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

Managerial Economics: Breaking it down Manager n A person who directs resources to achieve a stated goal. Directs efforts Purchases inputs Makes decision Economics n The science of making decisions in the presence of scarcity What was scarcity?? Managerial Economics n The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.

Economic vs. Accounting Profits Accounting Profits n Total revenue (sales) minus dollar cost of producing goods or services. n Reported on the firm’s income statement. Economic Profits n Total revenue minus total cost Total cost = Accounting costs + indirect costs What is another name for indirect costs? –Opportunity costs n “Good” managers use economic profit

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