MANAGERIAL ECONOMICS

1. MANAGERIAL ECONOMICS MSc Programme Prof.Howard Davies

2. Why Managerial Economics? • A powerful ‘analytical engine’ • A broader perspective on the firm • what is a firm? • what are the firm’s overall objectives? • what pressures drive the firm towards profit and away from profit • The basis for some of the more rigourous analysis of Marketing issues

3. The Economic Approach to the Firm Basic Models Transactions Cost Analysis: What Is A Firm? Ownership and Control, Diversification and Mergers The Behaviour of Costs Demand Theory and Forecasting Market Structures Game Theory Pricing in Theory and Practice Non-price Marketing decisions The Economics of the Information Sector Economics and the Analysis of Business Strategy What Topics Will We Cover?

4. CLASSROOM 6:45 -8:00 Lecture 8:00-8:15 Break 8:15 - 9:45 In-class activities ASSESSMENT In-class activities:20% Mid-term quiz 25% PBL Problem Solutions: 20% Peer Appraisal: 10% End of term Quiz: 25% Classroom Work and Assessment

5. Reading Materials • H.Davies and P-L Lam, Managerial Economics: An Analysis of Business Issues, FT Prentice Hall 2001 • Copies of academic journal articles

6. Managerial Economics • The application of economic analysis to business problems • Related to, but not the same as • industrial economics • management science

7. Managerial Economics • The economics ‘method’ • ‘illicit relationships with beautiful models’ • The steps:the hypothetico-deductive approach • make assumptions about behaviour • work out the consequences of those assumptions • make predictions • test the predictions against the evidence • PREDICTIONS SUPPORTED? The model is accepted as a good explanation (for the moment) • PREDICTIONS REFUTED? Go back and re-work the whole process

8. Managerial Economics • A ‘positive’ approach, not prescriptive or ‘normative’ • trying to explain ‘what is’ not what ‘should be’ • main objective to understand how a market economy works • Not very concerned about the descriptive realism of assumptions: ‘I assume X’ does not mean ‘I believe X to be true’ • Some real tension if the models are used for prescription • assume ‘perfect knowledge’: OK for model-building • cannot say to a manager: ‘behave AS IF you had perfect knowledge

9. The Basic Model of the Firm • The neo-classical model • The firm aims to maximize profit by choosing the level of output which gives the biggest difference between revenue and costs. • STEP BY STEP TO THE MODEL $ P1 Demand: Average Revenue P2 Quantity Produced Q1 Q2

10. The Basic Model of the Firm • The neo-classical model • The firm aims to maximize profit by choosing the level of output which gives the biggest difference between revenue and costs. • STEP BY STEP TO THE MODEL $ Demand: Average Revenue Quantity Produced Marginal Revenue

11. The Basic Model of the Firm • The neo-classical model • The firm aims to maximize profit by choosing the level of output which gives the biggest difference between revenue and costs. • WHAT IS THE EQUILIBRIUM? $ Marginal Cost Profit Maxing Price Demand: Average Revenue Quantity Produced ProfitMaxing Output Marginal Revenue

12. The Basic Model of the Firm • The neo-classical model • The firm aims to maximize profit by choosing the level of output which gives the biggest difference between revenue and costs. • MORE DETAIL ON THE EQUILIBRIUM $ Marginal Cost Profit Maxing Price Average Cost Demand: Average Revenue Quantity Produced ProfitMaxing Output Marginal Revenue

13. What Can We Do With This Model? • Comparative Statics • begin with an initial equilibrium position - the starting point • change something • identify the new equilibrium, e.g: • When demand increases? • When costs rise? • When a fixed cost increases? • This is the main purpose of the model -what it was designed to do • Normative prescriptions • it will cost me $30 per unit to supply something which will give me $20 per unit in revenue- should I do it? • I must pay $20 billion to set up in my industry. Should I charge higher prices to get that money back? • Positive and Normative are linked by “if?” IF the aim of the firm is to maximise profit what will it do/what should it do?

14. What Is A “Good” Model? • It allows us to make predictions and set hypotheses • The predictions can be tested against the empirical evidence • The predictions are supported by the empirical evidence • gravity - pulleys, weights and strings

15. Typical Exam/Quiz Questions for this Topic • Economists are often accused of using models which are based upon unrealistic assumptions and therefore cannot be useful. Write a defence of the economists’ approach and explain your own judgment on this issue. • Discuss the relative merits and disadvantages of auctioning mobile phone licenses versus allocating them through a ‘beauty contest’.

16. Look at the Discussion Topics for This Week • What assumption is being made about competition in the model described this week? • How will different kinds of competitive situation change the basic model of the firm? • Will auctioning licences for 3G mobile phones increase the price of calls?

17. See You Next Week • Do some preparation for the in-class work!!