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MANAGERIAL ECONOMICS. Assessment. Questions before class. Should you sell the product at a price which is lower than the average total cost of the goods? Why? Why publishers sell international version textbook at low price?
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Questions before class • Should you sell the product at a price which is lower than the average total cost of the goods? Why? • Why publishers sell international version textbook at low price? • Is it a good idea for a monopoly supplier to sell more goods than what they do now? • If you are a manager, how can you know production quantities?
Nature and Scope of Managerial Economics Chapter 1
What is managerial economics? • Managerial economics applies economics tools and techniques to business and administrative decision making.
Why a grocery retailer may offer consumers milk at an extremely low markup over cost, say 1% to 2%, and offer nonprescription drugs at markups as high as 40% over cost?
Theory of the Firm • Firms are useful device for producing and distributing goods and services. • The firm is thought to have profit maximization as its primary goal. • maximize short-run profit. • Today, the emphasis on profit has been broadened to encompass uncertainty and the time value of money
Value of the Firm = Present Value of Expected Future Profits
Constrained Optimization • To make decisions that maximize value, managers must consider how external constraints affect their ability to achieve organization objectives. • Limited availability of essential inputs • Limitations on investment funds • Constrained by Contractual requirements • Quality requirements • Legal restrictions
Limitations of the Theory of the Firm • Optimize or satisfice? • Value maximization • Size or growth maximization • Managers’ personal utility or welfare maximization
Profit Measurement Business (accounting) profit Reflects explicit costs and revenues. Be measured in profit margin (profit/sales revenue). Economic profit. Profit above a risk-adjusted normal return. Considers cash and noncash items. Be assessed in terms of ROE (return on stockholders’ equity) (net income/book value of the firm)
Economists versus Accountants Economic profit Accounting profit Implicit costs Revenue Revenue Total opportunity costs Explicit Explicit costs costs How an Economist How an Accountant Views a Firm Views a Firm
Business profits vary widely. • Average annual ROE in U.S. is 10%. (Normal rate of return on capital is the minimum return necessary to attract and retain investment.) • Variation in ROE • differential risk premiums • Overstate if accounting error or bias causes investments with long-term benefits to be omitted.
Why Do Profits Vary Among Firms? Disequilibrium Profit Theories Frictional profit theory Abnormal profits result from unanticipated changes in demand and cost conditions Monopoly profit theory Some firms earn above-normal profits because of monopoly position. (economies of scale, high capital requirements, patents, import protection) Compensatory Profit Theories Above-normal rates of return reward firms for extraordinary success in meeting customer need, maintaining efficient operations, and so forth.
Role of Economic Profits • Economic profits play an important role in a market-based economy. • Provide a signal for expansion and contraction. • Important reward for innovation and efficiency.
Structure of this Text Objectives Learn usefulness of economics in describing managerial behavior. Appreciate how economics can be used to improve managerial decisions. Understand vital role of business in society.
