ECONOMICS – deal w/ how to satisfy the unlimited
want and needs of human w/ limited or scarce
resources we have.
Responsibilities of the Management
1. Proactively solving business problems
a.
Macroeconomics – is a branch of economics that
studies how an overall economy—the market or
other systems that operate on a large scale—
behaves. (inflation; GDP&GNP; unemployment)
Microeconomics - is a branch of economics that
studies the behavior of individuals and firms in
making decisions regarding the allocation of scarce
resources and the interactions among these
individuals and firms. (demand and supply)
Managerial economics
- mixture between mgt and economics
- extracts from microeconomic theory those
concepts and techniques that enable managers to
select strategic direction, to allocate resources
efficiently – optimization and respond effectively to
tactical (short term) issues.
2. Should focus on teamwork and motivation
a.
- is the application of microeconomic to problems
faced by decision makers.
b.
Scope of Managerial Economics
Resource allocation
Inventory and queuing problem
Pricing problems
Investment problems
GOAL of Managerial economics:
Economic benefits/profits
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1. Identify the alternatives
2. Select the choice that accomplishes the
objectives in the most efficient manner
3. Taking into account the constraints
(limitations)
4. And the likely actions and reactions of rival
decision maker
The ability to make good decisions is the key to
successful managerial performance.
Moral hazard happens when an agent is
given an implicit guarantee of support in the
event of making a loss.
This prompts firm to take on more risk than
is optimal.
3. Selecting strategies
4. Creating org structure and culture based
org’s mission
5. Coordinate the integration of different dep’t
- can be applied to any organizations regardless of
motive.
1.
2.
3.
4.
Issues of mgt failure
i. Mismanagement
ii. Defeatism (against the objective)
iii. Overplanning
iv. Productivity shortfall
v. Underplanning
vi. Risk mismanagement
vii. Change mgt failure
viii. Defense of the status quo
ix. Failure to lead
x. Lack of control
xi. Authoritarianism (only truth is me)
xii. Perverse incentive
xiii. Rent seeking (dawat sweldo lang)
xiv. Neglect of culture
xv. Bozo explosion (deteriorating
competence)
xvi. Optimization myopia
xvii. Corporate
narcissism
(feeling
invincible)
returns to the owners of the business.
Difference between total sales revenue and
total economic cost.
Economic cost – highest valued alternative
opportunity that is forgone; opportunity cost.
Economic Profit
Revenue-opportunity costs
(explicit & implicit)
When
negative
profit
doesn’t
mean
it
is
experiencing loss; it means it
can be more efficiently done
Acctg Profit
Revenue-expenses
When
negative
literally
experiencing a loss
Role of Profits
The Decision-Making Model
1.
2.
3.
4.
Establish the objectives
Identify the problem
Examine possible alternative solutions
Analyze alternatives and select the best
(consider societal constraints & consider
organization and input constraints)
5. Perform a sensitivity analysis – analysis of
the best alternative; is a technique w/ch
allows the analysis of changes in assumption
used in forecasts; “what if” analysis.
6. Implementation and monitor the decision
Profits – residual amount of cost and sales.
1. Determines the type and quantity of goods
and services that are produced and sold
2. Determine the resulting derived demand for
resources
Why economic profits exist?
Risk-bearing Theory of Profit

By taking risk you should be rewarded.

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Economic profits arise in part to compensate the
owners of the firm for the risk they assume when
making their investments.
Profit relative to risk
Temporary Disequilibrium Theory of Profit


The Hypermarket Model – shopee
The Experience Model – unique cars
The Service Ecosystem Model – facebook w/ch has
gaming…
Objective of the Firm - SHAREHOLDER
WEALTH MAXIMIZATION
Temporary dislocations (imbalances) in various
sectors of the economy. (pandemic)
A point in time where firms might earn a rate of
return above or below the long-run normal
return level.
Monopoly Theory of Profit
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One firm is effectively able to dominate
(monopolize) the market and persistently earn
above-normal rates of return. (coz of economies
of scale, control of essential natural resources)
To maximize the value of the firm, managers should
maximize shareholder wealth.
Shareholder’s wealth – is measured by the market
value of a firm’s common stock, which is equal to
the present value of all expected future cash flows
to equity owners discounted at the shareholder’s
required rate of return plus (+) a value for the firm’s
embedded real options:
The lower the rate of return the higher the valuation.
Innovation Theory of Profit

above-normal profits are reward for successful
innovations.
Managerial Efficiency Theory of Profit
V0 = stock price

t = economic profits expected in each of the future
period (dividends)
above-normal profits can arise because of the
exceptional managerial skills of well-managed
firms.
No single theory of profit can explain the observe
profit rates in each industry.
Profit performance is in-variably the result of many
factors.
Ke = required rate of return
Real option value = cost savings or revenue
expansions that arise from preserving flexibility in
the business plans the managers adopt.
Abnormal profits & unicorns
Unicorns – term used in the venture capital industry
to describe a start-up company w/ a value $1 billion;
wa pa ni reach to the public.
EVA = economic value added (estimate of firm’s
economic profit)
Hyperdisruptive (innovative) Business Models:
WACC = weighted average cost of capital
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Barriers to entry – high start-up costs
Substitutes – deserve same purpose
Bargaining power of suppliers – pressure that suppliers can
put on companies
Bargaining power of buyer – pressure that customers can put
on businesses
The Subscription Model – Netflix
The Free Model – Facebook; Instagram (info)
The Freemium Model – Spotify
The Digital Platform Model – phone
The Access-Over-Ownership Model – grab
NOPAT = Net operating profit after tax
o
Competition among competitors – pressure caused by other
competitors
Cost advantage – gained by reducing production cost so that it
can offer cheaper prices
Differentiation advantage – having products unique from
others
Constrains (Frictions) on the Operations of the Firm
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Limited availability of inputs
Amount of investments
Contractual agreements
Level of output
Legal restrictions
Governmental rules
Technological issues
Financial issues
Some CRITICISMS of the Shareholder model:

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Firms are not homogenous unit. Owners may
want profit maxi, but managers have different
objectives.
Other objectives to profit maximization. Profit
maximization is not the only goal of a firm.
Marginal approach to firms is not replicated in
the real world.
Imperfect information.
Behavioral economics.
Separation of Ownership and Control: The
Principal-Agent Problem
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o
o
1. Grants of restricted stock or deferred stock options
to structure executive compensation in such a way as
to align the incentives for mgt w/ shareholder
interests.
2. Internal audits and acctg oversight boards to monitor
mgt’s actions (monitoring cost)
3. Bonding expenditures and fraud liability insurance
4. Lost profits (economic damages) arising from
complex internal approval processes designed to
limit managerial discretion (authority), but w/ch
prevent timely responses to opportunities.
Implications of Shareholder Wealth Maximization
The goal of shareholder wealth maximization
requires a long-term focus.
o
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All individuals will act in their own selfinterest.
Agents are in a position of power.
rationale of corporate governance
where alternatives are harder to identify, the
goals of owners and managers are seldom
aligned
Divergent Objectives and Agency Conflict

Manager often seek acceptable level of profit
and wealth because they have much less to lose
and pursue their self-interests – agency conflict.
Agency Problems

Agency costs – costs associated in resolving
conflicts of interest among shareholders,
managers, and lenders.
o
o
Monitoring costs – incurred by principal; annual
reporting, external auditing
Bonding costs – incurred by agent to demo that
they are goal congruent
Types of investors: Traders (sells the asset &
Passive (considers long-term appreciation)
SWM reflects dynamic changes in the info
available to the public about a company’s
expected future cash flows and foreseeable
risks.
Additional sources of equity value are referred
to as “embedded real options.”
What are real options? gives a firm's management
the right, but not the obligation to undertake certain
business opportunities or investments.
o Facilitate follow-on projects thru growth
options
o Exiting
early
w/out
penalty
thru
abandonment options
o Staging investment over a learning period
until better info is available thru deferral
options (halting operations)
2 key assumptions under this theory:
o
Info asymmetry (mgt has more info)
Poor communication
Poor understanding
Innocent & unintended self-interested behavior
by agents
Deliberate legal self-interested behavior
Illegal self-interested behavior by agents
Ways to mitigate the Agency Problem
BOD
o
Excessive non-financial benefits
Empire bldg. (act of increasing power)
Risk avoidance
Differing time horizons (mgt – short term)
These costs can arise as a result of:
o
o
o
o
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Cost relating to residual loss – incurred by
principal; agent will inevitably make decisions
that are not consistent w/ the principal’s interest.
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Value-maximizing manager commit himself or
herself to continuous incremental improvement
unlike satisficers who merely strive to “hit the
targets.”
Factors affecting share price
o The Market Place
o Demand and Supply
o Interest rates
o Dividends
o Management
o Economy
o Political climate
CAVEATS to Maximizing Shareholder Value
The Efficiency Objective in NFP Org
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Managers should concentrate on maximizing
shareholder value alone only if three conditions
are met.
These conditions require: (1) complete markets,
(2) no significant asymmetric info, (3) known
recontracting costs.
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Complete Markets
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All info flowing; all known to public
To directly influence a company’s cash flows,
forward or futures markets as well as spot
markets must be available for the firm’s inputs,
output, and by-products.
Know the price of asset in every possible state
Completeness of the markets allows a reduction
in the cost-covering prices of gasoline and
cappuccino.
Cost-benefit analysis – a resource-allocation
model that can be used by public sector and notfor-profit organizations to evaluate programs or
investments on the basis of the magnitude of
the discounted costs and benefits.
Goals:
1. Maximize the benefits for given costs.
2. Minimize the costs while achieving a
fixed level of benefits.
3. Maximize the net benefits (benefits
minus costs)
No Asymmetric Information
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This often leads to misunderstandings
Info should be the same within sellers and
buyers.
Not made possible because of fake news
Different sources of info
SUMMARY

Managers are responsible for proactively solving
problems in the current business model, for
setting stretch goals, establishing the vision, and
setting strategy for future business, for
monitoring teamwork, and integrating the
operations, marketing, and finance functions.

Economic profit is defined as the difference
between total revenues and total economic
costs. Economic costs include a normal rate of
return on the capital contributed by the firm’s
owners. Economic profits exist to compensate
investors for the risk they assume, because of
temporary disequilibrium conditions that may
occur in a market, because of the existence of
monopoly power, and as a reward to firms that
are especially innovative or highly efficient.

As an overall objective of the firm, the
shareholder wealth-maximization model is
flexible enough to account for differential levels
of risk and timing differences in the receipt of
benefits and the incurring of future costs.
Shareholder wealth captures the net present
value of future cash flows to owners from
positive NPV projects plus the value of
embedded real options.

Managers may not always behave in a manner
consistent with the shareholder wealthmaximization objective. The agency costs
associated with preventing or at least mitigating
Known Recontracting Costs
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Anticipate and mitigate recontracting problems.
Recontracting cost – cost possibly incurred if
there are renewal/change of contracts.
RESIDUAL CLAIMANTS

Shareholders have a residual claim on the firm’s
net cash flows after all expected contractual
returns have been paid.
Goals in the Public Sector and Not-for-Profit
Business
Characteristics of NFP Org
1. No one possesses a right to receive profit or
surpluses in an NFP enterprise.
2. Exempt from taxes on corporate income
3. Donations to NFP are tax deductible
Objective of NFP
1. Maximizing the quantity and quality of output
subject to a break-even budget constraint
2. Maximizing the outcomes preferred by the
NFP’s contributors
3. Maximizing the longevity of the NFP’s
administrators
Public goods – goods that may be consumed by
more than one person at the same time w/ little or
no extra cost, and for which it is expensive or
impossible to exclude those who do not pay (e.g.
national defense and flood control).
these deviations from the owner-principal’s
objective are substantial.

Changes in the firm’s performance, perhaps
unrelated to a manager’s effort, combined with
the unobservable nature of their creative
ingenuity presents a difficult principal-agent
problem to resolve. This combination makes it
difficult for ownerprincipals to know when to
blame manageragents for weak performances
versus giving them credit for strong
performances.
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Shareholder wealth maximization implies
forward-looking, long-run-oriented, dynamic
strategies that anticipate change in a risky
market environment. Managers can focus on
maximizing the discounted present value of the
firm’s cash flows if three conditions hold:
complete markets, no asymmetric information,
and known recontracting costs. Otherwise, they
must attend to these complications as well.

Governance mechanisms (including internal
monitoring by subcommittees appointed by
boards of directors and large creditors,
internal/external monitoring by large block
shareholders, auditing and variance analysis)
can be used to mitigate agency problems by
limiting managerial discretion.

Shareholder wealth maximization implies a firm
should be forward-looking, dynamic, and have a
long-term outlook; anticipate and manage
change;
acquire
strategic
investment
opportunities; and maximize the present value
of expected cash flows to owners within the
boundaries of the statutory law, administrative
law, and ethical standards of conduct.

Shareholder wealth maximization will be
difficult to achieve when firms suffer from
problems related to incomplete markets,
asymmetric information, and unknown
recontracting costs. In the absence of these
complications, managers should maximize the
present value of the discounted future net cash
flows to residual claimants—namely, equity
owners. If any of the complicating factors is
present, managers must first attend to those
issues before attempting to maximize
shareholder wealth.

Not-for-profit enterprises exist to supply a good
or service desired by their primary contributors.

Public sector organizations often provide
services
having
significant
public-good
characteristics. Public goods are goods that can
be consumed by more than one person at a time
with little additional cost, and for which
excluding those who do not pay for the goods is
exceptionally difficult or prohibitively expensive.

Regardless of their specific objectives, both
public and private institutions should seek to
furnish their goods or services in the most
efficient way, that is, at the least cost possible.