Managerial Economics: A Problem-solving Approach
Managerial Economics: A Problem-solving Approach . 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
Managerial Economics: A Problem-solving Approach
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Managerial Economics:A Problem-solving Approach
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
- Students want practical knowledge
- Not abstract theory
- Do MBA’s learn differently than we do?
- 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
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.
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.
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.
- 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.
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?
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?
How to fix it
Use benefit-cost analysis to choose the best (most profitable?) solution …….. Mohammed Give them information about Break Even here
- 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
- 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
- 1. Introduction: What this book is about
- 2. The one lesson of business
- Benefits, costs and decisions
- 4. Extent (how much) decisions
- 5. Investment decisions: Look ahead and reason back
- 6. Simple pricing
- Economies of scale and scope
- 8. Understanding markets and industry changes
- 9. Relationships between industries: The forces moving us towards long-run equilibrium
- 10. Strategy, the quest to slow profit erosion
- 11. Using supply and demand: Trade, bubbles, market making
- 12. More realistic and complex pricing
- 13. Direct price discrimination
- 14. Indirect price discrimination
- 15. Strategic games
- 16. Bargaining
- 17. Making decisions with uncertainty
- The problem of adverse selection
- The problem of moral hazard
- 21. Getting employees to work in the best interests of the firm
- 22. Getting divisions to work in the best interests of the firm
- 23. Managing vertical relationships
- 24. You be the consultant
- EPILOG: Can those who teach, do?
Managerial Economics - Table of contents