MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

Nature and Scope of Managerial Economics Chapter 1

Chapter 1 OVERVIEW How Is Managerial Economics Useful? Theory of the Firm Profit Measurement Why Do Profits Vary among Firms? Role of Business in Society Structure of this Text

Chapter 1 KEY CONCEPTS managerial economics theory of the firm expected value maximization value of the firm present value optimize satisfice business profit normal rate of return economic profit profit margin return on stockholders' equity frictional profit theory monopoly profit theory innovation profit theory compensatory profit theory

How Is Managerial Economics Useful? Evaluating Choice Alternatives Identify ways to efficiently achieve goals. Specify pricing and production strategies. Provide production and marketing rules to help maximize net profits. Making the Best Decision Managerial economics can be used to efficiently meet management objectives. Managerial economics can be used to understand logic of company, consumer, and government decisions.

Theory of the Firm Expected Value Maximization Owner-managers maximize short-run profits. Primary goal is long-term expected value maximization. Constraints and the Theory of the Firm Resource constraints. Social constraints Limitations of the Theory of the Firm Alternative theory adds perspective. Competition forces efficiency. Hostile takeovers threaten inefficient managers.

Profit Measurement Business Versus Economic Profit Business (accounting) profit reflects explicit costs and revenues. Economic profit. Profit above a risk-adjusted normal return. Considers cash and noncash items. Variability of Business Profits Business profits vary widely.

Why Do Profits Vary Among Firms? Disequilibrium Profit Theories Rapid growth in revenues. Rapid decline in costs. Compensatory Profit Theories Better, faster, or cheaper than the competition is profitable.

Role of Business in Society Why Firms Exist Business is useful in satisfying consumer wants. Business contributes to social welfare Social Responsibility of Business Serve customers. Provide employment opportunities. Obey laws and regulations.

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

MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

Demand and Supply Chapter 3

Chapter 3 OVERVIEW Basis for Demand Market Demand Function Demand Curve Basis For Supply Market Supply Function Supply Curve Market Equilibrium

Chapter 3 KEY CONCEPTS demand direct demand utility derived demand demand function demand curve change in the quantity demanded shift in demand Supply supply function supply curve change in the quantity supplied shift in supply equilibrium market equilibrium price surplus shortage comparative statics analysis

Basis for Demand Direct Demand Derived Demand Demand is the quantity customers are willing to buy under current market conditions. Direct demand is demand for consumption. Derived Demand Derived demand is input demand. Firms demand inputs that can be profitably employed.

Market Demand Function Determinants of Demand Demand is determined by price, prices of other goods, income, and so on. Industry Demand Versus Firm Demand Industry demand is subject to general economic conditions. Firm demand is determined by economic conditions and competition.

Demand Curve Demand Curve Determination The price-quantity demanded relation. All non-price variables are held constant.

Relation Between the Demand Curve and Demand Function Move along demand curve when price changes. Shift to another demand curve when non-price variables change.

Basis For Supply How Output Prices Affect Supply Firms offer supply to make profits. Higher prices boost the quantity supplied. Lower prices cut the quantity supplied. Other Factors That Influence Supply Everything that affects marginal production costs affects supply. If MC falls, supply rises. If MC rises, supply falls.

Market Supply Function Determinants of Supply Supply is determined by price, prices of other goods, technology, and so on. Industry Supply Versus Firm Supply Firm supply is determined by economic conditions and competition. Industry supply is the horizontal sum of firm supply.

Supply Curve Supply Curve Determination The price-quantity supplied relation. All non-price variables are held constant.

Relation Between Supply Curve and Supply Function Move along supply curve when price changes. Shift to another curve when non-price variables change.

Market Equilibrium Surplus and Shortage Surplus is excess supply. Shortage is excess demand.

Comparative Statics: Changing Demand Equilibrium changes with demand shifts. Comparative Statics: Changing Supply Equilibrium changes with supply shifts. Comparative Statics: Changing Demand and Supply

MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

Consumer Demand Chapter 4

Chapter 4 OVERVIEW Utility Theory Indifference Curves Budget Constraints Individual Demand Demand Curves and Consumer Surplus Consumer Choice Optimal Consumption

Chapter 4 KEY CONCEPTS budget constraint income effect utility nonsatiation principle indifference ordinal utility cardinal utility utility function utils market baskets marginal utility law of diminishing marginal utility indifference curves substitutes complements perfect substitutes perfect complements budget constraint income effect substitution effect price-consumption curve income-consumption curve Engle curve normal goods inferior goods consumer surplus two-part pricing bundle pricing optimal market basket revealed preference marginal rate of substitution consumption path

Utility Theory Assumptions About Consumer Preferences More is better. Consumers can rank preferences. Consumers ran-order desirability of products. Utility Functions Descriptive statement relates well-being and consumption. Marginal Utility Added benefit is focus of consumers. Law of Diminishing Marginal Utility Marginal utility eventually declines for everything.

Indifference Curves Basic Characteristics of Indifference Curves Higher indifference curves are better. Indifference curves do not intersect. Indifference curves slope downward. Indifference curves are concave to origin. Perfect Substitutes and Perfect Complements Perfect substitutes satisfy the same need. Perfect complements are consumed together.

Budget Constraints Basic Characteristics of Budget Constraints Shows affordable combinations of X and Y. Slope of –PX/PY reflects relative prices. Effects of Changing Income and Changing Prices Budget increase causes parallel outward shift. Budget decrease causes parallel inward shift. Income and Substitution Effects Income (substitution) effect is change in overall (relative) consumption.

Individual Demand Price-consumption Curve Income-consumption Curve Shows how consumption is affected by price changes (movement along demand curve). Income-consumption Curve Shows how consumption is affected by income changes (shifts from one demand curve to another). Engle Curves Plot between income and quantity consumed. Consumption of normal goods rises with income. Consumption of inferior goods falls with income (rare).

Demand Curves and Consumer Surplus Graphing the Demand Curve Demand curves always slope downward. Consumer Surplus Value received above amount paid. Consumer Surplus and Two-Part Pricing: An Illustration Membership fees and user fees extract consumer surplus for the seller. Consumer Surplus and Bundle Pricing Bundle pricing extracts consumer surplus for sellers.

Consumer Choice Marginal Utility and Consumer Choice Optimal consumption maximizes utility. Optimal consumption reflects marginal utility (benefits) and marginal costs. Revealed Preference Documented desire. Buyer decisions can be used to infer consumer preferences.

Optimal Consumption Marginal Rate of Substitution (MRS) MRSXY = -MUX/MUY and equals indifference curve slope. MRSXY shows tradeoff in the amount of X and Y consumed, holding utility constant. MRSXY diminishes as amount of substitution of X for Y increases. Utility Maximization Optimality requires PX/PY = MUX/MUY. Optimality requires MUX/PX = MUY/PY.

MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

Production Analysis and Compensation Policy Chapter 8

Chapter 8 OVERVIEW Production Functions Total, Marginal, and Average Product Law of Diminishing Returns to a Factor Input Combination Choice Marginal Revenue Product and Optimal Employment Optimal Combination of Multiple Inputs Optimal Levels of Multiple Inputs Returns to Scale Production Function Estimation Productivity Measurement

Chapter 8 KEY CONCEPTS ridge lines marginal revenue product economic efficiency net marginal revenue isocost curve (or budget line) constant returns to scale expansion path increasing returns to scale decreasing returns to scale output elasticity power production function productivity growth labor productivity multifactor productivity production function discrete production function continuous production function returns to scale returns to a factor total product marginal product average product law of diminishing returns isoquant technical efficiency input substitution marginal rate of technical

Production Functions Properties of Production Functions Production functions are determined by technology, equipment and input prices. Discrete production functions are lumpy. Continuous production functions employ inputs in small increments.

Returns to Scale and Returns to a Factor Returns to scale measure output effect of increasing all inputs. Returns to a factor measure output effect of increasing one input.

Total, Marginal, and Average Product Total Product Total product is total output.

Marginal Product Average product Marginal product is the change in output caused by increasing input use. If MPX=∂Q/∂X> 0, total product is rising. If MPX=∂Q/∂X< 0, total product is falling (rare). Average product APX=Q/X.

Law of Diminishing Returns to a Factor Diminishing Returns to a Factor Concept MPX tends to diminish as X use grows. If MPX grew with use of X, there would be no limit to input usage. MPX< 0 implies irrational input use (rare). Illustration of Diminishing Returns to a Factor

Input Combination Choice Production Isoquants Technical efficiency is least-cost production. Input Factor Substitution Isoquant shape shows input substitutability. C-shaped isoquants are common and imply imperfect substitutability.

Marginal Rate of Technical Substitution MRTSXY=-MPX/MPY Rational Limits of Input Substitution MPX<0 or MPY<0 are never observed.

Marginal Revenue Product and Optimal Employment MRPL is the revenue gain after all variable costs except labor costs. MRPL= MPL x MRQ = ∂TR/∂L. Optimal Level of a Single Input Set MRPL=PL to get optimal employment. Illustration of Optimal Employment

Optimal Combination of Multiple Inputs Budget Lines Least-cost production occurs when MPX/PX = MPY/PY and PX/PY = MPX/MPY Expansion Path Shows efficient input combinations as output grows. Illustration of Optimal Input Proportions Input proportions are optimal when no additional output could be produce for the same cost. Optimal input proportions is a necessary but not sufficient condition for profit maximization.

Optimal Levels of Multiple Inputs Optimal Employment and Profit Maximization Profits are maximized when MRPX = PX for all inputs. Profit maximization requires optimal input proportions plus an optimal level of output. Illustration of Optimal Levels of Multiple Inputs

Returns to Scale Returns to Scale Estimation Evaluating Returns to Scale Returns to scale show the output effect of increasing all inputs. Output Elasticity and Returns to Scale Output elasticity is εQ = ∂Q/Q ÷ ∂Xi/Xi where Xi is all inputs (labor, capital, etc.) εQ > 1 implies increasing returns. εQ = 1 implies constant returns. εQ < 1 implies decreasing returns. Returns to Scale Estimation

Production Function Estimation Cubic Production Functions Display variable returns to scale. First increasing, then decreasing returns are common. Power Production Functions Allow marginal productivity of each input to vary with employment of all inputs.

Productivity Measurement How Is Productivity Measured? Productivity measurement is the responsibility of the Bureau of Labor Statistics (since 1800s). Productivity growth is the rate of change in output per unit of input. Labor productivity is the change in output per worker hour. Uses and Limitations of Productivity Data Quality changes make productivity measurement difficult.

MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

Cost Analysis and Estimation Chapter 9

Chapter 9 OVERVIEW What Makes Cost Analysis Difficult Opportunity Cost Incremental and Sunk Costs in Decision Analysis Short-run and Long-run Costs Short-run Cost Curves Long-run Cost Curves Minimum Efficient Scale Firm Size and Plant Size Learning Curves Economies of Scope Cost-volume-profit Analysis

Chapter 9 KEY CONCEPTS historical cost current cost replacement cost opportunity cost explicit cost implicit cost incremental cost profit contribution sunk cost cost function short-run cost functions long-run cost functions short run long run planning curves operating curves fixed cost variable cost short-run cost curve long-run cost curve economies of scale cost elasticity capacity minimum efficient scale multiplant economies of scale multiplant diseconomies of scale learning curve economies of scope cost-volume-profit analysis breakeven quantity

What Makes Cost Analysis Difficult? Link Between Accounting and Economic Valuations Accounting and economic costs often differ. Historical Versus Current Costs Historical cost is the actual cash outlay. Current cost is the present cost of previously acquired items. Replacement Cost Cost of replacing productive capacity using current technology.

Opportunity Cost Opportunity Cost Concept Explicit and Implicit Costs Opportunity cost is foregone value. Reflects second-best use. Explicit and Implicit Costs Explicit costs are cash expenses. Implicit costs are noncash expenses.

Incremental and Sunk Costs in Decision Analysis Incremental Cost Incremental cost is the change in cost tied to a managerial decision. Incremental cost can involve multiple units of output. Marginal cost involves a single unit of output. Sunk Cost Irreversible expenses incurred previously. Sunk costs are irrelevant to present decisions.

Short-run and Long-run Costs How Is the Operating Period Defined? At least one input is fixed in the short run. All inputs are variable in the long run. Fixed and Variable Costs Fixed cost is a short-run concept. All costs are variable in the long run.

Short-run Cost Curves Short-run Cost Categories Total Cost = Fixed Cost + Variable Cost For averages, ATC = AFC + AVC Marginal Cost, MC = ∂TC/∂Q Short-run Cost Relations Short-run cost curves show minimum cost in a given production environment.

Long-run Cost Curves Economies of Scale Long-run cost curves show minimum cost in an ideal environment.

Cost Elasticity and Economies of Scale Cost elasticity is εC = ∂C/C ÷ ∂Q/Q. εC < 1 means falling AC, increasing returns. εC = 1 means constant AC constant returns. εC > 1 means rising AC, decreasing returns.

Long-run Average Costs

Minimum Efficient Scale Competitive Implications of Minimum Efficient Scale MES is the minimum point on the LRAC curve. Competition is most vigorous when: MES is small in absolute terms. MES is a small share of industry output. Disadvantage to less than MES scale is modest.

Transportation Costs and MES Terminal, line-haul and inventory costs can be important. High transport costs reduce MES impact.

Firm Size and Plant Size Multi-plant Economies and Diseconomies of Scale Multi-plant economies are cost advantages from operating several plants. Multi-plant diseconomies are cost disadvantages from operating several plants.

Economics of Multi-plant Operation: an Example Plant Size and Flexibility

Learning Curves Learning Curve Concept Learning Curve Example Learning causes an inward shift in the LRAC curve. Learning curve advantages are often mistaken for economies of scale effects. Learning Curve Example Strategic Implications of the Learning Curve Concept When learning results in 20% to 30% cost savings, it becomes a key part of competitive strategy.

Economies of Scope Economies of Scope Concept Scope economies are cost advantages that stem from producing multiple outputs. Big scope economies explain the popularity of multi-product firms. Without scope economies, firms specialize. Exploiting Scope Economies Scope economics often shape competitive strategy for new products.

Cost-volume-profit Analysis Cost-volume-profit Charts Cost-volume-profit analysis shows effects of varying scale. Breakeven analysis shows zero profit points of cost coverage.

Degree of Operating Leverage DOL=Q(P-AVC)/[Q(P-AVC)-TFC] DOL is the elasticity of profit with respect to output.

MANAGERIAL ECONOMICS 11th Edition By Mark Hirschey

Competitive Markets Chapter 10

Chapter 10 OVERVIEW Competitive Environment Factors That Shape the Competitive Environment Competitive Market Characteristics Profit Maximization in Competitive Markets Marginal Cost and Firm Supply Competitive Market Supply Curve Competitive Market Equilibrium

Chapter 10 KEY CONCEPTS normal profit economic profit market structure economic losses marginal analysis competitive firm short-run supply curve competitive firm long-run supply curve. market structure market potential entrant product differentiation competitive markets barrier to entry barrier to mobility barrier to exit perfect competition price takers

Competitive Environment What is Market Structure? Market structure is the competitive environment. Number of buyers and sellers. Potential entrants. Barriers to entry and exit, etc. Vital Role of Potential Entrants Competition comes from actual and potential competitors. Potential entrants often affect price/output decisions.

Factors that Shape the Competitive Environment Product Differentiation R&D, innovation, and advertising are important in many markets. Production Methods Economies of scale can preclude small-firm size. Entry and Exit Conditions Barriers to entry and exit can shelter incumbents from potential entrants. Buyer Power Powerful buyers can limit seller power.

Competitive Market Characteristics Basic Features Many buyers and sellers. Product homogeneity. Free entry and exit. Perfect information. Examples of Competitive Markets Agricultural commodities. Prominent markets for intermediate goods and services. Unskilled labor market.

Profit Maximization in Competitive Markets Profit Maximization Imperative Normal profit is return necessary to attract and maintain capital investment. Efficient firms can earn normal profit. Inefficient firms suffer losses. Role of Marginal Analysis Set Mπ = MR – MC = 0 to maximize profits. MR=MC when profits are maximized.

Marginal Cost and Firm Supply Short-run Firm Supply Competitive market price (P) is shown as a horizontal line because P=MR. Firm’s marginal-cost curve shows the amount of output the firm would be willing to supply at any market price. Marginal cost curve is the short-run supply curve so long as P > AVC .

Long-run Firm Supply Marginal cost curve is the long-run supply curve so long as P > ATC. In long run, firm must cover all necessary costs of production and earn a normal profit.

Competitive Market Supply Curve Market Supply With a Fixed Number of Competitors Supply is the sum of competitor output. Market Supply With Entry and Exit Entry results in more firms, increased output, a rightward shift in the supply curve, and drives down prices and profits. Exit reduces the number of firms, decreases the quantity of output, shifts the supply curve leftward, and allows prices and profits to rise for remaining competitors.

Competitive Market Equilibrium Balance of Supply and Demand Equilibrium is a balance of supply and demand. Normal Profit Equilibrium With a horizontal market demand curve, MR=P. P=MR=MC=ATC. There are no economic profits. All firms earn a normal rate of return.