity. These costs do not affect marginal cost & are irrelevant for optimal decisions. The ratio MB/P represents the additional benefit per additional dollar spent on the activity. Ratios of marginal benefits to prices of various activities are used to allocate a fixed number of dollars among activities To maximize or minimize an objective function subject to a constraint: • Ratios of the marginal benefit to price must be equal for all activities. • Constraint must be met. Chapter 4: Basic Estimation Techniques - Parameters: the coefficients in an equation that determine the exact mathematical relation among the variables. Parameter estimation: the process of finding estimates of the numerical values of the parameters of an equation. Regression analysis: a statistical technique for estimating the parameters of an equation and testing for statistical significance. Simple linear regression model relates dependent variable Y to one independent (or explanatory) variable X. • • - - Intercept parameter (a) gives value of Y where regression line crosses Y-axis (value of Y when X is zero). Slope parameter (b) gives the change in Y associated with a one-unit change in X: Parameter estimates are obtained by choosing values of a & b that minimize the sum of squared residuals • The residual is the difference between the actual and fitted values of Y: Yi – Ŷi The sample regression line is an estimate of the true regression line The estimates â & b do not generally equal the true values of a & b. • â & b are random variables computed using data from a random sample. The distribution of values the estimates might take is centered around the true value of the parameter. An estimator is unbiased if its average value (or expected value) is equal to the true value of the parameter Must determine if there is sufficient statistical evidence to indicate that Y is truly related to X (i.e., b 0). Even if b = 0, it is possible that the sample will produce an estimate that is different from zero. Test for statistical significance using t-tests or p-values. Performing a t-Test: • First determine the level of significance: probability of finding a parameter estimate to be statistically different from zero when, in fact, it is zero. (Probability of a Type I Error) • 1 – level of significance = level of confidence • • • t-ratio is computed as Use t-table to choose critical t-value with n – k degrees of freedom for the chosen level of significance n = number of observations k = number of parameters estimated If the absolute value of t-ratio is greater than the critical t, the parameter estimate is statistically significant at the given level of significance. - • • • - - - Using p-Values: • Treat as statistically significant only those parameter estimates with p-values smaller than the maximum acceptable significance level. • p-value gives exact level of significance Also, the probability of finding significance when none exists • Coefficient of determination: R2 measures the percentage of total variation in the dependent variable (Y) that is explained by the regression equation. Ranges from 0 to 1 High R2 indicates Y and X are highly correlated F-Test: Used to test for significance of overall regression equation. Compare F-statistic to critical F-value from F-table. Two degrees of freedom, n – k & k – 1 Level of significance If F-statistic exceeds the critical F, the regression equation overall is statistically significant at the specified level of significance. Multiple regression: • Uses more than one explanatory variable. • Coefficient for each explanatory variable measures the change in the dependent variable associated with a one-unit change in that explanatory variable, all else constant. Quadratic regression models: • Use when curve fitting scatter plot is U-shaped or ∩-shaped • Y = a + bX + cX2 For linear transformation compute new variable Z = X2 Estimate Y = a + bX + cZ Long-linear regression models: Use when relation takes the form: Y = aXbZc
