Introduction, Basic Principles and Methodology

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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

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• 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.

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Some Economic Principles of Managers

• 1. Role of manager is to make decisions. Firms
  come in all sizes but no firm has unlimited
  resources so managers must decide how resources
  are employed

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• Decisions are always among alternatives.
• Decision alternatives always have costs and
  benefits
• Opportunity cost next best alternative
  foregone.
• Marginal or incremental approach
• 4. Anticipated objective of management is to
  increase the firms value

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• Maximize shareholders wealth
• Negative impact principal-agent problem
• Firms value is measured by its expected profits
• Time value of money, discount rates
• 6. The firm must minimize cost for each level of
  production

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• The firms growth depends on rational investment
  decisions
• Capital budgeting decisions
• 8. Successful firms deal rationally and ethically
  with laws and regulations

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Macroeconomics Microeconomics

• Economists generally divide their discipline into
  two main branches
• Macroeconomics is the study of the aggregate
  economy.
• National Income Analysis (GDP)
• Unemployment
• Inflation
• Fiscal and Monetary policy
• Trade and Financial relationships among nations

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• Microeconomics is the study of individual
  consumers and producers in specific markets.
• Supply and demand
• Pricing of output
• Production processes
• Cost structure
• Distribution of income and output
• Microeconomics is the basis of managerial
  economics

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• 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

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• 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

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Review of Economic Terms

• Resources are factors of production or inputs.
• Examples
• Land
• Labor
• Capital
• Entrepreneurship

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• Managerial Economics
• The study of how to direct scarce resources in
  the way that most efficiently achieves a
  managerial goal.

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• Managerial economics is the use of economic
  analysis to make business decisions involving the
  best use (allocation) of an organizations scarce
  resources.

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• 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

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• Questions that managers must answer
• What are the economic conditions in a particular
  market?
• Market Structure?
• Supply and Demand Conditions?
• Technology?
• Government Regulations?
• International Dimensions?
• Future Conditions?
• Macroeconomic Factors?

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• Questions that managers must answer
• Should our firm be in this business?
• If so, what price and output levels achieve our
  goals?

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• Questions that managers must answer
• How can we maintain a competitive advantage over
  our competitors?
• Cost-leader?
• Product Differentiation?
• Market Niche?
• Outsourcing, alliances, mergers,
• acquisitions?
• International Dimensions?

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• Questions that managers must answer
• What are the risks involved?
• Risk is the chance or possibility that actual
  future outcomes will differ from those expected
  today.

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• Types of risk
• Changes in demand and supply conditions
• Technological changes and the effect of
  competition
• Changes in interest rates and inflation rates
• Exchange rates for companies engaged in
  international trade
• Political risk for companies with foreign
  operations

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• 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?

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• Economic Decisions for the Firm
• 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.

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• 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

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

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1. Entry
2. Power of input sellers
3. Power of buyers
4. Industry rivalry
5. Substitutes and Complements

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• 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

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• 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

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• 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

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• 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

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• 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.

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The Five Forces Framework
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Market Interactions

• Consumer-Producer Rivalry
• Consumers attempt to locate low prices, while
  producers attempt to charge high prices.
• Consumer-Consumer Rivalry
• Scarcity of goods reduces the negotiating power
  of consumers as they compete for the right to
  those goods.

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• Producer-Producer Rivalry
• Scarcity of consumers causes producers to compete
  with one another for the right to service
  customers.
• The Role of Government
• Disciplines the market process.