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Chapter 1The Fundamentals of Managerial EconomicsCopyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.IntroductionThe managerEconomicsManagerial economics definedEconomics of Effective ManagementIdentifying goals and constraintsRecognize the nature and importance of profitsUnderstand incentivesUnderstand marketsRecognize the time value of moneyUse marginal analysisLearning managerial economicsChapter OverviewChapter One1-22IntroductionChapter 1 focuses on defining managerial economics, and illustrating how it is a valuable tool for analyzing many business situations.This chapter provides an overview of managerial economics.How do accounting profits and economic profits differ? Why is the difference important?How do managers account for time gaps between costs and revenues?What guiding principle can managers use to maximize profits?Chapter Overview1-33The ManagerA person who directs resources to achieve a stated goal.Directs the efforts of others.Purchases inputs used in the production of the firms output.Directs the product price or quality decisions.Introduction1-44EconomicsThe science of making decisions in the presence of scarce resources.Resources are anything used to produce a good or service, or achieve a goal.Decisions are important because scarcity implies trade-offs.Introduction1-55The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.Should a firm purchase components like disk drives and chips from other manufacturers or produce them within the firm?Should the firm specialize in making one type of computer or produce several different types?How many computers should the firm produce, and at what price should you sell them?IntroductionManagerial Economics Defined1-66Basic principles comprising effective management:Identify goals and constraints.Recognize the nature and importance of profits.Understand incentives.Understand markets.Recognize the time value of money.Use marginal analysis.Economics of Effective ManagementEconomics of Effective Management1-77The Nature and Importance of ProfitsA typical firms objective is to maximize profits.Accounting profitTotal amount of money taken in from sales (total revenue) minus the dollar cost of producing goods or services.Economic profitThe difference between total revenue and the total opportunity cost of producing goods or services.Opportunity costThe explicit cost of a resource plus the implicit cost of giving up its best alternative.

Economics of Effective Management1-88The Role of ProfitsProfit Principle:Profits are a signal to resource holders where resources are most highly valued by society.

Economics of Effective Management1-99Power of Input SuppliersSupplier ConcentrationPrice/Productivity of Alternative InputsRelationship-Specific InvestmentsSupplier Switching CostsGovernment RestraintsPower ofBuyersBuyer ConcentrationPrice/Value of Substitute Products or ServicesRelationship-Specific InvestmentsCustomer Switching CostsGovernment RestraintsEntry

Substitutes & ComplementsIndustry RivalryConcentrationPrice, Quantity, Quality, or Service CompetitionDegree of DifferentiationLevel, Growth, and Sustainabilityof Industry Profits

Entry CostsSpeed of AdjustmentSunk CostsEconomies of ScaleNetwork EffectsReputationSwitching CostsGovernment RestraintsPrice/Value of Surrogate Products or ServicesPrice/Value of Complementary Products or ServicesNetwork EffectsGovernment RestraintsSwitching CostsTiming of DecisionsInformationGovernment RestraintsEconomics of Effective ManagementFive Forces and Industry Profitability1-1010Understand IncentivesChanges in profits provide an incentive to resource holders to change their use of resources.Within a firm, incentives impact how resources are used and how hard workers work.One role of a manager is to construct incentives to induce maximal effort from employees.1-11Economics of Effective Management11Two sides to every market transaction:Buyer (consumer).Seller (producer).Bargaining position of consumers and producers is limited by three rivalries in economic transactions:Consumer-producer rivalry.Consumer-consumer rivalry.Producer-producer rivalry.Government and the market.1-12Economics of Effective ManagementUnderstand Markets12The Time Value of Money Often a gap exists between the time when costs are borne and benefits received.$1 today is worth more than $1 received in the future. The opportunity cost of receiving the $1 in the future is the forgone interest that could be earned were $1 received todayManagers can use present value analysis to properly account for the timing of receipts and expenditures.1-13Economics of Effective Management13Present Value Analysis 11-14Economics of Effective Management14Present Value Analysis II1-15Economics of Effective Management151-16Economics of Effective ManagementThe Time Value of Money in Action16Net Present Value1-17Economics of Effective Management171-18Economics of Effective ManagementPresent Value of Indefinitely Lived Assets18Profit maximization principleMaximizing profits means maximizing the value of the firm, which is the present value of current and future profits.1-19Economics of Effective ManagementPresent Value and Profit Maximization19Present Value and Estimating Values of Firms I1-20Economics of Effective Management201-21Economics of Effective ManagementPresent Value and Estimating Values of Firms II21Short-term and long-term profits principleIf the growth rate in profits is less than the interest rate and both are constant, maximizing current (short-term) profits is the same as maximizing long-term profits.

1-22Economics of Effective ManagementShort-Term versus Long-term Profits221-23Economics of Effective ManagementMarginal Analysis231-24Economics of Effective ManagementUsing Marginal Analysis24Marginal principleTo maximize net benefits, the manager should increase the managerial control variable up to the point where marginal benefits equal marginal costs. This level of the managerial control variable corresponds to the level at which marginal net benefits are zero; nothing more can be gained by further changes in that variable.1-25Economics of Effective ManagementMarginal Analysis Principle I25Marginal Principle II1-26Economics of Effective Management26Marginal Analysis In Action1-27Economics of Effective Management271-28Quantity(Control Variable)Total benefitsTotal costs0Maximum total benefitsMaximum net benefitsEconomics of Effective ManagementDetermining the Optimal Level of a Control Variable281-29Quantity(Control Variable)Net benefits0Maximum net benefitsEconomics of Effective ManagementDetermining the Optimal Level of a Control Variable II291-30Quantity(Control Variable)Marginal benefits, costsand net benefits0Maximum net benefitsEconomics of Effective ManagementDetermining the Optimal Level of a Control Variable III301-31Economics of Effective ManagementIncremental Decisions31Learning Managerial EconomicsPractice, practice, practice Learn terminologyBreak down complex issues into manageable components.Helps economics practitioners communicate efficiently.1-32Learning Managerial Economics32ConclusionMake sure you include all costs and benefits when making decisions (opportunity costs).When decisions span time, make sure you are comparing apples to apples (present value analysis).Optimal economic decisions are made at the margin (marginal analysis).1-33Conclusion33