Economic Analysis for Managers (ECO 501) Fall Semester, 2012 Khurrum S. Mughal

Course Material Required Texts & Readings: Managerial Economics, by H. Craig Petersen & W. Cris Lewis Recommended Readings: Articles from Managerial Economics in a Global Economy, 5th Edition, by Dominick Salvatore Economist Weekly, Business Section.

Economics

Economics Definition: How societies use scarce resources to produce valuable goods and services and distribute them among different individuals. (Economics, 19th Edition by Paul A. Samuelson & William D. Nordhaus)

Economics Scarcity Efficiency Production is never high enough to meet everyone’s demand Wants are unlimited Efficiency An economy is producing efficiently unless no individual’s economic welfare can be improved unless someone else is made worse off

Basics of Economics Microeconomics Study of economics at smaller scale Adam Smith: Markets, Firms, & Households Wealth of Nations (1776): Determination of prices of land, labour, & capital; and strength and weaknesses of market mechanism Macroeconomics Study of overall performance of the economy General Theory of Employment, Interest & Money, John M Keynes (1936) What causes business cycles, with alternating spells of high unemployment and high inflation Fallacies Encountered in Economic Reasoning: The post hoc fallacy - causality Failure to hold other things constant The fallacy of composition

Basics of Economics Positive Economics Normative Economics Based on facts of an economy Normative Economics Involves ethical precepts and norms of fairness

Basics of Economics Types of Economies Market Economies: Individual and private firms make the major decisions regarding production and consumption (laissez-faire economy) Command Economies: Government makes all important decisions about production and distribution Mixed Economies

Basics of Economics Limited Resources: Land Labour Energy Factories and tools Technical knowledge etc. Allocation among innumerable possibilities Choice of input and output allocation Factors of Production: land, labour and capital

Basics of Economics

Basics of Economics Opportunity Cost: The cost of giving up any activity when one makes a choice to choose the best possible alternative Example: Choosing between production of computers and printers by a firm on PPF

Basics of Economics Marginal Analysis: How much you get from using one more unit Marginal Utility Marginal Product Marginal Revenue Marginal Cost

Basics of Economics Time Dimension: Short Run Long Run Operating period in which at least one factor of production is in fixed supply Long Run Operating period in which all factors of production are in variable supply Short Run Profits Vs Long Run Success of Business

Managerial Economics Application of theory and tools of analysis of decision science to examine how an organization can achieve its aims and objectives most efficiently

Management Decision Problems Managerial Economics Management Decision Problems Economic Theory: Micro & Macroeconomics Decision Science: Mathematical Economics and Econometrics Managerial Economics: Application of economic theory and decision tools to solve managerial decision problems

Relationship to Economic Theory Linked to individual firms investment decision, production and preferences of consumers. Macroeconomic conditions in which a firm is functioning. Economic theories aim to predict economic behaviour Theory of the firm is of utmost importance for Managerial Economics

Relationship to Decision Sciences Mathematical Economics is used to formalize the economic models of economic theory in the form of an equation Econometric tools are used to statistically analysis the models using real world data The tools are used for forecasting as well. For Example: Demand of Education

Relationship with Business Administration Integration of Economic Theory, Decision Science Tools, and Business Areas of Study Managerial Decision Process: Establishing the objective of the firm Problems and Obstacles towards achieving the objective Identifying the range of possible solutions Selecting the optimal solution Implementation of the solution

Relationship with Business Administration Types of Business Decisions Price and Output Decisions Demand Estimation Choice of technique of production Advertising Decisions Long-run Production Decisions Investment Decisions

Theory of The Firms Definition: A firm is an organization that combines and organizes resources for producing goods/services for sale Without firms it would be very costly for entrepreneurs to organize production or service activities Firms exist to save on transaction costs The larger a firms grows…………diminishing returns to management A firm pay household for their services and the income is used to buy commodities of the firm

Theory of The Firms Objective of the Firm: Traditionally to maximize short term profits The expenditure on R & D, New Capital Equipment and enhanced promotional campaigns are signals of long run profitability and growth. Primary Objective: Maximize the wealth or value of the firm

Theory of The Firms Value of the Firm: Discounted Stream of all the future profits of the firm Time dimension allows for uncertainty in future

Theory of The Firms TR depends on sales and product price TC depends on the resources and technology of production Discount Rate (r) depends on the perceived risk of the firm and on the cost of borrowing of funds To enhance the value of the firm: Marketing Dept can organize off season sales Production & HR Depts can enhance quality and introduce new products Accounts Dept can provide the cost and sale info well in time

Principal-Agent Problem Maximizing vs Satisficing Principal Agent Problem/Agency Problem Solutions

Profit Role of Profit Accounting Profit Economic Profit Opportunity Cost Economic Profit Vs Normal Profit Role of Profit Signal to Producers Encouragement to entrepreneurs

Theories of Profit Risk Bearing Theories of Profit Above normal profits like in oil and gas exploration sector Frictional Theory of Profit Profits arise from disturbances or friction in long-run equilibrium Monopoly Theory of Profit Firms with monopoly power can restrict output and charge higher prices than under perfect competition

Theories of Profit Innovation Theory of Profit Profit is the reward of a successful innovation Managerial Efficiency Theory of Profits Firms with avg efficiency earns avg rate of return as compared to an efficient firm in terms of management of productive operation and successfully meeting consumer needs

Functional Relationships in Economics y=f(x) or y=g(x,z) or y=h(x1, x2,…..xn) Total, Average and Marginal Products Example: Labor to be employed in Construction Economic Models: Experiments similar to Natural science experiments by holding everything else constant

Economic Models Equilibrium Qd=Qs Example of Demand and Supply Demand Function Qd=a-bP where b<0 Supply Function Qs=c+dP where d>0 Equilibrium Qd=Qs