Managerial Economics & Business Strategy Chapter 1 The Fundamentals of Managerial Economics

Opportunity Cost Accounting Costs n The explicit costs of the resources needed to produce produce goods or services. n Reported on the firm’s income statement. Opportunity Cost n The cost of the explicit and implicit resources that are foregone when a decision is made. Economic Profits n Total revenue minus total opportunity cost.

Why use opportunity cost? Situation: You are able to open a pizza shop in a building that you own. During the year Uncle Vinnie offers you a job with his pizza shop (he wants to eliminate the competition) which will pay $30,000 and Aunt Judy offers you $100,000 to rent the building for a year for her new hair salon. You decide to continue with your pizza shop. At the end of the year you calculate the following on your income statement. n Revenue = $100,000 n Cost of Supplies = $20,000 Did you make a good decision???

Did you??? Accounting profit n 100, ,000 = 80,000 n Looks like you did!!! Economic profit n 100,000 – 20,000 – 30,000 – 100,000 = -$50,000 n You could have done better by taking them up on their offers

Sustainabl e Industry Profits Power of Input Suppliers  Supplier Concentration  Price/Productivity of Alternative Inputs  Relationship-Specific Investments  Supplier Switching Costs  Government Restraints Power of Buyers  Buyer Concentration  Price/Value of Substitute Products or Services  Relationship-Specific Investments  Customer Switching Costs  Government Restraints Entry  Entry Costs  Speed of Adjustment  Sunk Costs  Economies of Scale  Network Effects  Reputation  Switching Costs  Government Restraints Substitutes & Complements  Price/Value of Surrogate Products or Services  Price/Value of Complementary Products or Services  Network Effects  Government Restraints Industry Rivalry  Switching Costs  Timing of Decisions  Information  Government Restraints  Concentration  Price, Quantity, Quality, or Service Competition  Degree of Differentiation The Five Forces Framework

Market Interactions Consumer-Producer Rivalry n Consumers attempt to locate low prices, while producers attempt to charge high prices. Consumer-Consumer Rivalry n Scarcity of goods reduces the negotiating power of consumers as they compete for the right to those goods. Out-bid or under-bid Producer-Producer Rivalry n Scarcity of consumers causes producers to compete with one another for the right to service customers. Better customer service, higher quality, perks… The Role of Government n Disciplines the market process. n Firms “tell on each other” to try to get the government to intervene

In order to make decisions in the future you need to know what the future holds…. Is a dollar today worth the same as a dollar in three years??

The Time Value of Money How much do I have to invest today to have $1,000 in three years if the interest rate is 10%?? Present value (PV) of a lump-sum amount (FV) to be received at the end of “n” periods when the per-period interest rate is “i”: Example: n Lotto winner choosing between a single lump-sum payout of $104 million or $198 million over 25 years.

How much do I have to invest then??

So… Present Value is the difference between the Future Value and the Opportunity Cost of waiting n PV = FV – OCW i OCW PV

Present Value of a Series What if you are “promised” different amounts every year?? Present value of a stream of future amounts (FV t ) received at the end of each period for “n” periods: