lecture 1 07
TRANSCRIPT
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What is managerial economics?
Managerial economics is the use of economic analysis to make business decisions involving the best use (allocation) of an organization’s scarce resources
Managerial economics is (mostly) applied microeconomics (normative microeconomics)
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Managerial economics deals with
“How decisions should be made by managers to achieve the firm’s goals - in particular, how to maximize profit.”
(Also government agencies and nonprofit institutions benefit from knowledge of economics, i.e. efficient recourse allocation is important for them too...)
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Relationship between Managerial Economics and Related Discipl ines
Management Decision Problems
Economic Concepts
Managerial Economics
Optimal Solutions to Managerial Decision Problems
Management Decision Problems
Managerial Economics
Optimal Solutions to Managerial Decision Problems
Decision Sciences
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Management Decision Problems Product Price and Output Make or Buy Production Technique Stock Levels Advertising Media and Intensity Labor Hiring and Training Investment and Financing
Management Decision Problems
Economic Concept s
Manager ial Economics
Opt imal Solut ions t o Managerial Decision Problems
Decision Sciences
Management Decision Problems
Economic Concept s
Manager ial Economics
Opt imal Solut ions t o Managerial Decision Problems
Decision Sciences
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Decision SciencesTools and Techniques of Analysis
Numerical Analysis Statistical Estimation Forecasting Game Theory Optimization Simulation
Management Decision Problems
Economic Concept s
Managerial Economics
Opt imal Solut ions t o Manager ial Decision Problems
Decision Sciences
Management Decision Problems
Economic Concept s
Managerial Economics
Opt imal Solut ions t o Manager ial Decision Problems
Decision Sciences
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Economic Concepts
Framework for Decisions Theory of Consumer Behaviour Theory of the Firm Theory of Market Structure and Pricing
Management Decision Problems
Economic Concept s
Managerial Economics
Opt imal Solut ions t o Manager ial Decision Problems
Decision Sciences
Management Decision Problems
Economic Concept s
Managerial Economics
Opt imal Solut ions t o Manager ial Decision Problems
Decision Sciences
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Managerial Economics Use of Economic Concepts and
Decision Science Methodology to Solve Managerial Decision Problems
Management Decision Problems
Economic Concept s
Managerial Economics
Opt imal Solut ions to Manager ial Decision Problems
Decision Sciences
Management Decision Problems
Economic Concept s
Managerial Economics
Opt imal Solut ions to Manager ial Decision Problems
Decision Sciences
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Ch 2 THE GOALS OF A FIRM
Economic Goals:Maximizing or Satisficing1. Profit2. Market share3. Revenue growth4. Return on investment5. Technology6. Customer satisfaction7. Shareholder value
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THE GOALS OF A FIRM continued
Non-economic Objectives:1. “A good place for our employees to
work”2. “Provide good products/services to our
customers”3. “Act as a good citizen in our society”
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Optimal Decision:
Given the goal(s) that the firm is pursuing, the optimal decision in managerial economics is one that brings the firm closest to this goal.
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Roles of Managers:Making decisions and processing information are the two primary tasks of managers.
Examples:• Whether or not to close down a branch of the firm?
• Whether or not a store or restaurant should stay open more hours a day?
• How a hospital can treat more patients without a decrease in patient care?
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Role of Managers continued
How a government agency can be reorganized to be more efficient?
Whether to install an in-house computer rather than pay for outside computing services?
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All these, as well as many other managerial decisions require the use of basic economics.
Economic theory helps decision makers to know what information is necessary in order to make the decision and how to process and use that information.
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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?♦ 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 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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DMs Optimize
We should emphasize that practically in all managerial decisions the task of the manager is the same!
Namely, each goal involves an optimization problem.
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The manager attempts either to maximize or minimize some objective function, frequently subject to some constraint(s).
And, for all goals that involve an optimization problem, the same general economic principles apply!
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REVIEW OF SUPPLY AND DEMAND“Economic analysis begins and ends with demand and supply.”
The primary importance of demand and supply is the way they determine prices and quantities sold in the market.
Managers are extremely interested in forecasting future prices and output, both for the goods and services they sell and for the inputs they use.
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DEMAND ELASTICITY
Elasticity measures the sensitivity of the quantity demanded to changes in the determinants of demand (supply).
Some elasticity concepts:• price elasticity of demand• elasticity of derived demand• cross-elasticity of demand• income elasticity of demand• elasticity of supply
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Determinants of Price Elasticity of Demand
1. The number and availability of substitutes
2. The expenditure on the commodity in relation to the consumer’s budget
3. The durability of the product4. The length of the time period under
consideration5. Consumer’s preferences
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Short-Run vs. Long-Run Elasticity
P2P1
PDS5 DS4 DS3 DS2 DS1
fe
dc b
a
DL
QQ1Q2Q3
A long-run demand curve will generally be more elastic than a short-run curve
As the time period lengthens consumers find way to adjust to the price change, via substitution or shifting consumption
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Elasticity of Derived Demand
The demand for components of final products is called derived demand
The derived demand curve will be the more inelastic:1. The more essential is the component in
question.2. The more inelastic is the demand for the
final product.3. The smaller is the fraction of total cost
going to this component.4. The more inelastic is the supply curve of
cooperating factors.5. The shorter the time period under
consideration.
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The Relationship between Elasticity and Total Revenue
IF DEMAND IS
P ↓ Q ↑ elastic if TR ↑ (relative ∆ Q> relative ∆ P)
P ↓ Q ↑ inelastic if TR ↓ (relative ∆ Q< relative ∆ P)
P ↑ Q ↓ elastic if TR ↓ (relative ∆ Q> relative ∆ P)
P ↑ Q ↓ inelastic if TR ↑ (relative ∆ Q< relative ∆ P)
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Demand, Total Revenue, Marginal Revenue, and Elasticity
Pri
ce a
nd
mar
gin
al
reve
nu
e ($
)
Quantity
Tot
al R
even
ue
($)
Quantity0
p0
D E>1E=1
E<1
D
MR
q0
q00
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The Cross-Elasticity of Demand
Cross-price elasticity measures the relative responsiveness of the quantity purchased of some good when the price of another good changes, holding the price of the good and money income constant.
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It is, therefore, the percentage change in quantity demanded in response to a given percentage change in the price of another good.
B
AX
P
QE
∆∆=
%
%
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Cross-elasticity can be either positive or negative. In particular, cross-elasticity is positive for substitutes and negative for complements.
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Categories of Income Elasticity
Income elasticity > 1: superior goods Income elasticity > 0, and <1: normal goods Income elasticity < 0: inferior goods
Superior
Normal
Inferior
Q
Y
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Applications of Supply and Demand
Interference with the Price Mechanism:
• the effect of a price ceiling• the effect of a price floor• the effect of a subsidy• the incidence of taxes
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The Effect of a Price Ceiling on Quantity of Supply and Demand
0
P1
P0
P2
P
Q1 Q0 Q2 Q
D
S
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The Effect of a Price Floor on Supply and Demand
W
0
W0
W1
Q1 Q0 Q2 Q
D
S
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The Use of Price Supports
Surplus (Q2-Q1) bought Production quota Q3 by the government introduced by the
government
Q0
P0
P1
P
Q1 Q2
D
S
Q0
P1
P
Q1 Q3
D
a) b)
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The Incidence of Taxes effect of demand elasticity effect of supply elasticity
Imposition of a Voluntary Export Quota
Shift in Demand as Consumer Tastes Change
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Demand Elasticity and Tax IncidenceMore elastic demand shifts the tax burden more to the supplier.
D’
0
P
Q
D
S
D’
0
P
Q
S
S’
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Supply Elasticity and Tax Incidence
P
P1P2
P*
Q1 Q2 Q* Q
D
S
S1
S1’
S’
The more elastic the supply, the more heavily consumers will bear the burden of the tax.
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Imposition of a Voluntary Export Quota
Q0
P0
P1
P
Q1 Q0
D
S0
S1
Q0
P’
P’’
P
Q’ Q’’
D’
S’
D’’
a)
b) D & S of other cars
D & S of Japanese cars in USA before 1981
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The Downward Shift in Beef Demand
Q0
P1
P0
P
Q1 Q0
D1
S0
D0D2
S1
Decrease in the demand of beef will, over time, shift resources out of beef production.