MANAGERIAL ECONOMICS 12 th Edition

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. Spell out production and marketing rules to maximize profits.   Making the Best Decision Managerial economics helps meet management objectives efficiently. Managerial economics shows the logic of consumer, and government decisions.

The Decision Process Where does economics fit in? Establish Objectives… what is our goal? Define the Problem…Competition is fierce... Identify factors that affect the problem… Other firms appear to produce a comparable product at lower costs… Specify Alternative Solutions… Should we expand our plant size or decrease our plant size or improve our product techniques? Collect Data and Other Information… Do bigger firms dominate the industry? or smaller firms? Have higher quality firms performed well? Evaluate and Screen Alternatives… Bigger firms are in better financing (need clarity) shape. Smaller firms are being (need clarity) customers are buying which ever costs the least. After further investigation of the best, cost less. Implement best alternatives and monitor results…

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.

Goal of the Firm © 2009, 2006 South-Western, a part of Cengage Learning Theory of the Firm Objective 1: Maximize stock prices. Maximize the present value (PV) of the expected future profits – maximize PV over time… Value of the Firm = present value of future profits. Expected profits are discounted, which puts more weight on profits in the near term than the long term. Any new information revealed about a company will immediately impact their stock price. Positive reports increase the prospects of future expected profit (stock prices rise), negative reports typically negatively impact the outlook of future profits (stock prices fall).

Stock Prices, Profits, and Goals i = interest rate = inflation rate + real rate of return П = TR – TC

Other Goals of Firms © 2009, 2006 South-Western, a part of Cengage Learning Alternative Objectives Maximize Growth (Status) Revenue Maximize Management Utility (Perks) Friedman’s Quote regarding economics in the work place. “Even though they don’t profess the laws of physics, pool players still use them….”

How are profits measured? Profits TR- TC = profit Business Perspective Profit =Total Revenue – Total Explicit Costs (Accounting) Economics Perspective Profit = Total Revenue – Total Explicit (Accounting) and Implicit Cost (Opportunity) In equilibrium Economic profit = 0 When are economic profits ≠ to 0? When are economic profits different from 0? How do disequilibrium shocks affect markets? market power – barriers? innovation/productivity? efficiency? risk bearing?

Free Market Breakdowns Businesses compete for inputs and consumer’s dollars. But this breaks down and there is a need for government intervention. natural monopolies cartels monopolies/unions externalities public goods, defense, bridges, schools circumstances where government influence is desired in microeconomics monopsonies (NCAA, Wal-Mart)

© 2009, 2006 South-Western, a part of Cengage Learning 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.

What are sunk costs?

Assignment © 2009, 2006 South-Western, a part of Cengage Learning Take a firm and characterize its industry, pricing ability, competition, foreign and domestic. Cigarettes, automotives, computers… How can they compete better? Remember the goal is to maximize the stock price.

© 2009, 2006 South-Western, a part of Cengage Learning Why Do Profits Vary Among Firms?   Disequilibrium Profit Theories Unexpected revenue growth. Unexpected cost savings.   Compensatory Profit Theories Profits accrue to firms that are better, faster, or cheaper than the competition. Profits accrue to firms that are better, faster, or cheaper than the competition.

© 2009, 2006 South-Western, a part of Cengage Learning Role of Business in Society   Why Firms Exist Businesses help satisfy consumer wants. Businesses contributes to social welfare   Social Responsibility of Business Serve customers. Provide employment opportunities. Obey laws and regulations.

© 2009, 2006 South-Western, a part of Cengage Learning

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.