ECONOMICS 004

Manegerial Economics 3. Identify possible solutions - Oliver Williamson

- application of economic theory and 4. Select the best solution - the advent of the modern corp.
the tools of analysis of decision science and the resulting separation of
to examine how an org. can achieve its 5. Implement the decision management from ownership,
objective most efficiently The Theory of the Firm managers are more interested in
maximizing their utility than in
Manegerial Decision Problems 1. Reason for Existence maximizing corporate profits
- arise when it seeks to achieve its goal - to save on transaction cost (principal-agent problem)
subject to constraints
- FIRM: combines and organizes c. Suficing Behavior
- goals and constraints may differ; resources for producing - Richard Cyert and James March
basic decision-making process is the goods/services
same - managers are not able to maximize
2. Objective and Value profits but can only strive for some
- before: the goal of the firm was to satisfactory goal in terms of sale,
Relationship to Economic Theory maximize current or short-term profit profits, growth, market share, and etc.
- helps solve management decision - now: the primary goal is to
problems maximize the wealth or the value of BUSINESS VS ECONOMIC PROFIT
Economic Theory the firm (by maximizing profits, and
1 2 n n
t
PV 
minimizing cost)
(1  r )1 (1  r ) 2
    
(1  r ) n t 1 (1  r )t
1. Business Profit
- predict and explain economic - revenue minus explicit/accounting
behavior based on a model cost of the firm
a. Microeconomics n
t n
TRt  TCt
Value of Firm    *Explicit – actual out-of-pocket
- individual units t 1 (1  r )t t 1 (1  r )t expenditures
3. Constraints on the Operation 2. Economic Profit
b. Macroeconomics
- total or aggregate level of economy - limitations on the availability of - revenue minus explicit and implicit
essential inputs cost of the firm
viewed as a whole
- legal constraints *Implicit - value of the inputs
- imposed in order to modify owned and used by the firm in its own
Relationship to the Decision Sciences
behaviors and make it more consistent production process (opportunity cost)
- used to construct and estimate with broad social welfare goals
decision models aimed at determining
the optimal behavior of the firm - CONSTRAINED OPTIMIZATION: THEORIES OF PROFIT
optimizing with respect to the
a. Mathematical Economics presence of the constraints variables 1. Risk-Bearing Theories of Profit

- formalize the economic models
b. Econometrics
- applies statistical tools to estimate
the models and for forecasting
Basic Process of Decision Making
1. Define the problem
2. Determine the objective
- restricts the range of freedom of - above normal returns are required
action and limits the value of the firm by firms to enter and remain in the
field
4. Limitations of the Theory
2. Frictional Theory of Profit
a. Sales Maximization
- profit arise as a result of friction or
- William Baumol disturbances from long-run
- managers seek to maximize sales equilibrium
after an adequate rate of profit has 3. Monopoly Theory of Profit
been earned to satisfy stockholders
b. Management Utility Maximization
 - due to restriction to enter in the GLOBALIZATION OF ECONOMIC *Marginal Cost – the change in total
industry, firms can continue earning ACTIVITY cost
profits in the long-run
 Goods and Services AC = TC / Q
 Capital
MC = ∆TC / ∆Q
 Technology
4. Innovation Theory of Profit
 Skilled Labor Concept of the Derivative
- profit is the reward for the
introduction of a successful innovation - the derivative of Y with respect to X is
equal to the limit of the ratio of ∆Y/∆X
Internet “net” – collection of
5. Manegerial Efficiency Theory of as ∆X approaches zero
computers throughout the world
Profit
linked together in a service, “World
dY Y
- average firm tends to earn only a Wide Web”
 lim
normal return on its investment, while
firms above normal will earn above
Information Superhighway dX X 0 X
normal returns - anyone can hook up with libraries,
databases, and marketing information RULES OF DIFFERENTIATION

- the vast amount of information was Constant Function Rule:

FUNCTION OF PROFIT
in our fingertips - the derivative of a constant, Y = f(x) =
- for the reallocation of society’s a, is zero for all values of ‘a’
resources to reflect changes in
consumer’s taste and demand METHODS OF EXPRESSING ECONOMIC dY
0
1. High Profits
RELATIONSHIPS dX
- simple: table or graph Power Function Rule:
- consumers want more outputs of
the industry - complex: equational form - the derivative of a power function,
- more firms will enter the industry*Equational Form – most efficient where a and b are constants, is defined
way for the firm to achieve its as:
- reward for greater efficiency
objective
Y  f (X )  a X b dY
2. Lower Profits or Losses  b  a X b 1
*Regression/Rules of Calculus - dY dU dX dV
- consumers want less of the determine the optimal solution  
commodity
dX dX Rule:
Sum-and-Differences dX

- methods are not efficient - the derivative of the sum or

MARGINAL ANALYSIS difference of two functions
- for firms to leave the industry for
- the firm maximizes profits when
more profitable ones
marginal revenue is equal to marginal
cost

BUSINESS ETHICS Marginal Relationship Product Rule:

- identifies types of behavior that the - change in the dependent variable - the derivative of the product of two
business and its employees should not with a unitary change in one of the functions
engage in independent variable
dY dV dU
U V
- provide guidance, of what is - change in total revenue with one-unit dX dX dX
acceptable behavior in business change in units sold
transactions, beyond the laws Quotient Rule:
*Total Revenue (TR) - price per unit x
*Ethics Officer – keep employees quantity sold - the derivative of the ratio of two
conduct upright than the law requires functions
*Total Cost (TC) – total fixed cost +
total variable cost
dY

V dU  dX  
 U dV
dX 
2
dX V
 Ft = Ft-1 + α (At-1 – Ft-1) STANDARD DEVIATION

*Ft = forecast for period ‘t’

*Ft-1 = forecast for the previous period
Chain Rule:
*α = smoothing constant
- the derivative of a function that is a
*At-1 = actual data for the previous
function of X
period CORRELATION COEFFICIENT
dY dY dU
  - A-F is the error term, α is the %
 
dX dU dX feedback

DISTINGUISHING BET A MAX AND

DETERMINATION OF COEFFICIENT
MIN
LINEAR TREND EQUATION
- the rule is if the derivative is positive,
we have a minimum, and if the second Ft = a + bt
derivative is a negative, we have a *Ft = forecast for period t
maximum
*t = specified number of time periods
*a = value of Ft at t
FORECASTS TECHNIQUE
*b = slope
Stable Time Series Data
F (t) = A (t – 1)
TREND PROJECTION
Seasonal Variations
Linear Trend
F (t) = A (t – n)
St = S0 + bt
Data with Trends
b = growth per time period
F (t) = A (t – 1 ) + [A (t – 1) – A (t – 2)]
Constant Growth Rate (Non-Linear)
St = S0 + (1 + g)t
FORECASTS TECHNIQUE
g = growth rate
1. Moving Average
Estimation of Growth Rate
- averages a number of recent actual
values, updated as new values become In St = In S0 + t In (1 + g)
available

REGRESSION EQUATION

2. Weighted Moving Average

Y = a + Bx
*Y = dependent variable
- more recent values in a series are
given more weight in computing the *X = independent variable
forecast
*a = y-axis intercept
*b = slope

EXPONENTIAL SMOOTHING
NEW MANAGEMENT TOOLS
a. Benchmarking
- finding out how other firms doing
something better or cheaper so you
can copy or improve the technique
b. Total Quality Management
- constantly improving the quality of
the products to increase its value
c. Reengineering
- reorganizing the firm’s process
d. The Learning Organization
- values continuing learning (new
model, shared vision, team learning)