Introduction to Managerial Economics

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Introduction to Managerial
Economics
Rudolf Winter-Ebmer
Dep. of Economics
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Preliminaries
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Slides of presentation at my homepage on Tuesdays
www.econ.jku.at/Winter
You should read assigned text before the course
exercises and examples will also be provided after the
lectures
2 exams
Watch out exact dates of lectures! – 120 minute lecture
each week
2 home assignments will be sent out by e-mail
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More preliminaries
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Teaching Assistant:
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Bernd Speta: [email protected]
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Phone: Ext. 8332
Office Hours:
Tuesday, 17.00 - 18.00
Room: K 152D1
The teaching assistant shall be the first person to contact if you have problems understanding
something and also for organizational issues.
We have 15 minutes break each lecture to have coffee and talk …
Textbook: Allen, Doherty, Weigelt and Mansfield “Managerial Economics, 6th edition
7th edition is ok as well
E-help … quizzes, etc …
www.wwnorton.com/college/econ/mec6/
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Norton Media Library
W. Bruce Allen
Neil A. Doherty
Keith Weigelt
Edwin Mansfield
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Grading
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2 exams, 48 points each, mostly MC questions
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2 homeworks during the term:
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6 points for each homework possible
to complete the course, at least 6 homework-points are
necessary!
Total sum of points (including extra points) must
be higher than 48 for a positive result
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What is Managerial Economics?
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Applied micro-economics, but with a focus on
decision making
„What shall a manager do in this and that
situation?“
Pricing decisions in different circumstances
Market entry, innovation, auction theory
Organization of the firm
Personnel policy, how to motivate workers
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Theory of the firm
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A theory indicating how a firm behaves
and what its goals are
Value of the firm should be
maximal:
The present value of the firm’s expected
future cash flows …
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Present value of expected
future profits
TR t − TC t
∑
t
(1
+
i)
t =1
n
where: TRt = the firm’s Total Rev. in year t
TCt = the firm’s Total Cost in year t
i = the interest rate
and t goes from 1 (next year) to n (the last year in
the planning horizon)
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Economic profit concept
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Profit the firm owner makes over and above
what their labor and capital employed in the
business could earn elsewhere.
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In competitive industries profits are zero
Why?
What are competitive industries?
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Are most industries competitive industries?
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Situations with positive profits
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Innovations
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Market entry is not (easily) possible
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Risk involved
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Industry is not competitive
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Chapter 3
Demand Theory
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The market demand curve shows the total
quantity of the good that would be purchased
at each price
Market Demand for Personal Computers,
3200
Price
3000
2800
2600
2400
2200
2000
0
500
1000
1500
2000
qua ntity
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Other determinants of market demand
besides the price
Consumer tastes and preferences
Consumer incomes
Level of other prices
Size of consumer population
Advertising
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Price elasticity of demand
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The percentage change in quantity demanded resulting from
a 1 percent change in price. Usually a negative figure.
∂Q P
η=
∂P Q
(called eta)
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Important for pricing decisions.
(notation: sometimes eta is written with a positive sign; take
care!)
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Calculating elasticities
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Point estimate: (demand function is known); calculated
at a specific point of demand.
Use statistic regression analysis (ch.5)
∂Q P
η=
∂P Q
Arc elasticity: uses average values of Q and P as
reference points (if only a table is known)
∆Q ( P1 + P2 ) / 2 (Q2 − Q1 ) ( P1 + P2 ) / 2
η=
=
∆P (Q1 + Q2 ) / 2 ( P2 − P1 ) (Q1 + Q2 ) / 2
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Price elasticity of demand
and gross revenues
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η < -1 ==> an inverse relationship between price changes
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η > -1 ==> a direct relationship between price changes
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η = -1 ==> no change in gross revenues as price changes.
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Important because of pricing decisions: is it useful to raise
or lower prices?
and gross revenues.
and gross revenues.
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Total revenue, marginal revenue
and price elasticity
Suppose P = a - bQ,
(linear demand function)
then TR = aQ - bQ2
MR = dTR/dQ = a - 2bQ
Since η = (dQ/dP) . (P/Q)
1 (a − bQ )
η=−
b
Q
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Total revenue, marginal revenue
and price elasticity
Price a
η < −1
Demand
and MR
η = −1
η > −1
a/2b
Dollars
a/b
Quantity
Total
Revenue
Quantity
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Marginal Revenue, price
and price elasticity
d ( PQ )
..... note
dQ
MR
=
MR
= P + Q
dP
dQ
P = P ( Q ) .... why ?
⎡
Q dP ⎤
=
= P ⎢1 +
⎥
P dQ ⎦
⎣
⎛
1 ⎞
= P ⎜⎜ 1 +
⎟⎟
η ⎠
⎝
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If product is price elastic (η<-1, marginal revenue must be positive)
Example: what is MR if price is $10 and price elasticity is -2?
10(1+1/(-2)) = $5.
„ Isn‘t this strange? Price is $10, you sell one piece more, but your
revenues rise only by $5 ???
What if product is very price elastic (η=-∞)?
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Determinants of price
elasticity of demand
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Elasticity is greater (in absolute values,
i.e more elastic) when:
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there are more substitutes for the product.
the product is a more important part of a
consumer’s budget.
the time period under consideration is
greater.
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Puzzle
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A soccer promoter must allocate 40,000 seats in the stadium
among the supporters of the two competing teams, the
Wolverton Gladabouts and Manteca United. This promoter
can set different prices for seating in the Wolverton and
Manteca sections. If she sells W seats to Wolverton
supporters, she will receive £20-W/2000 for each, while she
can get £10 per ticket from Manteca supporters, regardless
of the number of tickets she sells to them. Her objective is
to allocate the 40,000 seats she has available to maximize
her gate receipts. A fried suggests that an equal allocation
of 20,000 seats to each side is best, since this will mean
that the price of each ticket is the same, £10; at any other
division, she would be making more per ticket on one team
than on the other. Why is this friend wrong?
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Price Elasticity versus Marginal
Return
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Price elasticity means … how strongly do consumers
react (by buying less) if you raise your price
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You really should know this figure for your products
Price elasticity is defined as the reaction of quantity on price
Marginal return is defined as the reaction of money
on quantities sold
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How do revenues increase if you sell one more unit
MR = Marginal Revenue = Marginal Return
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Price setting: a simple rule
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Do not set price so low that demand is price-inelastic (η>-1):
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Marg. Revenue is negative, i.e. by raising price, total revenue will increase and (!) costs
will decrease.
MC = MR = P (1 +
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1
η
⎛
1
⇒ P = MC ⎜⎜
⎝ 1 + 1 /η
) ... pricing rule
⎞
⎟⎟ .... optimal
⎠
price
==> optimal price depends upon MC and price elasticity
==> The higher (the absolute value of) price elasticity, the lower the optimal price
•
Why is this so? In what market are you in?
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Income elasticity
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The percentage change in quantity
demanded resulting from a 1 percent
change in consumer income (I)
∂Q I
ηI =
∂I Q
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Table 3.6 Income Elasticity of Demand,
Selected Commodities, United States
Commodity
Income elasticity of demand
Alcohol
Housing, owner-occupied
Furniture
Dental services
Restaurant meals
Shoes
Medical insurance
Gasoline and oil
Butter
Coffee
Margarine
Flour
1.54
1.49
1.48
1.42
1.40
1.10
0.92
0.48
0.42
0
-0.20
-0.36
Source: H. Houthakker and L. Taylor, Consumer Demand in the United States
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Cross price elasticity
• The percentage change in quantity demanded of good X
resulting from a 1 percent change in the price of good Y
η X ,Y
δ Q X PY
=
δ PY QX
• How does demand for your product react to other
companies’ price hikes?
• How does demand for your products 2-n react to price
changes of your product 1?
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Use elasticities for market
forecasts
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Price elasticity: what will happen to my demand if I
change the price?
==> be careful, if elasticity of the whole industry or the
specific firm is concerned
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Income elasticity: given a forecast of GDP-growth is
available, what is the growth prospect of my product?
==> you may want to target specific income groups
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Advertising elasticity
• The percentage change in quantity demanded
resulting from a 1 percent change in
advertising expenditure
∂Q A
ηA =
∂A Q
• Is it worth to spend more on advertising?
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