Managerial Economics
Introduction to the Course
Aalto University
School of Science
Department of Industrial Engineering and Management
January 12 – 28, 2016
Dr. Arto Kovanen, Ph.D.
Visiting Lecturer
A little bit about me …
 I am a Finn, but I have spent over 30 years in the
United States to study and work
 I received my doctoral degree in economics from
Purdue University, but I have also studied in Finland
 I have taught economics at universities in the U.S.
 Most of my career, I have spent in institutions that
deal with economic policy issues, including Bank of
Finland, the IMF, and the Institute of International
Finance
 Currently, I own a consulting company and advise
policy makers on macro- and monetary policy matters,
conduct economic research, and teach economics
What are you in for?
 What kind of course is this? – we apply economic
thinking to everyday problems of firms
 Pre-requisite: principles of economics or similar,
some basic math is also required
 The course is taught in English!
 What is expected of you in this course?
 Class participation / attendance is not monitored, but
not everything is in the course textbook!
 Complete individual homework assignments on time!
 Do well in the final exam!
General information
 The course will comprise 6 lectures, on three Tuesdays
and Thursdays, from 14 – 17 (15 minutes break in the
middle)
 There will be 2 individual homework exercises and a
final exam
 FINAL EXAM (first attempt): February 18, 2016
 Grades will be based on (maximum 100 points):
 Final exam: 60 points
 Individual exercises (2 exercises): 40 points (2 x 20 points)
 Minimum requirement to pass: 60 points, of which at
least 20 points must come from homework!
 Grading scale: 5 ≥ 90; 4 ≥ 80; 3 ≥ 70; 2 ≥ 60; 1 ≥ 50; 0 < 50
General information (cont.)
 Individual homework exercises:
 Goal: apply economic thinking to firm’s decision-making
 Homework 1 is due Tuesday, January 19, 2016 in class
(review session on Wednesday, January 20, 2016; time to
be confirmed)
 Homework 2 is due Tuesday, January 26, 2016 in class
(review session on Wednesday, January 27, 2016; time to
be confirmed)
 No late submissions accepted (i.e., after the class)
 Must be completed/submitted individually
 Lecture slides and exercises will be posted on the web
 Assistant : Mr. Joosef Valli (joosef.valli@aalto.fi)
Content of the Course
 Course text: Managerial Economics; Economic Tools for
Today’s Decision Makers; 7th Edition; Keat-Young-Erfle
(earlier editions of the textbook are fine)
 Additional material will be covered in the classroom
 Everything is not in the course textbook (so attend the
class and read the additional handouts)
 The course is divided into three segments:
 Decision-making within the firm
 Competing with markets
 Decision-making applications
Content of the Course (cont.)
 Segment 1: Decision-making within the Firm
 Optimal decisions using marginal analysis (1st week)
 Production and cost analysis (1st week)
 Demand analysis and optimal pricing (1st week)
 Estimating and forecasting demand (2nd week)
 These topics roughly correspond to chapters 1 through 7 in
the course textbook and will be covered during the first and
second weeks of classes
Content of the Course (cont.)
 Segment 2: Competing with Markets
 Perfect competition (2nd week)
 Monopoly and oligopoly (2nd week)
 Game theory and competitive strategies (2nd week)
 Market failure and government intervention (3rd week)
 These topics roughly correspond to chapters 8 through 11,
and 14 in the course textbook and will be covered during
the second and third weeks of classes
Content of the Course (cont.)
 Segment 3: Decision-making Applications
 Linear programming (3rd week)
 Asymmetric information (3rd week)
 Decision-making under uncertainty (3rd week)
 Segment 3 materials are not covered in the course text and
will be covered during the third week of classes
 Other useful textbooks to read:
 Hall Varian, Intermediate Microeconomics
 Thomas J. Webster, Managerial Economics
 Samuelson and Marks, Managerial Economics
What is managerial economics?
It is all about economics!
Mankiw, Principles of Economics
What is managerial economics?
“Managerial economics is the application of economic
concepts and economic analysis to the problems of the
firm to formulate rational managerial decisions”
“It is sometimes referred to as business economics and is
a branch of economics that applies microeconomic
analysis to decision methods of businesses and other
managerial units”
“It draws heavily on quantitative techniques including
regression analysis, correlation and calculus”
“It attempts to help optimize business decisions given
firm’s objectives and constraints”
Managerial economics (cont.)
 Economics is relevant for business decisions:
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What is the demand for firm’s product?
How much to charge from customers/pay for inputs?
What are the relevant costs of production?
Should the firm enter into a new market?
 Economic practice involves principles and modeling for
specific answers: analysis and prediction
 Relevant economic fields: finance, marketing, industrial
organization, labor economics, macroeconomics
(public policy making), statistics
Decision-making
 Decision-making lies at the heart of business activity
 The range of business decisions is vast:
 Should a high-tech company undertake expensive
research (pros and cons, and potential risks)?
 What kind of bid should a company submit to obtain a
contract with government?
 How to price a product in response to new competitor’s
entry in the market?
 The best way to become familiar with managerial
economics is to study real-world decision-making
Decision-making (cont.)
 Steps to decision-making (in general):
 Define the problem facing the management
 What is the key objectives (profits, revenues)?
 What are the possible courses of action and what
parameters can the decision-maker control?
 What are the consequences of each alternative
action and how would the outcome change if the
conditions change?
 What is the preferred course of action (is it optimal)?
 Perform sensitivity analysis (underscores uncertainty
about the future)
Economics and choice
 Choice is an essential element of human decisions
 Economics is the study of understanding how we make
choices
 It seeks to build a theoretical model or roadmap for
rational choices, to explain and evaluate the social
interaction
 Choices that the society must make:
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What goods to produce?
What is the best way to produce them?
Who will produce them (e.g., public/private sector)?
For whom to produce?
Scarcity and decision making
 Scarcity and choice are central for decision making and
the discipline of economics
 Individuals and societies cannot have everything they
desire because resources are limited – leads to choices
 Goods and services, and productive resources that are
scarce have positive prices, which results from the
interaction between supply and demand for them
 Examples of scarce goods: natural resources, labor,
land, physical capital, financial resources
Scarcity (cont.)
 How does scarcity influence business decisions?
 How do constraints limit firm’s operations?
 Examples:
 How much to produce?
 Should a firm make its own spare parts or buy them from
an outside vendor?
 Should a firm buy or lease a fleet of trucks it uses to
transport its products to markets?
 Should a firm expand to international markets?
 Should a firm hire more labor or invest in capital?
Importance of markets
Mankiw: Principles of Economics
Importance of markets (cont.)
 What is a market? A place? A product or service? Which
sellers? Which buyers?
 Demand substitutability / differentiation important
 Products or services are considered to be in the same
market if similar in the eyes of BUYERS
 Relevance of existing and potential buyers
 Relevance of existing and potential sellers
 Ease of entry and exit
Importance of markets (cont.)
MIT
Importance of markets (cont.)
 In a free and voluntary exchange, both parties (producers
and consumers) must gain, or at least one gains while the
other is no worse off, for a trade to take place
 Having a good product does not necessarily sell if there is
no demand for it (e.g., nobody uses typewriters anymore)
 Markets tend to exploit all mutually beneficial trades
 Important issues:
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The law of one price (in equilibrium)
Market power
Symmetry of information (or the lack of it)
Are externalities present?
Role of government policies
Mankiw 2009.
Government policies (cont.)
 Demand and supply are also influenced by economic
policy decisions of the government and central bank
 E.g., investment decisions are affected by the cost
and availability of credit; employment decisions are
influenced by labor market policies and taxation
 Aggregate demand: Y = C + I + e*(X – M) + G
 Aggregate supply: Y = f(L, K, ….)
 Decisions about fiscal, monetary, exchange rate, and
income policies important for consumers and firms
 They influence expectations and behavior
Government policies (cont.)
 Government’s policy objectives differ from those of
the private sector
 Private sector maximizes profits/value of the firm
 Government has broader objectives, for instance, to
promote social welfare and full employment
 Government often tries to balance benefits and
costs of its decisions to the society (cost-benefit
analysis more important that making profits)
 Government also considers distributional effects
 For instance, how are costs and benefits distributed
(e.g., building a public road)?