Managerial Economics Duke MBA Cross Continent

Global Economics for Managers

MBA 505

1



Stephen E. Margolis

MBA 505 Economics for

Managers

2

Economics

It’s not about the money


Managers

3

Economics Defined

The study of:

• Responses of humans to unlimited wants and limited resources .

• Scarcity

Elaborations:

• Exchange (James Buchanan)

• Optimization and coordination

MBA 505 Economics for Managers

So, what are we?

• Greedy materialists?


So, what are we?

• Greedy materialists?

Or

• Noble visionaries?


Our concern is with anything that people value.

• Yes, it’s all the stuff we buy: food, shelter, clothing, entertainment, education, medical care, automobiles, travel, jewelry, art, gadgets and so on.

• It is also everything else we value. Security, health, clean air and water, leisure, privacy,

…children…


But isn’t scarcity temporary?

• No

• We will live in scarcity – in the economists sense of it, so long as we can imagine things we would like to have….more food, better food, better health, safer cars, cleaner air, faster travel, more free time.

• So again, is it greed? Imagination?


Adam Smith on self interest:

He advocates generosity in The Theory of

Moral Sentiments , but in The Wealth of

Nations famously offers this:

“It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest”


What Makes Economics Different?

• Scarcity: The inevitability of choice.

9

Cost is the value of what is given up— Opportunity Cost

• Rationality: People pursue their own interests as they know it.

• Competition

• Individualism:

As a methodology

As an ethical foundation


Today’s Lecture

• Definition (done)

• Course operation

• Approach to economics

• Law of demand

• Supply and demand

• Prices

• Costs

• Comparative Advantage

10


Course Operation

• Syllabus

• Groups

• Evaluation

• Moodle

• Paper

11


About this course

• Economics for business

• Primarily microeconomics, but with some coverage of macroeconomics and the principles of trade

• Introductory—intermediate level

• Economics of business decisions

• Applied as opposed to theoretical

• It can be a first course in economics.


P

P m

13

(Don’t copy this down)

MC

MR D

Q


Managers

P

5675

P m

(This either)

MC

14

12389

MR

456550

D

Q


Managers

Objectives

• Understand how markets work

• Understand the economic logic in business decisions.

In other contexts this is expressed as organization and optimization , respectively.


Normative and Positive

Economics

• Positive

• Normative

• Prescriptive

16


Normative and Positive

Economics

• Positive: What is

• Normative: What’s good

• Prescriptive: What to do

(See Normative)

17


Managers Are Teachers



Stephen E. Margolis

Mathematics

19

Algebra 1?

y = mx + b p = a - bq


a

P

This will become familiar

P = a - bQ a/b

Q/t


a

P

This will become familiar

P = a - bQ

-b is the slope, a is the vertical intercept a/b

Q/t


More math

I will use some calculus. It will always be optional.

Some things are easier and more persuasive that way.


Back to Economics

Demand, Supply, and Equilibrium

A very quick overview.

Incentives matter.

We pick the low hanging fruit first.

The fundamental structure of economics


Incentives matter.

The fundamental structure of economics

We pick the low hanging fruit first.

Law of demand The law of diminishing marginal product

Supply behavior


The Law of Demand

If the price of some good goes up, all other things equal, the quantity of the good that is consumed will fall.

Incentives Matter

What would the alternative be?

26


Managers

Suppose

Green Peppers

Regular Price: $.99 per pound

Today Only: $1.49


Price

Demand as a Diagram

28

0

Q/t

A flow


Managers

Demand as a Diagram

(My coffee consumption)

Price

3.00

2.00

1.00

0

*

*

*

1 2 3

29

Q/t

A flow


Managers

Demand as a Diagram

Hillsborough St. Shops

Price

3.00

2.00

1.00

0

30

*

*

*

1,000 2,500 5000

A flow

Q/t


Managers

It’s not (just) about the money

• Extensions to the law of demand

– Seatbelts

– Meetings

– Emily’s Band-Aids

– Insulin

– Shaving

31


P Supply

S

32

Q/t


Managers

P

Po

33

S and D

S

D

Qo

Q/t


Managers

P

Po

34

Price Adjustment

D

Q/t


Managers

P

Po

More price Adjustment

35

D

Q/t


Managers

P

P’

Po

36

S and D

S’

S

D

Qo

Q/t


Managers

P

Po

P

1

37

S and D

S

S

’

D

Qo Q

1

Q/t


Managers

P

Po

38

S and D

S

D

D

1

Qo Q

1

Q/t


Managers

P

S and D (one more time)

S

Po

P

1

39

Q

1

Q

0

D

D’

Q/t


Managers

40

About Prices


Managers

41

About Prices

• Chapter 2 material.

• What matters is relative price.

– How many restaurant meals per month do I give up to make payments on an Cayman S.

– How many loaves of bread do I give up to get a bottle of wine?

– How many hours of leisure do I give up to get a

60” HDTV


Suppose every price doubles

• You wage is a price, that doubles too.

• So do all your stocks.

• And your bonds too. (Although that one is more of a fantasy)

What Happens?


43

2008 2013

Movie 6.00

Ticket

9.00

1 lb.

Coffee 10.00

12.00


Managers

What Is Pure Inflation?

44

A balanced increase in the prices of all goods, services and non money- denominated assets.


Managers

45

Does that ever happen?


Managers

46

Does that ever happen?

Well actually, No.


Managers

47

What about the overall price level?

Suppose some prices went up 20% and some prices went up 50%, and you wanted to know what happened to the price level?


Managers

Laspeyres Index

The cost of the old bundle at the old prices


49

A price index

L

 i

N 



1 i

N 



1

P i , t q i , 0

P i , 0 q i , 0



100


Managers

Even Steven

Vegetarians, just make believe for a minute.

Suppose the price of beef goes up dramatically, but no other price changes. Suppose further that the cost of the bundle that you consume goes up exactly 5%. And finally, suppose you get a raise of exactly 5%, just to keep things even. Are things even?

50


Managers

Opportunity Cost Again

• Again, it is the concept of cost in economics.

• If taking an action does not impose any forgone opportunity, it has no cost.

• The empty factory floor


Exchange and Production

“The division of labour is limited by the extent of the market” Adam

Smith

52

Specialization is a fundamental issue in economics, a fundamental characteristic of modern life


Managers

Paul

Comparative Advantage

Motor

40

Paint

30

45

Steve 30

53


Managers

Paul

Comparative Advantage

Motor Paint

40 30 70

50

Steve 30 80

54


Managers

Specialization

Motor Paint

Paul 40

30

30

50

70

80

Steve

Steve does both motors and finishes in 60 hours, Paul does both paint jobs; 60 hours.

55


Managers

Costs

Motor Paint

Paul 40 30 70

Steve 30 50 80

If Paul paints both cars he takes 60 hours

If Steve reworks both motors, he also takes 60 hours.

56


Managers

Costs

Motor Paint

Paul 40 30 70

Steve 30 50 80

Steve’s cost of a motor is 3/5 of a paint job.

Paul’s cost of a motor is 4/3 of a paint job.

57

Steve is the low cost provider of motor work


Managers

Costs

Motor Paint

Paul 40 30 70

Steve 30 50 80

Steve’s cost of a paint job is 5/3 of a motor overhaul.

Paul’s cost of a paint job is 3/4 of a

58 motor overhaul.

Paul is the low cost provider of painting.


Managers

59

Now, Suppose Steve is worse at both activities.

Motor Paint

Paul 40 30 70

Steve 45 75 120

CAN THEY TRADE?


Managers

Steve’s comparative advantage?

Motor Paint

Paul 40 30 70

60

Steve 45 75 120

Steve does both motors, finishes in 90 hours. Paul does both paint jobs, finishes in 60. Notice that Steve’s opportunity costs haven’t changed.


Managers

Lesson

Your can be better at everything and still be the high cost provider, in terms of opportunity cost, of something.

You can be worse at everything and still be the low cost provider, in terms of opportunity cost, in something.

61

You may have an absolute advantage in no activity and still have a comparative advantage in something.


Managers

Consumer Theory

• Foundations of demand

• Illustrates choice under uncertainty

• A tool for conceptualizing certain problems

• Used in business fields

– Finance

– Marketing

62


What we assume about preferences.

• More is preferred to less

• Consumers are willing to substitute

• If A is preferred to B, and P is preferred to

C, then A is preferred to C

• The more x you have and the less y, the more x you would be willing to give up to get additional units of y.

63


Introducing…


So, you’re driving to work….

In need of coffee. You pull into the parking lot of an odd shop marked only by the sign:

DONUTS

There is also something slightly odd about the man behind the counter.

There is a display case that might once have displayed prices.


You order your coffee and then you ask,

“How much is a donut?”


A march down the demand curve

.

80

.70

.60

.

50

.

40

.30



.

80

.70

.60

.

50

.

40

.30

So the donut seller says, $.80. and then, if you want a second,

$.70. And if you want a third…



$

.

80

.70

.60

.

50

.

40

.30

.80 + .70 + .60 + .50 + .40 + .30 = $3.30

And yet, to sell six donuts with simple pricing, you would have to charge how much per donut?

And revenue would be what?

Donuts



$

.

80

.70

.60

.

50

.

40

.30

.80 + .70 + .60 + .50 + .40 + .30 = $3.30

Conventional pricing would require a price of $.30 to get the buyer to purchase six donuts, yielding revenue of 6*.30 = 1.80

Donuts


OK, swell, what’s the point?

• Diminishing marginal valuation

• The step function that we see is also the individual’s demand curve.

• So, downward sloping demand originates in diminishing marginal evaluation


We will see the donut seller again

• Consumer surplus

• Price discrimination


The Science of Success.

Why this book?

• The theme of this course is, what ideas that are accepted principles in economics are readily carried into business management?

• And related, to that, how does economics help us to better understand accepted business principles?

Market Based Management

• Views the firm as a miniature societies.

• Uses the principles that permit societies to prosper.

• These principles include the principles of markets.


Examples of applied economics

• Opportunity cost (p. 33, 109)

• Marginal analysis (p. 107)

• Comparative advantage (p. 35-6 and elsewhere)


And still more

Comparative advantage:

Unless two people (nations) are exact multiples of each other in terms of productivity, they will each have a comparative advantage, even if one is absolutely better in each activity.

The more productive party will benefit from practicing the activity in which it has the greatest advantage. The less productive party will benefit from practicing the activity in which it is least disadvantaged.

77

Elasticity

How we characterize demand and supply functions.

Here we will deal with price elasticity of demand.

78

Dreaded Elasticity

79

Scared as a Child?

 

Q

1

Q

1

P

1

P

1









Q

2

Q

2

P

2

P

2

MBA 505

80

Hear Elasticity…

Think

Responsiveness

P

P

P’

Q

81

P

P’

P

Q

Q’

Q’

D

Q

Elastic

Q

Inelastic

82

P

P

P’

P

P’

P

Q

Q

Responsive

D

Elastic

Q’

Q

Not so responsive

Inelastic

Q’

Q

Is it just slope?

83

Suppose price goes up $1 and the number of units sold goes down 100,000 units.

Responsive or not?

We need to know not just the change in quantity and the change in price, but also the price and quantity. We get







Q

Q



P

P



100



100



%



Q

%



P

84

85







Q

Q



P

P

Rearranging:





Q

Q

P



P





Q



P

P

Q

Or, letting



P and



Q get small:

  dQ dp p q

Examples

• Your sales force reports that if they were to cut price by 10%, units sold would increase by 14%. What is the elasticity of demand?

• You are given a study that says that the elasticity of demand for one of your products is –2.5. A price increase of 4% will do what to units sold?

86

87

A simple numerical example

Q=4000-.5P

What is the price elasticity of demand when P is 1500?

88

A simple numerical example

Q=4000-.5P


  dQ dP

P

Q

89

Q=4000-.5P


  dQ P dP



.

23

Q

  

.

5

1500

3250

  

.

23

Now consider the relationship between price changes and revenue.

For example, if you raise price, what happens to revenue?

Does revenue always go up?

90

For example, if you raise price, what happens to revenue?

Does revenue always go up?

If you said no, you’re correct. If demand is very responsive, then the decrease in quantity will more than offset the increase in price.

91

.

Elasticity informs us about the effect of price changes on revenues. For this purpose, its more convenient to talk about the absolute values of elasticity. IF:

 



1 ,

Then the proportionate change in quantity is greater than the proportionate change in price. Revenues will increase when price

92 decreases.

93

On the other hand, IF:

 

1

.

Then the proportionate change in quantity is less than the proportionate change in price.

Revenues will decrease when price decreases.

NC State MBA Program Fall

2002

94

Elasticity varies along a straight-line demand curve.

P

P/Q is large

P/Q is small

D

Q


2002

Here’s a useful mnemonic;

95

P The arrows point in the direction of increased revenues.

Elastic

 

1

Inelastic

Revenues are maximized where

 

1

D

Q


2002

Managerial Economics Duke MBA Cross Continent

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