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Managerial Economics
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TEXT BOOK
Managerial Economics WWW.mhhe.com/economics/maur
ice7
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The author
S.Charles Maurice ???? AM?? Christopher R
Thomas ???????
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REFERRENCE
1. P A Samuelson,W D Nordhaus. Economics.16th
Edition,1998,McGraw-Hill Companies,Inc. 2.
Joseph E Stiglitz.Economics.2th edition,1997,W W
Norton Company 3. Robert S Pindyck,Daniel L
Rubinfeld. Microeconomics.5th edition,2001,Prentic
e-Hall
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4. Hal R Varian. Intermediate MicroeconomicsA
Modern Approach. 5th eds, W W Norton Company,
1999 5. Gregory N Mankiw. Principles of
Economics. The Dryden Press, 1998 6. James R .
McGuigan, R Charles Moyor, Frederick H.
Management EconomicsApplication, Strategy, and
Tactics
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Why do we learn Managerial Economics?

• Business students who wish to become successful
  managers of business enterprises should
  understand how the economic forces of the market
  create both opportunities and constraints for
  making profit.

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• Managerial Economics brings together those topics
  in microeconomic theory that can be applied to
  business decision making to create a powerful and
  timeless way of thinking about markets and
  business decisionsboth today decisions and
  tomorrow.

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What is Managerial Economics?

• Managerial economics applies microeconomic
  theory-the study of the behavior of individual
  economic agents -to business problems in order to
  teach business decision makers how to use
  economic analysis to make decisions that will
  achieve the firms goal the maximization of
  profit.

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Emphasis on the Economic Way of Thinking

• The primary goal of this book continues to teach
  students the economic way of thinking about
  business decisions. Managerial Economics
  emphasizes critical thinking skills and provides
  students with a logical way of analyzing business
  decisions.
• Emphasize active study rather than passive
  study.

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Chapter 1 Managers,Profits,and Markets

• Managerial economics and economic theory
• maximizing profit
• separation of ownership and control
• market structure and Managerial decision making

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Some basic understandings
In Chinese lectures, the instructor usually
follow the practice
Give further examples or analysis
What is managerial economics?
Explain the context
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But in the original English textbook, the
order is just inverted.
To find problems (case study)
To summarize the theory
Try to find solutions
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• 1.1Managerial economics and economic theory
• Economics tells you basis theories and
  principles (which may be found not applicable)
• Managerial economics tells you how to manage
  your firm economically.
• p4

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Problems faced by decision makers in management
Managerial economics, which applies and extends
economics and the decision science to solve
management problems
Decision science
Economic theory
Solutions to decision problems faced by managers
Relationship between managerial economics and
related disciplines
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• Managerial economics provides a systematic,
  logical way of analyzing business decisions that
  focuses on the economic forces that shape both
  day-to-day decisions and long-run planning
  decisions. Managerial economics applies
  microeconomic theory-the study of the behavior of
  individual economic agents -to business problems
  in order to teach business decision makers how to
  use economic analysis to make decisions that will
  achieve the firms goal the maximization of
  profit.

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• Economic theory helps managers understand
  real-world business problems by using simplifying
  assumptions to abstract away from irrelevant
  ideas and information and turn complexity into
  relative simplicity. Like a road map, economic
  theory ignores everything irrelevant to the
  problem and reduces business problems to their
  most essential components.

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e.g. You are an ice-cone firm. In the just
passing summer, your performance were not so
satisfactory as a whole, so you are thinking of
some possible decisions for the next summer. ?
What will you do?
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Profit maximization
Satisfactory EPS ( Earning per share)
Not so satisfactory
Market share
Market growth rate, etc
(usu. )Profit maximization
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1.2 maximizing profit

• In practice,owners of firms,seeking to increase
  their personal wealth,generally do run a business
  primarily for the purpose of making as much
  profit as possible.This text focuses on making
  profitable business decisions.
• Usually firms are assumed to maximize its
  profits

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1.2.1 Economic profit versus Accounting profit

• Economic profit is the difference between a
  firms total revenue and the total economic cost
  of using productive resources. The economic cost
  of using resources is the opportunity cost of
  using those resources.

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• For resources owned by others, the opportunity
  cost of resource use is the dollar amount paid to
  the resource owners.These payments made to
  resource owners are called explicit costs.For
  resources the firm uses that are owned by the
  firm, the opportunity cost is equal to the
  largest payment that the owner could have
  received if those resources had been leased or
  sold in the market.These costs of using a firms
  own resources are called implicit costs.

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• economic profitThe difference between total
  revenue and total economic cost, including both
  explicit and implicit costs.
• explicit costsThe opportunity cost of using
  resources owned by others.
• implicit costsThe opportunity costs of using
  resources owned by the firm

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• accounting profit differs from economic profit
  because accounting profit does not subtract from
  total revenue the implicit costs of using
  resources.The value of owning a business is
  measured by economic profit rather than
  accounting profit.accounting profitThe
  difference between total revenue and explicit
  costs.

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• The opportunity cost of using the owners own
  resources is called normal profit. Normal profit
  is part of total cost,just another name for the
  implicit cost . When economic profit is zero, the
  firm is just earning a normal profit. When
  economic profit is positive (negative), the firm
  earns more (less) than a normal profit. Since
  accountants are not allowed to deduct normal
  profit as a cost, economic profit is less than
  accounting profit by the amount of normal profit

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• Economic profit Accounting profit - Normal
  profit
• normal profitThe implicit cost of
  owner-supplied resources.
• p7

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• Since all costs matter to owners of a firm,
  maximizing economic profit, rather than
  accounting profit, is the objective of the firms
  owners.
• p23 1. 2.

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1.2.2 maximizing the value of the firm

• The value of a firm is the price for which it can
  be sold, and that price is equal to the present
  value of the expected future profits of the firm.
  

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Present value
Why you prefer money today? It is the property of
the passage of time.
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Since interest can be earned over time
means that, all future costs and revenues (future
cash flows) must be discounted to get the present
value (PV).
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• value of a firmThe price for which the firm can
  be sold, which equals the present value of future
  profits.

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• The risk associated with not knowing future
  profits of a firm is accounted for by using a
  higher risk-adjusted discount rate to calculate
  the present value of the firms future profits.
  The larger (smaller) the risk associated with
  future profits, the higher (lower) the
  risk-adjusted discount rate used to compute the
  value of the firm, and the lower (higher) will be
  the value of the firm.

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• risk premiumAn increase in the discount rate to
  compensate investors for uncertainty about future
  profits.

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• In the absence of any agency problems, the
  objective of a manager is to maximize the value
  of the firm. A manager will maximize the value of
  a firm by making decisions that maximize profit
  in every single time period, unless cost and/or
  revenue conditions in any period depend upon
  decisions made in other time periods.If
  increasing current output has a positive effect
  on----.single-period profit.

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1.3 separation of ownership and control

• Traditional objective Profit Maximization
• 
  (the only objective)
• In reality a wide range of objectives
• personal goals
• company growth target
• maximization of market share, etc

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1.3.1the principal-agent problem

• In firms where the managers are not also the
  owners, the managers are agents of the owners, or
  principals.
• A principal-agent problem exists when the agent
  has objectives different from those of the
  principal, and the principal either has
  difficulty enforcing agreements with the agent or
  finds it too difficult and costly to monitor the
  agent to verify that he or she is furthering the
  principals objectives.

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• Agency problems arise because of moral hazard.
  Moral hazard exists when either party to an
  agreement has an incentive not to abide by all
  the provisions of the agreement and one party
  cannot cost-effectively find out if the other
  party is abiding by the agreement or cannot
  enforce the agreement even when the information
  is available.

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• Principal-agent problemThe conflict that arises
  when the goals of management (the agent) do not
  match the goals of the owner (the principal).
• moral hazardExists when either party to an
  agreement has an incentive not to abide by all
  provisions of the agreement and one party cannot
  cost-effectively monitor the agreement.

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Illustration 1.3

• In many industries, the most profitable firms are
  not the largest or fastest-growing ones, as
  illustration 1.3 shows.

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1.3.2 corporate control mechanisms

• In order to address agency problems, shareholders
  can employ a variety of corporate control
  mechanisms. Shareholders can reduce or eliminate
  agency problems by (1) requiring that managers
  hold a stipulated amount of the firms equity,
  (2) increasing the percentage of outsiders
  serving on the companys board of directors, and
  (3) financing corporate investments with debt
  instead of equity. Corporate takeovers also
  create an incentive for managers to make
  decisions that maximize the value of a firm.

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1.4 market structure and Managerial decision
making

• The structure of the market in which a firm
  operates can limit the ability of managers to
  increase the price of the firms products.
• In some markets, firms are price-takers. In these
  markets prices are determined not by managers but
  by market forces that cannot be controlled.
• In other markets, managers of price-setting firms
  possess some degree of market power and can raise
  price without losing all their sales.

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• price-taker A firm that cannot set the price of
  the product it sells, since price is determined
  strictly by the market forces of demand and
  supply.
• price-setting firm A firm that can raise its
  price without losing all of its sales.
• market power A firms ability to raise price
  without losing all sales.

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1.4.1what is a market?

• A market is any arrangement that enables buyers
  and sellers to exchange goods and services,
  usually for money payments.
• A market may be a location at a certain time, a
  newspaper advertisement, a website on the
  Internet, or any other arrangement that works to
  bring buyers and sellers together. Markets exist
  to reduce transaction costs, the costs of making
  a transaction.

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• marketAny arrangement through which buyers and
  sellers exchange anything of value.
• transaction costsCosts of making a transaction
  happen, other than the price of the good or
  service itself.

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1.4.2 different market structures

• A market structure is a set of market
  characteristics that determines the economic
  environment in which a firm operates (1) the
  number and size of the firms operating in the
  market, (2) the degree of product
  differentiation, and (3) the likelihood of new
  firms entering.

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• A perfectly competitive market has a large number
  of relatively small firms selling an
  undifferentiated product with no barriers to
  entry. A monopoly market is one in which a single
  firm, protected by barriers to entry, produces a
  product that has no close substitutes. In a
  monopolistically competitive market, a large
  number of relatively small firms produce
  differentiated products without any barriers to
  entry. Finally, in an oligopoly market, there are
  only a few firms experiencing interdependence-each
  firms pricing decision affects all other
  firmssprofits-with varying degrees of product
  differentiation and barriers to entry.

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• market structure Market characteristics that
  determine the economic environment in which a
  firm operates.

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