2. 2014 Managerial Economics Stefan Markowski Managerial Economics Stefan Markowski How? When? What? The economics of competitive advantage Why? Where? Who? Introduction: The scope of managerial economics

3. Course aims The aim of the course is to apply the basic concepts and principles of microeconomics within the broader framework of organisational management course aims toIn particular, the course aims to: –outline economic determinants of managerial decisions –outline economic determinants of managerial decisions under different market conditions, methods of economic analysis, decision support aids and tools and selected economic theories that help managers understand economic processes and structures; and –develop skills –develop skills needed to analyse links between the firm’s business activities, its external environment and the broader socio-economic phenomena While the course focuses on managerial decision making in the commercial (private) sector, the application of microeconomic principles in the public sector will also be considered

4. Student learning outcomes By the conclusion of this course you should be able to: –understand and identify factors impacting managerial decision making; –outline the scope of managerial decision making and the available decision aids; –explain managerial decision under different market conditions; –evaluate the impact of external and internal factors on managerial decision making; –apply managerial decision making tools; and –determine the demand for and supply of the focal firm’s products

5. Detailed course schedule Day no TopicTextbook ch. 1 (24 Nov; 3 hrs) 1. Introduction. Decision making process and its elements. The scope of economic decision making. Application of marginal analysis Chs. 1-2 2 (25 Nov; 3 hrs) 2. Demand analysis and demand elasticitiesCh. 3 3 (26 Nov; 3 hrs) 3. Buyer product valuation and choices. Consumer surplus. Buyer pricing decisions Ch. 4 4 (27 Nov; 2 hrs) 4. Production/transformation process. Production technologies and input-output structure Ch. 5 5 (28 Nov; 2 hrs) 5. Cost structure and cost drivers of producer pricing strategies. Production scale and scope. Chs. 5 and 7 6 (1 Dec; 3 hrs) 6. Structure-conduct-performance. Market structures: competition and contestability. Pricing strategies of buyers and sellers Ch. 8 7 (2 Dec; 3 hrs) 7. Market structures: monopoly/monopsony, monopolistic competition and oligopoly. Pricing strategies and strategic behaviour Chs. 9-10 8 (3 Dec; 3 hrs) 8. Input sourcing and investment. Pricing and market powerChs. 6 and 11 9 (4 Dec; 2 hrs) 9. Decision making under conditions of uncertainty. Informational asymmetries and risk management Ch. 12 10 (5 Dec; 2 hrs) 10. Market research and market analysis. Auction and rings. Strategic behaviour Ch. 13 11 (8 Dec; 2 hrs ) 11. Public sector perspectiveCh. 14 12 (9 Dec; 2 hrs) 12. Revision 13. Examination 13 (11 Dec; 2 hrs) Examination

6. Readings Main reading: M. R. Baye, Managerial economics and business strategy, 7 th edition, Irwin/McGraw-Hill, 2010 Focus on managerial challenges rather than economic issues as such. Please note that Microeconomics is specified as a prerequisite of this course

7. Topic 1: The scope of managerial economics Topic Contents 1.1 Economics and economists 1.2 Why economics is useful to managers 1.3 Managers and the market 1.4 Principles of decision making 1.5 Marginal analysis 1.6 Decision making processes and their elements 1.7Principles of economic interaction 1.8 Circular flow of economic activity 1.9 Firms and governments 1.10Further reading

8. 1.1Economics and economists Economics scarce resourcesEconomics is the study of how people manage and/or should manage their scarce resources economyAn economy is a group of people interacting with each other as producers, consumers and traders. It used to have spatial boundaries but it may also be virtual economists study/analyseTo understand how it works, economists study/analyse how: –individuals, firms, communities and governments make decisions about scarce resources –economic decision-makers interact with each other –private and social products and outcomes of this interaction

9. 1.1Economics and economists MicroeconomicsMicroeconomics is the study of individual (e.g., persons, households, firms) economic behaviour under conditions of scarcity and uncertainty MacroeconomicMacroeconomic is the study of aggregate economic variables such as national income, consumption or investment Specialised or functional areas of economics application such as growth, development, health or education Managerial economicsManagerial economics is the science (and art) of directing scarce resources to manage more effectively (using economic principles to manage better)

10. 1.2Why economics is useful to managers It helps to understand:  gains from specialisation and trade  economic trade-offs and valuation  opportunity cost (opportunities foregone)  opportunity cost (opportunities foregone) of production and consumption substitution and complementarity  the nature of substitution and complementarity in economic activities ”thinking at themargin”  the application of ”thinking at the margin” economic incentives and disincentives  the nature of economic incentives and disincentives net benefitprofit maximisation  the mechanics of net benefit and profit maximisation  market power markets  market power and how people interact in markets

11. 1.3Managers and the market validatedProducts/outputs of production activities are validated in output markets –value chains –value chains run from downstream (end product) to upstream –cost (supply) chains –cost (supply) chains run from upstream to downstream selling/marketingMarkets for outputs – goods and services (selling/marketing) sourcing/procurement/hiring/renting)Markets for inputs – labour, capital, knowledge, land (sourcing/procurement/hiring/renting) discipline of the market -The discipline of the market - money votes Market powerMarket power –the power to set the terms of market exchange

12. 1.3Managers and the market Value Costs

13. 1.3Managers and the market

14. Markets comprise clusters of buyers and sellers who try to engage each other to exchange goods and services area of opportunityMarket as an area of opportunity (what, where, why?) informationMarket as a source of information seller/buyer powerMarket as a source of seller/buyer power uncertainty risk mitigation mechanismMarket as a source of uncertainty and as risk mitigation mechanism economic umpireMarket as an economic umpire (winners and losers)

15. 1.4Principles of decision making scarce economicallyResources are finite, thus scarce, and should be used economically must make choicesDecision-makers face trade-offs and must make choices opportunity costEvery choice implies opportunity cost To economisethink at the marginTo economise, decision-makers must think at the margin (see below) incentivesDecision-makers usually respond to incentives value of timeDecision-makers should consider the value of time (or time value of money)

16. 1.5 Marginal analysis incremental (marginal) unit of activity marginal cost marginal benefitTo economise, we compare the cost of an incremental (marginal) unit of activity, its marginal cost, with the benefit produced by this increment of activity, marginal benefit If Marginal Benefit > Marginal Cost, it pays to engage in an activity providing that its Average (or Total) Benefit equals or exceeds its Average (or Total) Cost Thus, to maximise the Net Benefit (Benefit less Cost) of an economic activity we should engage in it as long as its MB>MC providing that its AB>AC Max NB when MB=MC and AB>AC or TB>TC

17. 1.5 Marginal analysis Costs and Benefits Total cost, TC MB Max NBloss MC profit/net gain Total benefit, TB loss Optimal scaleVolume of output or scale of activity

18. 1.6 Decision making processes and their elements Production perspective –Scoping (definition/measurement/analysis) –Design –Development –Production –Launch –In-production optimisation/refinement/improvement –Control/evaluation –Decommission Sourcing perspective –Requirements specification –Acquisition/tendering

19. 1.6 Decision making processes and their elements –Sustainment in-service/use –Disposal –Evaluation The process of organisational decision making –Organisational planning –Organising –Leading –Monitoring and control –Change management incl. corrective action –Evaluation economic modelsIn managerial economics we normally use economic models which provide concise description of activities of interest and allow us to analyse options

20. 1.6 Decision making processes and their elements Example production mgt for six sigma quality

21. 1.7 Principles of economic interaction Trade can make everyone better offTrade can make everyone better off organisingMarkets are usually good for organising economic activity and moving resources to areas of best use Governments may sometimes improve on the market performance but they could also make things worse But, institutions of the state are needed to underpin market operations (e.g., produce “money” to trade or create a legal framework to contract business)

22. 1.7 Principles of economic interaction Distinction between –stocks –stocks (quantities of specified items measured at a point in time); and –flows –flows (changes in quantities measured over a period of time) They can be mixed but should not be confused Ceteris paribusCeteris paribus – “holding other things equal” to examine a change associated with or attributed to the factor being studied independently of changes associated with/attributed to other factors or influences

23. 1.7 Principles of economic interaction Markets facilitate exchange of property rightsMarkets facilitate physical exchange of goods and services and the exchange of property rights Property rightsProperty rights are the rights established in law to receive the benefits of ownership of a good, service or an asset ‘marketable’ property rights positive or negative externalitiesFor some goods and services ‘marketable’ property rights cannot be economically produced and/or enforced, e.g., positive or negative externalities (re: Topic 11) seek market power market structuresMarket participants often seek market power to set terms of exchange to favour their interests (re: market structures)

24. 1.8Circular Flow of Economic Activity Macroeconomic model: Circular flow of economic activity People/households/ consumers/investors /savers/employees Firms/ buyers/ sellers/ employers Output Markets Input Markets Principle of market exchange: Buying is also selling, e.g., to exchange goods for money is to exchange money for goods

25. 1.9Firms and governments nature of the firmThe nature of the firm Business objectivesBusiness objectives –profit –rents –satisfaction principal-agent frameworkThe principal-agent framework –owners/shareholders –managers/employees government economic interventionLimits of government economic intervention –rationale for intervention: market failure –principal-agent problem –rationale for non-intervention: government failure –excessive government

26. 1.10 Further reading M. R. Baye, Managerial economics and business strategy, 7 th edition, Irwin/McGraw-Hill, 2010: chs. 1-3