1. Homework Assignment and Labs Monday  Last few minutes of class I will introduce lab  Only the lab (part I) will be posted  You will need to work through it by Wednesday’s class  Questions at end to submit or a quiz on Wed Wednesday  Weekly assignment (part II) will be posted.  I will introduce it in lecture.  Handed in the next Monday class period. No lab/homework next week

2. Lecture 3: Introductory Spreadsheet Modeling AGEC 352 Fall 2012 – August 29 R. Keeney

3. Material to Date Reviewed some mathematics and economics ◦ Introduced optimization Relating the algebra and calculus we have seen to the economic principles from previous courses ◦ This is a general pattern for this course factoring in that most of the math we do shows up in spreadsheet formulae

4. Spreadsheet Modeling Ways to think of it… Miniature, reduced, simplified version of an economic problem A firm plans… ◦ Production schedule ◦ Purchase and sale activities (inputs and outputs) ◦ Cost and inventory management ◦ Transfers within company ◦ Marketing and promotion ◦ Managerial and labor assignments

5. Basics Identification of the management problem ◦ Must be clearly specified ◦ Goal of modeling is not to ‘solve’ the problem— rather to guide decision making Given the management problem ◦ Identify the management objective ◦ Identify the choice(s) under management control ◦ Identify other variables not under management’s control  Other steps as we advance in class

6. Price setting example What price to charge to earn highest profit? Under the firm’s control: Price Firm’s objective: Maximum Profits Not under the firm’s control (at least in short run) ◦ Everything else…  Demand (intercept and slope of equation)  Cost function (intercept and slope of equation)

7. Map the Problem Out Maximum Profits Price Charged by Firm What comes in between?

8. Map the Problem Out Maximum Profits Price Charged by Firm Revenue Costs Price charged affects revenue (P x Q) Does price charged affect costs? C = ???

9. Map the Problem Out Maximum Profits Price Charged by Firm Revenue Costs minus Price multiply Quantity Fixed Costs plus Variable Costs

10. Map the Problem Out Maximum Profits Price Charged by Firm Revenue Costs minus Price multiply Fixed Costs plus VC = Q x U Q = a + bP

11. Map the Problem Out Maximum Profits Price Charged by Firm Revenue Costs minus Price multiply Fixed Costs plus VC = U x (a + bP) Q = a + bP

12. Summary Firm sets a price to influence profits The price chosen influences ◦ Quantity sold as determined by demand curve ◦ Revenue due to price and the quantity sold ◦ Costs through variable costs and the quantity sold Not of the firm’s control: ◦ Demand curve numbers ( a and b) ◦ Cost curve numbers (Fixed costs, U)

13. Classification Free/choice variable: price ◦ Firm can set any value it wants Consequence variable: quantity, variable costs, profits ◦ The value depends on the choice of the firm and some values not under its control Parameter (exogenous variable): demand curve intercept and slope, fixed costs, unit cost of production ◦ These values are given and do not change when the firm changes its choices

14. Building a spreadsheet model Labeling ◦ Every value entered into a spreadsheet needs an accompanying label  Easy to find  Clearly identifies what the cell entry is Formula linkages ◦ Every calculation in a spreadsheet needs to be attached to the simplest accurate formula  E.g. quantity instead of the full demand calculation Parameter specification ◦ Every parameter (fixed number value) that is part of a formula needs to be entered into its own cell

15. Model Results: What is different about each section?

16. Graphical Analysis

17. Modeling to help decisions We said a model is a simplification of a management/economic problem What do we do with it? ◦ We’ve seen how it guides price setting What else? ◦ Management/planning questions

18. Model as a lab Another way to think of an economic model is as a laboratory for doing experiments or scenarios ◦ (some textbooks call this ‘what if’ analysis) Unlike physical sciences, it is rare to see experimental trials in economics ◦ Agents like to earn on resources, not randomize decisions to see which one emerges as best…

19. Model utility Just like in lab experiment settings, models of economic situations are only as useful as their proximity to actual conditions Difficulties ◦ Many interconnected decisions and relationships at work ◦ Rely on historical data to express relationships in the future

20. Next Week Begin linear programming Constraints and feasibility Given a set of resources that are fixed ◦ How do I mathematically and graphically describe all possible production alternatives?