Welcome
ECON 6313
Managerial Economics
Fall semester, 2008
Professor Chris Brown
Outline
What is managerial economics and why
should you study it?
Examples of managerial decisions
Six steps to decision making
?
What is managerial economics?
Managerial
economics is the
application of
economic theory to
management
decision making
Examples
How to use economic theory to set prices that
maximize profits.
How to use economic theory to choose the costminimizing production technique for a given scale of
output.
How to use economic theory to select the “optimal”
location for a new restaurant, grocery store, etc.
How to use economic theory to forecast near-term
demand for goods and services.
Examples of Management Decisions
1.
What rates should Cingular charge for its wireless telephone service?
2.
How many iPods should Apple manufacture in the current quarter?
3.
Should Red Lobster locate a restaurant in Jonesboro?
4.
Should Time-Warner leave the cable TV business?
5.
Should Minneapolis build a new baseball facility for the Twins?
6.
Should Ohio Edison scrap its coal-fired power plants in favor of oil
fired plants to comply with regulatory controls on sulfur emissions?
Or should it install expensive “scrubbing” equipment to its existing
plants?
7.
Should ASU charge differential tuition for business, nursing, and
engineering courses?
8.
Should the City of Jonesboro offer bus service?
9.
Should H & R Block outsource tax preparation to India?
Six Steps to Decision Making
1. Defining the Problem
2. Determining the
Objective
3. Exploring the
Alternatives
4. Predicting the
consequences
5. Making a choice
6. Performing
sensitivity analysis
Defining the problem
“I have a flat tire.”
Defining the objective
The spare won’t last long I
gotta get this tire replaced!
Exploring the alternatives
Go to Sears
Go to Wal-Mart
Predicting the consequences
Wal-Mart is closer and cheaper.
Sears has a sale on Michelin radials.
Making a choice
I’m going to Wal-Mart
Sensitivity Analysis:
Why is it Useful?
•Sensitivity analysis provides an insight into the key
features of a problem that affect a decision—e.g., the
decision to continue a product line depends of profit
forecasts, which in turn are based on assumptions about
future sales, prices, or costs. What happens to our
forecast when we modify the assumptions?
•It allows us to trace the effects of changes about which
the manager may be uncertain.
•It can give solutions to decisions which are recurring, but
must be made under slightly different conditions.
Estimates of the profits
derived from the purchase
of a new fleet of tractortrailer rigs are sensitive to
assumptions made about
a number of factors, including
the price of diesel fuel.
Present value (V)
maximization
The naïve version of model
assumes that managers
maximize profits—but over
what time horizon? We get
around this problem by
assuming that managers
seek to maximize the present
value of the firm
 Ri  Ci   R1  C1   R 2  C 2 
 Rn  Cn 
V  


 ...  

n
2 
n
(
1

r
)
(
1

r
)
(
1

r
)
(
1

r
)
i 1 
 
 



n
Where:
Ri is sales revenues of the firm in period i (quarter i, year i);
Ci is cost of the firm in period i (quarter i, year i);and
r is the discount rate
Theory of the firm
•Managerial economics is based on the “model of
the firm.”
•The model of the firm is based on the assumption
that firms, or managers of firms, are “optimizers.”
•What is it that managers optimize—i.e., what is
the nature of the managerial “objective function”?
Berle and Means
view1
V MAX
•The gigantic, publicly-owned, vertically integrated corporation has
displaced the small, owner managed business as the dominant
form of economic organization.
•Given the separation of ownership and control indicative of
modern corporatism, a large share of economic resources are
under the control of the professional management class—i.e.,
owners, or shareholders, are “passive.”
•There is no guarantee that the interests of shareholders and
managers will coalesce—i.e., managers may be interested in
objectives other than value maximization(e.g., growth of the firm,
power, job security or perquisites).
1 Adolph
Berle and Gardiner Means. The Modern Corporation
and Private Property
Topics we will cover in ECON 6313
(Managerial Economics)
Demand Analysis and
Forecasting
Chapters 3, 4, and 5
Competitive Analysis and
Market Structure
(Game Theory)
Chapters 10, 11, and 12
The Firm
(Profit Analysis)
Chapters 2, 3
Decision Making
Under Uncertainty
Chapters 8 and 9
Cost Analysis
Chapters 7