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 etc

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Managerial economics a problem solving approach

Managerial Economics:A Problem-solving Approach

Why is teaching economics to mba s so difficult
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?


  • 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
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
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
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.

Problem solving
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.

Keep the ultimate goal in mind
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
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
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

  • 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

    • 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