1. Contact Information
Details
Dr. Daniel Simons
Building Room 416
Lectures: W: 8:30 – 11:30
Building 250 – Room 205
Office Hours:
T Thu : 11:45 – 12:45
W: 11:30 – 12:30 Or
By appointment
Dr. Rosmy Jean Louis
Building 250 – Room 464
Lectures: W: 9:00 – 12:00
Building 200 – Room 238

2. Suggestions for Best Individual Performance
Attend all classes
Take notes. Course covers a lot of material and your notes are essential
Complete all assignments (not for grade)
Read the book
Participate, enrich class discussion, provide feedback and ask questions
Revise materials between classes, integrate concepts, make sure you understand the tools and their application
Don’t hesitate to contact me if necessary

3. Evaluation Method Tests have a mix of problems that evaluate Concepts
Problem sets (assignments)
Class applications
Readings
New applications
3 closed book time constrained tests to reward knowledge and speed
Each test covers slides, assignments, and required readings.
Evaluation system may not be perfect but it works

4. Main Course Objectives
Present relevant tools for effective management of organizational processes and resources
Show the application of core concepts to typical business problems and management decisions
Provide the foundation for late in-depth coverage of business issues in Economics
Present a general framework to better understand and meet the challenges faced by organizations
Contribute to the generation and implementation of strategies to create economic value and sustain competitive advantage in organizations

5. Introduction, Basic Principles and Methodology
The central themes of Managerial Economics:
Identify problems and opportunities
Analyzing alternatives from which choices can be made
Making choices that are best from the standpoint of the firm or organization

6. Not true that all managers must be managerial economists
But managers who understand the economic dimensions of business problems and apply economic analysis to specific problems often choose more wisely than those who do not.

7. Manager-:
A person who directs resources to achieve a stated goal
Economics-:
Study of making decisions in the presence of scarce resources

8. Managerial Economics Defined
Is the study of how to direct scarce resources in the way that most efficiently achieves a managerial goal Main thrust of Managerial Economics is to provide you with a vast pool of skills that will allow you to make sound decisions and to determine the right incentives within your company

9. Methodology, data and application
Methodology- is a branch of philosophy that deals with how knowledge is obtained.
How can you know that you are managing efficiently and effectively?
You need some theory to do some analysis.
Without theory, there can be no good analysis

10. Microeconomics (probably more than other disciplines) provides the methodology for managerial economics Managerial Economics is about both methodology and data You need data to plug into some model to do some analysis. This gives you the information to manage Managerial Economics lends empirical content to the study of effective management

11. Decisions are always among alternatives
Decisions are always among alternatives. Decision alternatives always have costs and benefits Opportunity cost = next best alternative foregone. Marginal or incremental approach

12. Review of Economic Terms
Resources are factors of production or inputs.
Examples:
Land
Labor
Capital
Entrepreneurship

13. Relationship to other business disciplines
Marketing: Demand, Price Elasticity
Finance: Capital Budgeting, Break-Even Analysis, Opportunity Cost, Economic Value Added
Management Science: Linear Programming, Regression Analysis, Forecasting
Strategy: Types of Competition, Structure-Conduct-Performance Analysis
Managerial Accounting: Relevant Cost, Break-Even Analysis, Incremental Cost Analysis, Opportunity Cost

14. The Economics of Effective Management
An effective manager must
Identify goals and constraints
Recognize the nature and importance of profits
Understand incentives
Understand markets
Recognize the time value of money
Use Marginal Analysis

15. Identify Goals and constraints
Well-defined goals and recognize constraints such as available technology, prices of inputs used in production, decisions made by competitors etc.

16. Because of scarcity, an allocation decision must be made
Because of scarcity, an allocation decision must be made. The allocation decision is comprised of three separate choices:
What and how many goods and services should be produced?
How should these goods and services be produced?
For whom should these goods and services be produced?

17. What: The product decision – begin or stop providing goods and/or services.
How: The hiring, staffing, procurement, and capital budgeting decisions.
For whom: The market segmentation decision – targeting the customers most likely to purchase.

18. Three processes to answer what, how, and for whom
Market Process: use of supply, demand, and material incentives
Command Process: use of government or central authority, usually indirect
Traditional Process: use of customs and traditions

19. Profits are a signal to resource holders where resources are most valued by society
So what factors impact sustainability of industry profitability?
Porter’s 5-forces framework discusses 5 categories of forces that impacts profitability

20. Entry
Power of input sellers
Power of buyers
Industry rivalry
Substitutes and Complements

21. Entry:
Heightens competition
Reduces margin of existing firms
Ability to sustain profits depends on the barriers to entry: cost, regulations, networking, etc.
Profits are higher where entry is low

22. Power of input suppliers:
Do input suppliers have power to negotiate favorable input prices?
Less power if
inputs are standardized,
not highly concentrated
alternative inputs available
Profits are high when suppliers power is low

23. Power of buyers:
High buyer power if
buyers can negotiate favorable terms for the good/service
Buyer concentration is high
Cost of switching to other products is low
perfect information leading to less costly buyer search

24. Industry rivalry:
Rivalry tends to be less intense
in concentrated industries
high product differentiation
high consumer switching cost
Profits are low where industry rivalry is intense

25. Substitutes and complements:
Profitability is eroded when there are close substitutes
Government policies (restrictions e.g. import restriction on drugs from Canada to US) can affect the availability of substitutes.

26. Understand Markets
Power or bargaining position of consumers and producers in the market is limited by 3 sources of rivalry:
Consumer – consumer rivalry
Because of scarcity, consumers compete with each other for the right to purchase the available goods
Those willing to pay higher prices will outbid others for the right to consume the product

27. Consumer-Producer Rivalry
Consumers attempt to locate low prices, while producers attempt to charge high prices.
The ability of each party to achieve its goal is limited.
Offer too low a price and producer will refuse to sell the product
Charge to high a price and consumers will refuse to buy the product

28. Producer-Producer Rivalry
Scarcity of consumers causes producers to compete with one another for the right to service customers.
The Role of Government
When agents on either side of the market feel aggrieved in the market process, they attempt to induce government to intervene on their behalf,
Disciplines the market process.

29. The Firm and Its Goals The Firm Economic Goal of the Firm
Goals Other Than Profit
Do Companies Maximize Profits?
Maximizing the Wealth of Stockholders
Economic Profits

30. Profits
Profit is the difference between revenue received and costs incurred.

31. Economic vs. Accounting Profits
Total revenue (sales) minus dollar cost of producing goods or services.
Reported on the firm’s income statement.
Economic Profits
Total revenue minus total opportunity cost.

32. Cost
Accounting Costs
The explicit costs of the resources needed to produce produce goods or services.
Reported on the firm’s income statement.

33. Opportunity Cost Economic Profits
The cost of the explicit and implicit resources that are foregone when a decision is made.
Economic Profits
Total revenue minus total opportunity cost.

34. Economic Goal of the Firm
Primary objective of the firm (to economists) is to maximize profits.
Profit maximization hypothesis
Other goals include market share, revenue growth, and shareholder value
Optimal decision is the one that brings the firm closest to its goal.

35. Goals Other Than Profit
Market share maximization (as measured by sales revenue or proportion of quantity sold to total market
Growth rate maximization (increasing size of the firm over time. Higher rates of growth in other variables than profit)
Profit margin
Return on investment, Return on assets

36. Shareholder value
Technological advancement
Customer satisfaction
Maximization of managerial returns (manager’s own interest subject to generating sufficient profits to keep their jobs)

37. Non-economic Objectives
Good work environment
Quality products and services
Corporate citizenship, social responsibility

38. Do Companies Maximize Profit?
Criticism: Companies do not maximize profits but instead their aim is to “satisfice.”
“Satisfice” is to achieve a set goal, even though that goal may not require the firm to “do its best.”

39. Two components to “satisficing”:
Position and power of stockholders
Position and power of professional management

40. Position and power of stockholders
Medium-sized or large corporations are owned by thousands of shareholders
Shareholders own only minute interests in the firm
Shareholders diversify holdings in many firms
Shareholders are concerned with performance of entire portfolio and not individual stocks.

41. Most stockholders are not well informed on how well a corporation can do and thus are not capable of determining the effectiveness of management.
Not likely to take any action as long as they are earning a “satisfactory” return on their investment.

42. Position and power of professional management
High-level managers who are responsible for major decision making may own very little of the company’s stock.
Managers tend to be more conservative because jobs will likely be safe if performance is steady, not spectacular.

43. Management incentives may be misaligned
E.g. incentive for revenue growth, not profits
Managers may be more interested in maximizing own income and perks
Divergence of objectives is known as “principal-agent” problem or “agency problem”

44. Counter-arguments which support the profit maximization hypothesis.
Large number of shares is owned by institutions (mutual funds, banks, etc.) utilizing analysts to judge the prospects of a company.
Stock prices are a reflection of a company’s profitability. If managers do not seek to maximize profits, stock prices fall and firms are subject to takeover bids and proxy fights.
The compensation of many executives is tied to stock price.

45. Company tries to manage its business in such a way that the dividends over time paid from its earnings and the risk incurred to bring about the stream of dividends always create the highest price for the company’s stock.
When stock options are substantial part of executive compensation, management objectives tend to be more aligned with stockholder objectives.

46. Maximizing the Wealth of Stockholders
Views the firm from the perspective of a stream of earnings over time, i.e., a cash flow.
Must include the concept of the time value of money.
Dollars earned in the future are worth less than dollars earned today.

47. Future cash flows must be discounted to the present.
The discount rate is affected by risk.
Two major types of risk:
Business Risk – up and down of the economy
Financial Risk – due to a leverage

48. Maximization of stockholder’s wealth vs Maximization of profits
MSW seems to be a more comprehensive goal because
It is a long-run concept
It considers the timing of benefits
It incorporates the concept of risk

49. The Time Value of Money
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”: .

50. Examples:
Lotto winner choosing between a single lump-sum payout of $104 million or $198 million over 25 years.
Determining damages in a patent infringement case

51. Present Value of a Series
Present value of a stream of future amounts (FVt) received at the end of each period for “n” periods:

52. Net Present Value
Suppose a manager can purchase a stream of future receipts (FVt ) by spending “C0” dollars today. The NPV of such a decision Is
Decision Rule:
If NPV < 0: Reject project
NPV > 0: Accept project

53. Present Value of a Perpetuity
An asset that perpetually generates a stream of cash flows (CF) at the end of each period is called a perpetuity.
The present value (PV) of a perpetuity of cash flows paying the same amount at the end of each period is

54. Firm Valuation
The value of a firm equals the present value of current and future profits.
PV = S pt / (1 + i)t

55. If profits grow at a constant rate (g < i) and current period profits are po:

56. If the growth rate in profits < interest rate and both remain constant, maximizing the present value of all future profits is the same as maximizing current profits.

57. Marginal (Incremental) Analysis
Control Variables
Output
Price
Product Quality
Advertising
R&D

58. Net Benefits
Basic Managerial Question: How much of the control variable should be used to maximize net benefits?
Net Benefits = Total Benefits - Total Costs
Profits = Revenue - Costs

59. Marginal Benefit (MB)
Change in total benefits arising from a change in the control variable, Q:
Slope (calculus derivative) of the total benefit curve.

60. Marginal Cost (MC)
Change in total costs arising from a change in the control variable, Q:
Slope (calculus derivative) of the total cost curve

61. Marginal Principle
To maximize net benefits, the managerial control variable should be increased up to the point where MB = MC.
MB > MC means the last unit of the control variable increased benefits more than it increased costs.
MB < MC means the last unit of the control variable increased costs more than it increased benefits.

62. The Geometry of Optimization
Total Benefits
& Total Costs
Costs
Benefits Q
Slope =MB B
Slope = MC C Q*

63. Conclusion
Make sure you include all costs and benefits when making decisions (opportunity cost).
When decisions span time, make sure you are comparing apples to apples (PV analysis).
Optimal economic decisions are made at the margin (marginal analysis).

64. Maximizing the Wealth of Stockholders
Another measure of the wealth of stockholders is called Market Value Added (MVA)®.
MVA represents the difference between the market value of the company and the capital that the investors have paid into the company.

65. Maximizing the Wealth of Stockholders
Market value includes value of both equity and debt.
Capital includes book value of equity and debt as well as certain adjustments.
E.g. Accumulated R&D and goodwill.
While the market value of the company will always be positive, MVA may be positive or negative.

66. Maximizing the Wealth of Stockholders
Another measure of the wealth of stockholders is called Economic Value Added (EVA)®.
EVA=(Return on Total Capital – Cost of Capital) x Total Capital
If EVA is positive then shareholder wealth is increasing. If EVA is negative, then shareholder wealth is being destroyed.

67. Lessons There is no free lunch
The cost of an action is the alternative that is sacrificed
The relevant costs and benefits are the marginal ones
People respond to incentive
Things aren’t always what they seem