1. ECONOMICS 6000: Managerial Economics

2. Important Information E-mail Communication- Use mtmail, or D2L in all communications. Use of cellphones or other electronics gadgets are not allowed because it is a distraction for you and your neighbor. Please turn them off during class period. We have MA and Ph. D students who can answer most of your questions during lab hours, if you need them. Please complete the survey on the Global Environment

3. Course Overview Introduction ( 1&2 ) Review of the tools of analysis- optimization techniques-Appendix C, linear programming) Demand Theory and Estimation (3 & 4) Demand Forecasting (Trend projections and correcting for seasonality) (5) TEST # 1: February 24, 2015. Production Theory and Estimation (7) Cost Theory and Estimation ( 8 & 9) Test # 2 – March 31, 2015 Pricing and Output Decisions in Different Markets (Perfect Competition, Monopoly, Monopolistic Competition, Oligopoly) (10- 14) FINAL EXAMINATION: May 5, 2015 6:00-8:00pm

4. 1. Managerial Economics

5. Managerial Economics Managerial Economics- Integrates and applies microeconomic theory and decision sciences to solve managerial problems faced by private, public, and not-for- profit organizations. Q=f(Price, Income, AD)

6. 2. Some Management Decision Problems  Demand Analysis & Forecasting  Product pricing and output decision  Buy or lease decisions [vehicles]  Production techniques [capital vs. labor]  Inventory levels – JIT  Advertising media [ TV, newspaper, radio]  Labor hiring and training  Investment and Financing

7. Decision Making Process Objective Function: Max PV of profits {S 1, S 2 } where S 1 is to expand capacity now, or S 2 expand capacity later. Decision Rule: – Choose S 1 if PV {Profits of S 1 } > PV { Profits of S 2 } or – Choose S 2 if PV { Profits of S 1 } < PV { Profits of S 2 } – If equal profits, then flip a coin

8. 4. Basic Decision Making Model Statement of the problem => [ International competition threatens Black and Decker’s profits] Identification of objectives => [ Maintain, or gain market share ] Identify possible solutions => [ Changing production techniques, market strategies, etc. ]

9. 4. Basic Decision Making Model Select the best solution from an array of alternative solutions. Implement the decision. Evaluate performance (Sensitivity analysis-helps to determine how one variable (the target variable) may be affected by changes in another variable e.g. property income forecasting agency wants to determine how the ROI varies with changes in the vacancy rates (VR). When vacancy rate is 15%=> ROI= 16%; for VR =18% => expected ROI= 5%

10. 5. Common Managerial Questions  What to produce?=> Consumers-Typically, the answer depends on what the consumers want  Determine what price to charge. => Market forces determine the price in a market economy  Determine the optimal resource use=> Firms  Choice of feasible investment projects.

11. Problem Solving Approach You can analyze any problem by asking three questions: Who is making the bad decision? Does the decision maker have the information to make good decision? The incentive to make bad decision? Source: Froeb et al. (2014)

12. 6. Management Theories of of the goal of the Firm  Value or profit maximization model-primary goal of managers (popular theory)- Road Map for the course  Sales maximization model [ Baumol, 1959 ]- managers seek to maximize sales after an adequate profit is achieved to satisfy shareholders (salaries and sales)  Management Utility maximization model (Williamson, 1963) - managers may seek to maximize their compensation [salaries, fringe benefits, stock options], the size of their staff, extent of their control over the corporation =>(principal-agent problem).  Management satisficing behavior (Cyert,1963; Herbert Simon, 1949)- Because of the complexity of modern corporation, managers seek to achieve satisfactory results in terms of growth in sales, profits, and market share.

13. Responsibility of Management Managers solve problems before they become a crisis Managers select strategies to try to assure the success of the firm Managers create an organizational culture attune to the mission of the organization Senior management establishes a vision for the firm Managers motivate and promote teamwork Managers promote the profitability of the firm And many managers see it in their long-run interest to promote sustainability of their enterprise in their environment (CSR). Managers who fail at these responsibilities are reviled, be they mangers of BP, Enron, or Bernie Medoff

14. 7 a. The present value of the firm’s future net earnings The objective of the firm is to maximize the value of the firm, the true measure of short-run business success. Two key questions are the measure of value and how managers add value to the firm  1  2  n V = [--------] + [ --------] +... + [ -------- ] (1+r) 1 (1+r) 2 (1+r) n N  t V =  [ ------- ], t = 1, 2,..., N t = 1 (1+r) t Value =  [(TR t - TC t )/(1+r) t ], t = 1, 2,..., N

15. Broad Definition of Value Profit = Total Rev - Total Cost  = P. Q d - VC. Q s - F where  profit, P = price, Q d = quantity demanded, VC = variable cost per unit, Q s = quantity supplied, F = total fixed costs

16. Determinants of Value of the Firm N  t N P. Q d - VC. Q s - F V =  [ ------- ] =  [---------------------- ] t=1 (1+r) t t=1 (1+r) t Whatever raises the price of the product and/or the quantity of the product sold Whatever lowers the variable and fixed costs Whatever lowers the “r” (discount rate or the perceived “risk” of investment) will maximize the value of the firm. Do Class Exercises # 1 and 2 in the handout (page 2)

17. 7b. Value maximization as a Team Effort  The marketing department has the responsibility for increasing sales by using the most effective promotional strategy [radio, TV, Newspaper ads]  The production department has the responsibility for minimizing costs by using new methods of production.  The finance department has a major responsibility of acquiring capital for the firm when the cost capital is low (retiring debt and expanding investment)

18. Course Architecture

19. 8. Major Constraints to value maximization Resource scarcity or constraints i.e. limited availability of essential input such as skilled labor, raw material, energy, machinery warehouse, etc. Contractual Obligations Meeting nutritional requirements for feed mixture, reliability requirements. Legal restrictions minimum wage laws, health and safety standards, pollution emission standards, fuel efficiency requirements, fair pricing, etc.

20. 9 a. Profi ts (Accounting vs Economic) Business or accounting profits refer to the difference between total revenue and explicit costs. Accounting (Business) Profit = TR-Explicit costs Profit(Econ) = Total revenue - Total costs =Total Revenue - [Explicit costs + Implicit costs] Examples: Exercise #1 Problems 3 & 4 page 2 handout

21. 9b. Theories of Why Profits Exist RISK-BEARING THEORY (Oil exploration; Investing in Stocks) TEMPORARY DISQUILIBRIUM THEORY OF PROFIT (Windfall Gains) MONOPOLY THEORY OF PROFIT INNOVATION THEORY OF PROFIT (Gates, Job, Schmidt-Page- billionaires) MANAGERIAL EFFICIENCY THEORY OF PROFIT (a reward for organizational efficiency)

22. 10. Examples  Multinational Production & Pricing  Euro Disney  Market Entry  Building an Airport  A Regulatory Problem  An R&D Decision Canon  Texaco VS. Pennzoil 11. In a global economy, what happens in one country has a direct bearing on the economies other countries (The 2011 Flooding in Thiland and production disruption at Toyota, Honda Plants in the US; Ford Escort parts coming from global manufacturing sources)

23. Term Paper Organization Term Paper Title I. Introduction - Statement of issue(s) to be addressed - Importance of the study - Objective of the paper II. A Review of Selected Literature -Recognize previous studies related to topic -Find a niche where you make some contribution to the literature

24. Term Paper Organization III. Data and Analytical Framework Develop a theoretical model underlying the issue IV. Analyses and Interpretations of Empirical Results Statistical test results of the theoretical model V. Summary and Conclusion References