MANAGERIAL ECONOMICS

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MANAGERIAL ECONOMICS
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Assessment
Assessment Item Value Due Date
Individual Assignment 25 May 16th
Group Work 25 May 6th
Examination 50 May 24th
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Questions before class

• Should you sell the product at a price which is
  lower than the average total cost of the goods?
  Why?
• Why publishers sell international version
  textbook at low price?
• Is it a good idea for a monopoly supplier to sell
  more goods than what they do now?
• If you are a manager, how can you know production
  quantities?

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Nature and Scope of Managerial Economics

• Chapter 1

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What is managerial economics?

• Managerial economics applies economics tools and
  techniques to business and administrative
  decision making.

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• Why a grocery retailer may offer consumers milk
  at an extremely low markup over cost, say 1 to
  2, and offer nonprescription drugs at markups as
  high as 40 over cost?

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Theory of the Firm

• Firms are useful device for producing and
  distributing goods and services.
• The firm is thought to have profit maximization
  as its primary goal.
• maximize short-run profit.
• Today, the emphasis on profit has been broadened
  to encompass uncertainty and the time value of
  money

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Value of the Firm

• Present Value of Expected Future Profits

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Constrained Optimization

• To make decisions that maximize value, managers
  must consider how external constraints affect
  their ability to achieve organization objectives.
• Limited availability of essential inputs
• Limitations on investment funds
• Constrained by Contractual requirements
• Quality requirements
• Legal restrictions

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Limitations of the Theory of the Firm

• Optimize or satisfice?
• Value maximization
• Size or growth maximization
• Managers personal utility or welfare maximization

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Profit Measurement

• Business (accounting) profit
• Reflects explicit costs and revenues.
• Be measured in profit margin
• (profit/sales revenue).
• Economic profit.
• Profit above a risk-adjusted normal return.
• Considers cash and noncash items.
• Be assessed in terms of ROE (return on
  stockholders equity)
• (net income/book value of the firm)

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Economists versus Accountants
How an Economist
How an Accountant
Views a Firm
Views a Firm
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• Business profits vary widely.
• Average annual ROE in U.S. is 10.
• (Normal rate of return on capital is the
  minimum return necessary to attract and retain
  investment.)
• Variation in ROE
• differential risk premiums
• Overstate if accounting error or bias causes
  investments with long-term benefits to be omitted.

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Why Do Profits Vary Among Firms?

• Disequilibrium Profit Theories
• Frictional profit theory
• Abnormal profits result from unanticipated
  changes in demand and cost conditions
• Monopoly profit theory
• Some firms earn above-normal profits because of
  monopoly position.
• (economies of scale, high capital requirements,
  patents, import protection)
• Compensatory Profit Theories
• Above-normal rates of return reward firms for
  extraordinary success in meeting customer need,
  maintaining efficient operations, and so forth.

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Role of Economic Profits

• Economic profits play an important role in a
  market-based economy.
• Provide a signal for expansion and contraction.
• Important reward for innovation and efficiency.

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Structure of this Text

• Objectives
• Learn usefulness of economics in describing
  managerial behavior.
• Appreciate how economics can be used to improve
  managerial decisions.
• Understand vital role of business in society.