Cengage Webinar:
Managerial Economics:
A Problem-solving Approach
nd
(2 Edition)
Managerial Economics: A Problem Solving Appraoch (2nd Edition)
Luke M. Froeb, luke.froeb@owen.vanderbilt.edu
Brian T. McCann, brian.mccann@owen.vanderbilt.edu
Website, managerialecon.com
COPYRIGHT © 2008
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Why is teaching economics to MBA’s
so difficult?
 Students with varying backgrounds:
 English majors vs. Engineers;
 Econ. and Business majors;
 Executive MBA’s and non-degree Exec. Ed.
 Healthcare professionals
 Terminal class:
 Last microeconomics class most MBA’s will take
 Students want practical knowledge
 Not abstract theory
 Do MBA’s learn differently than we do?
Solution
 Use a problem-based pedagogy (instead of model-based)
 Begin with a real business problem
 Give students just enough analytical structure to understand the
problem and find a solution
 Teaches students to solve problems by
 Identifying profitable decisions (benefit-cost analysis)
 And implement them (principal-agent theory)
 Links study of economics to other MBA disciplines
 Accounting, finance, statistics, marketing, strategy, operations
4
Example: Over-bidding OCS gas tract
• A young geologist was preparing a bid recommendation for an
gas tract in the Gulf of Mexico.
• With knowledge of the productivity of neighboring tracts also
owned by company, the geologist recommended a bid of $5
million.
• Senior management, though, bid $21 million - far over the
next highest-bid of $750,000.
• What, if anything, is wrong?
• The goal of this text is to provide tools to help diagnose and
solve problems like this.
5
Analyze the over-bidding mistake
• Another clue:
• After winning the bid, the geologist increased the
estimated reserves of the company.
• But, after a “dry” well was drilled, the reserve
estimates were decreased.
• Senior Management stepped in and rejected the
decrease in the estimate (kept it high)
• Last clue:
• Senior management resigned several months later.
ANSWER: Manager bonuses for
increasing reserves
• The bonus system created incentives to over-bid.
• Senior managers were rewarded for acquiring
reserves regardless of their profitability
• Bonuses also created incentive to manipulate the
reserve estimate.
6
7
Problem solving
• Two distinct steps:
• Figure out what’s wrong, i.e., why the bad decision was made
• Figure out how to fix it
• Both steps require a model of behavior
• Why are people making mistakes?
• What can we do to make them change?
• Economists use the rational actor paradigm to model
behavior. The rational actor paradigm states:
• People act rationally, optimally, self-interestedly
• i.e., they respond to incentives – to change behavior you must change
incentives.
8
Keep the ultimate goal in mind
Align the incentives of employees with the
profitability goals of the company.
• How do we make sure employees have the
information necessary to make good decisions?
• And the incentive to do so?
9
How to figure out what is wrong
• Under the rational actor paradigm, mistakes are
made for one of two reasons:
• lack of information or
• bad incentives.
• To diagnose a problem, ask 3 questions:
1. Who is making bad decision?
2. Do they have enough info to make a good decision?
3. Do they have the incentive to do so?
10
How to fix it
• The answers will suggest one or more solutions:
1. Let someone else make the decision, someone with
better information or incentives.
2. Change the information flow.
3. Change incentives
• Change performance evaluation metric
• Change reward scheme
• Use benefit-cost analysis to choose the best (most
profitable?) solution
11
Coverage & Changes to 2nd ed.
• Traditional coverage (see TOC)
• Changes to second edition
• Examples from the financial crisis
• Additional material
• Insights from behavioral econ (psychological pricing, barriers to
rational decision making)
• Iceland: Trade, Foreign Exchange, Bubbles
• Chapters cut into smaller pieces
• Uncertainty & Auctions
• Long-run equilibrium & Strategy
12
1. Introduction: What this book is about
Managerial Economics 2. The one lesson of business
3.Benefits, costs and decisions
Table of contents
4. Extent (how much) decisions
5. Investment decisions: Look ahead and reason back
6. Simple pricing
7.Economies of scale and scope
8. Understanding markets and industry changes
9. Relationships between industries: The forces moving us towards long-run equilibrium
10. Strategy, the quest to slow profit erosion
11. Using supply and demand: Trade, bubbles, market making
12. More realistic and complex pricing
13. Direct price discrimination
14. Indirect price discrimination
15. Strategic games
16. Bargaining
17. Making decisions with uncertainty
18. Auctions
19.The problem of adverse selection
20.The problem of moral hazard
21. Getting employees to work in the best interests of the firm
22. Getting divisions to work in the best interests of the firm
23. Managing vertical relationships
24. You be the consultant
EPILOG: Can those who teach, do?