session 1 fundamentals of nepal

8/8/2019 Session 1 Fundamentals of Nepal

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Michael R. Baye,

Session 1

The Fundamentals of Managerial Economics



Economic Mysteries

Why is airline food so bad?

Why have paper towels

replaced hot-air hand

dryers in public restrooms?



More Economic Mysteries

Why do prices of some goods, like

apples, go down during months of heaviest consumption, while others

like beachfront cottages, go up?

Why do National Football Leaguegames cost so much more than major

league baseball games?



Even More Economic

Mysteries

Why is gravel made by hand in

Nepal, but by machine in the U.S.? Why do color photographs cost less

than black and white photographs?

Why do manual transmissions havefive forward speeds and automatics

have only four?



Economics Reasoning Quiz

(Worksheet 1)

The best things in life are free.

(True or False)The largest cost of going to

college is tuition, room and

board.

(True or False)



The purpose of economic activity is to

improve the well-being of some people at

the expense of others.(True or False)

Anything worth doing is worth doing well.

(True or False)Life is priceless.

(True or False)

Economics Reasoning Quiz



Guide to Economics Reasoning

Worksheet 2

PEOPLE ECONOMIZE. People

choose the alternative which seemsbest to them because it involves the

least cost and the greatest benefit.

ALL CHOICES INVOLVE COST.Cost is the second best choice given

up when people make their best

choice.




PEOPLE RESPOND TO

INCENTIVES. Incentives are

actions or rewards that

encourage people to act. When

incentives change, people¶sbehavior changes in predictable

ways.




ECONOMIC SYSTEMS

INFLUENCE INDIVIDUALCHOICES AND INCENTIVES.

How people cooperate is governed

by written and unwritten rules. Asrules change, incentives change and

behavior changes.




VOLUNTARY TRADE CREATES

WEALTH. People can producemore in less time by concentrating

on what they do best. The surplus

goods or services they produce canbe traded to obtain other valuable

goods or services.




THE CONSEQUENCES OF

CHOICES LIE IN THE FUTURE.

The important costs and benefits ineconomic decision making are those

which will appear in the future.

Economics stresses making decisions

about the future because it is only thefuture that we can influence. We cannot

influence things that have happened in

the past.



Cost-Benefit Approach to

Decision Making

C(X) = Cost of doing

activity X

B(X) = Benefit of doing

activity X

If B(X) > C(X) then do X



Pitfalls to good decision making

Ignoring opportunity costs in

making decisions. Opportunity costs should be included.

Including sunk costs in making

decisions. Sunk costs should NOT be included.



Should I go skiing today?

B(X) = $50 to you.

C(X) = $30 for lift ticket

& equipment.

Do you go skiing?



Should graduate student sell a

car to his father-in-law?

$10,000 Chevrolet

Does not have to pay the normal 50%

tariff.

Car sells for $15,000 in home country.

Estimates he can sell it for $14,000.

Father-in-law wants to pay $10,000.

What is the graduate student¶s

opportunity cost if he sells it to his father-

in-law?



What is the opportunity cost of going to college?



Why does it make more sense

to attend college at age 20 than

at age 50?



Is it fair to charge interest

when lending a friend somemoney?



Why do banks pay interest inthe first place?



Sunk Costs

Sometimes an expenditure seems

like a relevant cost when inreality it is not.

Sunk costs are beyond recoveryat the moment a decision is

made.



Should I drive to Boston or

take the bus?

250 mile trip

Bus fare is $100

Costs of typical 10,000 mile drivingyear for your car are: Insurance $1000

Interest $2000

Fuel, oil $2000

Total = $5000

Cost per mile is 5000/10,000 = 50

cents?



Pizza Experiment

All you can eat lunch for $3.

One-half of the tables are given a $3refund.

They other half gets no refund.

What differences do you predict in

the amounts eaten by these two

groups?



Tickets To A Concert

Jim wins a ticket from a radio

station.

Mike paid $18 for a ticket. On the evening of the concert there

is a tremendous thunderstorm.

If they have the same tastes, shouldthere be a difference in their

behavior as to whether or not to

attend the concert?



Should you keep your business

open for one additional hour ? ±Scenario: You are managing a fast

food hamburger restaurant.

± You currently close at 10 pm everynight, but are considering

extending your hours to 11 pm on

weekends.

±What are the relevant

considerations?



Your monthly rent?

Other sunk costs?

The hourly wages you pay your

employees?Other variable costs associated

with the extra hour?

Your weekly revenues?

Your likely revenues for the extra

hour?



The Invisible Hand

Decentralized

Freedom Self-interest

Motivated by incentives



Overview of Managerial

EconomicsThe Economics of Effective

Management

±Identify Goals and Constraints

±Recognize the Role of Profits

±Understand Incentives

±

Understand Markets ±Recognize the Time Value of

Money

±Use Marginal Analysis



Managerial Economics

Manager

± A person who directs resources to

achieve a stated goal. Economics

± The science of making decisions in thepresence of scare resources.

Managerial Economics

± The study of how to direct scarceresources in the way that mostefficiently achieves a managerial goal.



Economic vs. Accounting Profits

Accounting Profits

± Total revenue (sales) minus dollar cost

of producing goods or services ± Reported on the firm¶s income

statement

Economic Profits

± Total revenue minus total opportunity

cost



Opportunity Cost

Accounting Costs

± The explicit costs of the resources needed to

produce produce goods or services

±

Reported on the firm¶s income statement Opportunity Cost

± The cost of the explicit and implicit resources

that are foregone when a decision is made

Economic Profits ± Total revenue minus total opportunity cost



Market Interactions Consumer-Producer Rivalry

± Consumers attempt to locate low prices, whileproducers attempt to charge high prices

Consumer-Consumer Rivalry

±Scarcity of goods reduces the negotiatingpower of consumers as they compete for theright to those goods

Producer-Producer Rivalry ±

Scarcity of consumers causes producers tocompete with one another for the right toservice customers

The Role of Government ± Disciplines the market process



The Time Value of Money

Present value (PV) of an amount (FV) to be

received at the end of ³n´ periods when

the per-period interest rate is ³i´:

PV

FV

i n!

1Examples?



Present Value of a Series

Present value of a stream of future

amounts (FVt) received at the end of

each period for ³n´ periods:

PV

FV

i

FV

i

FV

i

n

n!

1

1

2

21 1 1...



Net Present Value

Suppose a manager can purchase a streamof future receipts (FVt ) by spending ³C0´

dollars today. The NPV of such a decision is

NPV C FV

iFV

iFV

in

n!

0

11

22

1 1 1...

NPV < 0: RejectNPV > 0: Accept



Firm Valuation

The value of a firm equals the presentvalue of all its future profits ± PV = 7 Tt / (1 + i)t

If profits grow at a constant rate, g < i,then: ± PV = T

Si) / ( i - g), T

S!current profit level.

Maximizing Short-Term Profits

±If the growth rate in profits < interest rate andboth remain constant, maximizing the presentvalue of all future profits is the same asmaximizing current profits.



Control Variables

± Output

±

Price ± Product Quality

± Advertising

± R&D

Basic Managerial Question: Howmuch of the control variable shouldbe used to maximize net benefits?

Marginal (Incremental) Analysis



Net Benefits

Net Benefits = Total Benefits -

Total Costs

Profits = Revenue - Costs



Marginal Benefit (MB)

Change in total benefits arising

from a change in the control

variable, Q:

MB = (B / (Q

Slope (calculus derivative) of thetotal benefit curve



Marginal Cost (MC)

Change in total costs arising

from a change in the control

variable, Q:

MC = (C / (Q

Slope (calculus derivative) of thetotal cost curve



Marginal Principle

To maximize net benefits, themanagerial control variable shouldbe increased up to the point whereMB = MC

MB > MC means the last unit of thecontrol variable increased benefits

more than it increased costs MB < MC means the last unit of the

control variable increased costsmore than it increased benefits



Marginal Analysis

The marginal cost of any good or

activity is its opportunity cost

The opportunity cost is the next bestalternative given up when a decision

is made?

What is your opportunity cost for being here today?

Is it the same for everyone in this

room?



The Geometry of Optimization

Q

Benefits & Costs

Benefits

Costs

Q*

B

CSlope = MC

Slope =MB



Cancer Screening Program

(Worksheet)

Population

Screened

Total Annual

Cost

Total Lives

Saved

60-70 yr. olds $ 80,000 3550-70 yr. olds $160,000 65

40-70 yr. olds $240,000 85

30-70 yr. olds $320,000 95

20-70 yr. olds $400,000 100



Mobile Cardiac

Arrest Units Number of

Units

Total Annual

Cost

Total Lives

Saved

1 $ 80,000 100

2 $160,000 150

3 $240,000 175

4 $320,000 190

5 $400,000 200



Relevant Articles & Worksheets

Worksheets, pp. 1-5, 1-6, and 1-8.

³Eager to Boost Traffic, More Internet

Firms Give Away Services,´, pp. 1-9& 1-10.

³Beyond the InformationRevolution´, pp. 1-11 to 1-18f

Problem Set #1, worksheets pages 1-19 and 1-20

session 1 fundamentals of nepal

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