Managerial Economics: A Problem-solving Approach
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Managerial Economics: A Problem-solving Approach

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Why is teaching economics to MBA\'s so difficult? . Students with varying backgrounds: English majors vs. Engineers; Econ. and Business majors; Executive MBA\'s and non-degree Exec. Ed.Healthcare professionalsetcStudents want practical knowledge Not abstract theoryDo MBA\'s learn differently t
Managerial Economics: A Problem-solving Approach

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1. Managerial Economics: A Problem-solving Approach http://www.cengage.com/economics/discipline_content/preview_guide/ Ordering Information: Betty Jung Marketing Specialist, Finance/Economics/Decision Sciences South-Western | Cengage Learning 5191 Natorp Boulevard, Mason, OH 45040 The ISBN for your 2e book alone is:? 1439077983 ? The Bundle ISBN for your 2e book + the printed access card for MBA Primer is:?0538771240 http://www.cengage.com/economics/discipline_content/preview_guide/ Ordering Information: Betty Jung Marketing Specialist, Finance/Economics/Decision Sciences South-Western | Cengage Learning 5191 Natorp Boulevard, Mason, OH 45040 The ISBN for your 2e book alone is:? 1439077983 ? The Bundle ISBN for your 2e book + the printed access card for MBA Primer is:?0538771240

2. Why is teaching economics to MBA?s so difficult? Students with varying backgrounds: English majors vs. Engineers; Econ. and Business majors; Executive MBA?s and non-degree Exec. Ed. Healthcare professionals etc Students want practical knowledge Not abstract theory Do MBA?s learn differently than we do?

3. Solution Use a problem-based pedagogy (instead of model-based) Begin with a real business problem Give students just enough analytical structure to understand the problem and find a solution Teaches students to solve problems by Identifying profitable decisions (benefit-cost analysis) And implement them (principal-agent theory) Links study of economics to other MBA disciplines Accounting, finance, statistics, marketing, strategy, operations

4. Example: Over-bidding OCS gas tract A young geologist was preparing a bid recommendation for an gas tract in his exploration to oil With knowledge of the productivity of neighboring tracts also owned by company, the geologist recommended a bid of BD5000000 Senior management, though, bid BD21000000 - far over the next highest-bid of BD 750,000. What, if anything, is wrong? The goal of this text is to provide tools to help diagnose and solve problems like this. 4

5. Analyze the over-bidding mistake Another clue: After winning the bid, the geologist increased the estimated reserves of the company. But, after a ?dry? well was drilled, the reserve estimates were decreased. Senior Management stepped in and rejected the decrease in the estimate (kept it high) Last clue: Senior management resigned several months later. 5 For the OVI story: (1) Senior Management made bad decision (2) They had enough information to make a good decision (3) The incentives provided did not support the good decision The answer is to change the incentives of senior management. For the OVI story: (1) Senior Management made bad decision (2) They had enough information to make a good decision (3) The incentives provided did not support the good decision The answer is to change the incentives of senior management.

6. ANSWER: Manager bonuses for increasing reserves The bonus system created incentives to over-bid. Senior managers were rewarded for acquiring reserves regardless of their profitability Bonuses also created incentive to manipulate the reserve estimate. 6

7. Problem solving Two distinct steps: Figure out what?s wrong, i.e., why the bad decision was made Figure out how to fix it Both steps require a model of behavior Why are people making mistakes? What can we do to make them change? Economists use the rational actor paradigm to model behavior. The rational actor paradigm states: People act rationally, optimally, self-interestedly i.e., they respond to incentives ? to change behavior you must change incentives. 7

8. Keep the ultimate goal in mind Align the incentives of employees with the profitability goals of the company. How do we make sure employees have the information necessary to make good decisions? And the incentive to do so? 8

9. what is wrong Under the rational actor paradigm, mistakes are made for one of two reasons: lack of information or bad incentives. To diagnose a problem, ask 3 questions: 1. Who is making bad decision? 2. Do they have enough info to make a good decision? 3. Do they have the incentive to do so? 9

10. How to fix it The answers will suggest one or more solutions: 1. Let someone else make the decision, someone with better information or incentives. 2. Change the information flow. 3. Change incentives Change performance evaluation methods within your firm Change reward scheme Use benefit-cost analysis to choose the best (most profitable?) solution ??.. Mohammed Give them information about Break Even here 10 Discussion: Is the best solution the most profitable? Discussion: Is the best solution the most profitable?

11. Coverage Traditional coverage (see TOC) Changes to second edition Examples from the financial crisis Additional material Insights from behavioral econ (psychological pricing, barriers to rational decision making) Iceland: Trade, Foreign Exchange, Bubbles Chapters cut into smaller pieces Uncertainty & Auctions Long-run equilibrium & Strategy 11

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