Managerial Economics

Almudena Sevilla
Professor in Economics, SBM

Email: a.sevilla@qmul.ac.uk
http://www.busman.qmul.ac.uk/staff/sevillaa.html
Room number: Francis Bancroft Building, FB4.13D
Personalized feedback sessions: Wednesday 14.00-16.00
(or by appointment)
TA/s Name: Daniela Parker

Personalized feedback sessions: Wednesday 14.00-15.00
Description of QMPLUS
Module outline in qmplus
Qmplus (ask Joseph Okitikpi to give you student access):
- Announcements (admin issues)
- Each Week:
- Content/Topic
- During lecture:
- Lecture Readings before coming to lecture
(textbook, academic articles etc)
• Question of the week to discuss in class
- Seminar: Case Study + Problems/Applications
- Additional Resources (URLs, Articles, etc)
- Academic Background and state of the art
Description & Aims
• Applies microeconomics to:
• problems confronting decision-making within firms
• current events and policy debates that are relevant to
businesses
• Aims:
• New perspective on how best to make economic decisions as
managers (Q2)
• Limits of economic policy and the implications for
businesses (Q1)
Graduate attributes
Deep learning approach (Critical thinking):
• Lecture:
• Introduction to threshold concepts using economic tools
Question of the week & case studies (news analysis)
• Academic background and state of the art
• Seminar:
• Technical knowledge: Problems and applications
• Critical thinking: Case studies (news analysis)
Teaching Method
• 1 lecture and 1 Seminar per week
• Seminars begin in week 2
• No seminars in weeks 6 and 12 (due to
midterm/final exam).
• No seminars or lectures during week 7 (reading
week).
• Week 11: Mock exam (during lecture)
Academic Content
• Topic 1: Key aspects of the functioning of markets
• Demonstrate the analytical and quantitative skills to
understand basic economic concepts such as principles of
(micro) economics (scarcity, optimization, modelling, S&D,
externality) and how managers can apply them (week 1)
• Topic 2: Personnel and labour economics
• Be aware of the different approaches to creating workforce
incentives and their advantages and disadvantages, CEO
compensation, inequality (week 2- week 4)
• Topic 3: Market structures & pricing strategies
• Know the main differences between different market
structures and their implications in terms of manager
behaviour (week 5-week 10)
Assessment
- Please refer to the module’s outline and the

UG module directory
- One MCQ tests in week 6 (40%)
- One final exam in week 12
- 2 case studies out of 3
- Critical thinking (60%)
How to succeed in BUSM051
- Before lecture:
- readings
- After lecture:
- readings
- MCQ from Mankiw to check you understand
- try out question of the week and lecture case study
- try out problems and applications for seminar
- try out case study for seminar
- Still questions:
- Personalized feedback sessions
Main Textbooks
• N Gregory Mankiw and Mark P Taylor,

MicroEconomics 3e, Cengage Learning
[Mankiw]
• Link in Qmplus
Other Reading (all in QMPLUS)
• QMPLUS structure for BUSM051
Distribution of Grades 2016
- 5% fail
- Normal distribution, mean 55
- 10% above 70
Let’s Start!
• 1 How is it like to think like an economist?
Q1
• 2 How markets work?
Lecture Case study
• 3 Why are markets efficient?
Q2
• 4 When do markets fail?: externalities
Seminar 1’s case study
Copyright © 2010 Cengage Learning

Thinking Like an
Economist
1
Economics
….. The word economy comes from a Greek word for “one who
manages a household” …
….. Economics is the study of how society manages its scarce

resources …
…... Microeconomists study decision making by households and

firms in the marketplace ….
….. Here we will look at decision making within the firm ….

Economic Way of Thinking
• Every field of study has its own terminology
• Economics: analytical and objective
• Makes appropriate assumptions and build simplified models (graphs

appendix, on-line) in order to understand the world around them and
develop theories
• Ex: 2xdimensional (assumption) google map
• Ex: Assumptions and models during economic crisis
• Collects, and analyses data to evaluate the theories

• Ex: data on accuracy (how many people got to destination) =>
prediction
Scarcity
Society and Scarce Resources:
• The management of society’s (firm’s) resources is

important because resources are scarce
• Scarcity. . . means that society has limited resources

and therefore cannot produce all the goods and
services people wish to have

Scarcity
Scarce resources can be allocated in three
specific ways:
• Centrally planned/command economy

• Market economy
• Mixed economy
Question: Can you think of example of countries and

economies for each case?

Economic Principles
• When individuals make decisions, they face trade-offs among
alternative goals.
• The cost of any action is measured in terms of foregone
opportunities (opportunity cost):
• Different from accounting (week 2, week 6)
• Ex: Cost of university is more than tuition fee
• People change their behavior in response to the incentives they
face (week 3, week 4) (how much, when, how)
• Rational people make decisions by comparing marginal costs
and marginal benefits (limitations .. but on average holds)
• Important when there are sunk costs (week 6)
• Ex: expensive restaurant (investment decisions)
How is it like to think like an
economist?
• Understand the concept of “thinking at the
margin” or “marginal decision making”:
Ø Question of the week 2

ØLog into QMPLUS - BUSM051 - Week 1
ØGo to question of the week 2, Read scenario
ØClick on Question of the week 2: Answer
Ø Feedback: You tube video on “sunk cost”
https://www.youtube.com/watch?v=4lEX_lqnJbg
The Market Forces of
Supply and Demand
2
(technical)
How Prices Allocate Resources
Markets are usually a good way
to organize economic activity (efficient)
• In market economies, prices adjust to balance
supply and demand.
• These equilibrium prices are the signals that
guide economic decisions and thereby allocate
scarce resources.

Markets and Competition
• A market is a group of buyers and sellers of a
particular product.
• In this chapter, we assume markets are perfectly
competitive.
• A competitive market is one with many buyers
and sellers
• In a perfectly competitive market:
• All goods exactly the same
• Buyers & sellers so numerous that no one can affect
market price—each is a “price taker”

Demand
• The quantity demanded of any good is the
amount of the good that buyers are willing and
able to purchase (at any given price), given
their income, preferences, needs, etc
• Law of demand: the claim that the quantity

demanded of a good falls when the price of the
good rises (other things equal)

Demand Curve Shifters: # of Buyers
P Suppose the number

$6.00 of buyers increases.
Then, at each P,
$5.00
Qd will increase
$4.00 (by 5 in this example).
$3.00
$2.00
$1.00
$0.00 Q
0 5 10 15 20 25 30

Demand Curve Shifters
• Number of Consumers
• Prices of other goods (complements vs
substitutes)
• Tastes
• Expectations
• Income (Inferior vs normal goods)

Supply
• The quantity supplied of any good is the
amount that sellers are willing and able to sell,
given their costs, their technology, etc
• Law of supply: the claim that the quantity

supplied of a good rises when the price of the
good rises, other things equal

Supply Curve Shifters: Input Prices
P Suppose the
$6.00 price of milk falls.
At each price,
$5.00
the quantity of
$4.00 lattes supplied
$3.00
will increase
(by 5 in this
$2.00 example).
$1.00
$0.00 Q
0 5 10 15 20 25 30 35

Summary: Variables that Influence Sellers
Variable A change in this variable…

Price …causes a movement
along the S curve
Input Prices …shifts the S curve
Technology …shifts the S curve
# of Sellers …shifts the S curve
Expectations …shifts the S curve

Equilibrium: Supply and Demand Together
P
$6.00 D S Equilibrium:
P has reached
$5.00
the level where
$4.00 quantity supplied
$3.00 equals
quantity demanded
$2.00
$1.00
$0.00 Q
0 5 10 15 20 25 30 35

Why S=D is an Equilibrium?
- Old and new equilibrium
- Process of adjustment from the old to the

new equilibrium

Three Steps to Analyzing Changes in Eq’m
To determine the effects of any event (shock):

1. Decide whether event shifts S curve,
D curve, or both.
2. Decide in which direction curve shifts.
3. Use supply—demand diagram to see

how the shift changes eq’m P and Q
Understand the dynamics as well as where the

new equilibrium is

Case Study: Olive Oil Market

Olive Oil is Good!
• Olive oil is delicious!
• Its high content of monsaturated fat makes it among
the most healthy of cooking oils
• It has zillions of other uses, too . .
• Great for your skin
• Olive-oil-infused jeans
• Try it for shaving!
Picture source: Alex Ex via http://commons.wikimedia.org/wiki/File:Italian_olive_oil_2007.jpg
Feb 5, 2013 Ed Dolan’s Econ Blog http:// Copyright © 2010 Cengage Learning
But Olive Oil Prices are Soaring. Why?
² Unfortunately for consumers, the price of olive oil is soaring

² This chart shows futures prices for the 2012/13 harvest season
Changes in Consumer Behavior
• No meal in Southern Europe is complete
without a basket of bread and a dish of
olive oil
• However, the economy is bad in Europe.
Consumers there are cutting back even on
staples like olive oil
• Meanwhile, people around the world are
starting to recognize the pleasure and
heath benefits of the Mediterranean diet.
Olive oil is becoming more popular with
consumers in the U.S., China, Brazil,
Russia, and elsewhere
Bread and Olive Oil

Photo by Ewan Munro http://commons.wikimedia.org/wiki/
File:Murano,_Mayfair,_London_%285210809193%29.jpg
Question: How Do Changes in Consumer Behavior Affect Price?
How do changes in consumer incomes and
tastes affect the price of olive oil?
Consider each factor separately, and then
together
• Does the demand curve shift? If so, show
the new demand curve
• Does the supply curve shift? If so, show
the new supply curve
• Show the new equilibrium price
Answer: How Changes in Consumer Behavior Affect Price
• Olive oil is a normal good so fall in European
consumer incomes by themselves would shift
demand toward D1
• Meanwhile increasing preference for olive oil in
the rest of the world would have the opposite
effect, shifting demand back toward D0
• In practice, the two effects are expected to
roughly cancel each other out during 2013,
leaving demand little changed
• The changes in consumer behavior do not
affect the other things being equal conditions
behind the supply curve, so they do not shift the
supply curve
Bad Weather in Spain, the Biggest Producer
• Spain is by far the largest
producer of olive oil
• The weather has been bad
• Frost in spring of 2012
• Drought in summer of 2012
• The winter harvest was down
by more than half
• No other producer is large
enough to make up the lost
Spanish production
Question: How Does the Bad Weather
Affect the
Other things being equal, how does bad
Price?
weather affect the price?
• Does the demand curve shift? If so,
show the new demand curve as D2
• Does the supply curve shift? If so,
show the new supply curve as S2
• Show the new equilibrium price as P2
Answer: How Bad Weather Affects the Price
• Bad weather will cause the supply
curve to shift to the left, for example,
from S0 to S2 as shown here.
• Other things being equal, the weather
will not affect the demand curve
• The market moves long the demand
curve until a new equilibrium price is
reached at the level P2
The Bottom Line
• Demand will not be a big factor
affecting olive oil prices for 2013,
although world demand can be
expected to grow in the future
• In the short run, there is no way other
countries can make up for the supply
lost from bad weather in Spain
• In the long run, new production in
Tunisia, California, and elsewhere will
help keep olive oil affordable around
the world
By how much will the quantity decrease?
• See estimating demand functions in
additional resources
“Slope coefficients provide estimates of

the change in sales that might be
expected following a 1-unit increase in
price….”
Case Study: Olive Oil Market
• You are the manager of an Italian restaurant in
London
• Olive oil represents 20% of your food budget

• S&D analysis gives you an understanding of how
the world works
• S&D enables you (as a manager) to better forecast
your costs and thus better plan for the future

The Efficiency of
Markets
3
(Threshold Concept)
Why Markets are Efficient?:
• Threshold concept in Economics

• Do markets produce a desirable allocation of
resources (p and q)? Or could the market
outcome be improved upon?
• Efficiency: If nobody can be made better off
(without making somebody else worse off)
• Consumers who are willing to pay the most (either
because they have the money, or because they need the
good, etc)
• Producers who are willing to sell the good at the lowest
price
Efficiency vs. Equity
• Efficiency is not fairness
• Efficiency: Objective (positive statement)
• Are market outcomes fair?

• Fairness: Subjective (normative statement)

Objectivity? Positive vs Normative
• A positive statement is an assertion about how
the world is (based on assumptions!)
ex. Market Efficiency
• A normative statement is an assertion about
how the world ought to be
Ex. Market Fairness
• When economists make normative statements,
they are acting more as policy advisors than
scientists
• Goal: To understand when we are making positive
Welfare Economics
• Efficient allocation of resources refers to:
• how much of each good is produced (and at what
price)
• which producers produce it which consumers
consume it
• Welfare economics studies how the allocation of

resources affects economic well-being

Consumer Surplus
P The demand for shoes

$ 60
CS is the area b/w P
and the D curve, from 50
0 to Q. h
40
Recall: area of
a triangle equals 30
½ x base x height 20
Height =
10
$60 – 30 = $30. D
So, 0 Q
CS = ½ x 15 x $30 0 5 10 15 20 25 30
= $225.
Producer Surplus
60 P The supply of shoes
PS is the area b/w 50

P and the S curve, 40 S
from 0 to Q.
30
The height of this
triangle is 20
h
$30 – 15 = $15. 10
So, 0
PS = ½ x b x h
0 5 10 15 20 25 30 Q
= ½ x 25 x $15

CS, PS, and Total Surplus
CS = (value to buyers) – (amount paid by buyers)
= buyers’ gains from participating in the market
PS = (amount received by sellers) – (cost to sellers)

= sellers’ gains from participating in the market
Total surplus = CS + PS
= total gains from trade in a market PIE!
= (value to buyers) – (cost to sellers)

Efficiency
Total
surplus = (value to buyers) – (cost to sellers)
An allocation of resources is efficient if it maximizes total
surplus. Efficiency means:
• The goods are consumed by the buyers who are
willing to pay the most (Key: either because they
value the good most highly or they are able to afford
the highest prices)
• The goods are produced by the producers with the
lowest costs (willing/able to offer the good for the
least money)
=> Raising or lowering the quantity of a good
would not increase total surplus.
How policy affects business?
Understanding Efficiency is Crucial for Policy
• Efficiency grounds: everybody wins (although

there may be some losers/winners in the short run)
PIE
• Equity grounds: some losers/some winners

Efficiency vs. Fairness: The Minimum Wage
Min wage laws unemp-
do not affect W loyment S
highly skilled Min.
$7.25
workers. wage
They do affect teen $6.00

workers.
Studies:
A 10% increase
in the min wage D
raises teen L
400 550
unemployment
by 1–3%.

Free Market vs. Govt Intervention

to organize economic activity
• Prices are the signals that guide the allocation of
society’s resources
• This allocation is altered when policymakers restrict
prices
• Price controls often intended to help the poor,
but often hurt more than help
• Laissez faire (French for allow them to do ):

the notion that govt should not interfere with the market
Adam Smith and the Invisible Hand
Passages from The Wealth of Nations, 1776
Every man…neither intends to promote the
public interest, nor knows how much he is
promoting it….
He intends only his own gain, and he is
in this, as in many other cases, led by
an invisible hand to promote an end
which was no part of his intention.
Nor is it always the worse for the society
that it was no part of it. By pursuing his
own interest he frequently promotes
Adam Smith,
that of the society more effectually than
1723-1790
when he really intends to promote it.”

Free Market vs. Govt Intervention

to organize economic activity but…
• There are market failures (Q1: Market for Organs)
• Government intervention justified (advisable?)
• Caution: If no market failures in one market… does not
mean no market failures in another market…
- Institutional context: Keep in mind… rules of the game
are not the same for every one…
- Ex: Min wage: Unemployment (Maybe better policies
changing how market agents arrive to the market, ex:
raising the Demand for labor through investment in skills
if for example, market failures in the credit market that
hinder access to education) Copyright © 2010 Cengage Learning
Efficiency vs Equity
Ø Question of the week 1
ØLog into QMPLUS - BUSM051 - Week 1
ØBBC link on question of the week 1
ØClick on Question of the week 1: Answer the survey
Ø Feedback: in qmplus

Externalities 4
(Introduction to Case
Study in Seminar 1)
Market Failures
• Such market failures occur when:

• a buyer or seller has market power—the ability to affect
the market price. (example: imperfect competition)
• transactions have side effects, called externalities, that
affect bystanders. (example: pollution)
• We’ll use welfare economics to see how public policy may

improve on the market outcome in such cases
• How policy affects decision making within the firm

EXTERNALITIES AND MARKET
INEFFICIENCY
• An externality arises...
. . . when a person engages in an activity that affects
the well-being of a bystander
… and yet neither pays nor receives any
compensation for that effect.
• When the impact on the bystander is adverse,
the externality is called a negative externality.
• When the impact on the bystander is beneficial,
the externality is called a positive externality.

INEFFICIENCY
• Negative Externalities
• Car exhaust fumes
• Cigarette smoking
• Barking dogs (loud pets)
• Loud stereos in an apartment building

INEFFICIENCY
• Positive Externalities
• Immunizations
• Restored historic buildings
• Research into new technologies

INEFFICIENCY
• Negative externalities lead markets to produce a
larger quantity than is socially desirable.
• Positive externalities lead markets to produce a
smaller quantity than is socially desirable.

Figure 2 Pollution and the Social Optimum
Price of
Social
Aluminum
cost
Cost of
pollution
Supply
(private cost)
Optimum
Equilibrium
Demand
(private value)
0 QOPTIMUM QMARKET Quantity of

Aluminum
Copyright©2011
Copyright
South-Western
© 2010 Cengage Learning
Figure 3 Education and the Social Optimum
Price of
Education
Supply
(private cost)
Social
value
Demand
(private value)
0 QMARKET QOPTIMUM Quantity of

Education
Copyright©2011
Copyright
South-Western
© 2010 Cengage Learning
PRIVATE SOLUTIONS TO
EXTERNALITIES
• Government action is not always needed to
solve the problem of externalities
• Internalizing an externality involves altering

incentives so that people take account of the
external effects of their actions

The Coase Theorem
• The Coase Theorem is a proposition that if

private parties can bargain without cost over the
allocation of resources, they can solve the
problem of externalities on their own.
• Ex: polluting firm and a neighbourhood
• Independent of who owns property rights
• Transaction costs are the costs that parties incur
in the process of agreeing to and following
through on a bargain.

PUBLIC POLICY TOWARD
EXTERNALITIES
• When externalities are significant and private
solutions are not found, government may
attempt to solve the problem through . . .
• Command-and-control policies.
• Stipulations on pollution emission levels set by the
government.
• Market-based policies.
• Ex: Tradable pollution permits allow the voluntary
transfer of the right to pollute from one firm to another
• Case study: Due in Week 2 Seminar

Week 2 Seminar
Carbon prices, Breathing difficulties
A market in need of a miracle
THE European Union's Emissions Trading System (ETS), the world's biggest carbon market, has two main aims. One is to restrict the
carbon-dioxide emissions of the 11,000 companies trading on it to an agreed cap. The other is to give these firms an incentive to
invest in clean technology. On the first count, thanks to the economic malaise, the ETS is a success: its participants' emissions are
well below the current cap. On the second, for the same reason, it is failing wretchedly. Oversupplied with permits, the market has
tanked. Having reached nearly €30 ($47) a tonne in 2008, the carbon price is now persistently under €10: much too low to prod firms
to make their investment plans greener…..
Questions
Imagine you are the CEO of Drax, a polluting coal-fired power plant in the UK.
Your firm produces electricity.
1- Greater consumption of electricity leads to more carbon emissions and, thus, imposes
costs on bystanders.
Is your firm under producing or overproducing electricity?

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Almudena Sevilla

Professor in Economics, SBM

TA/s Name: Daniela Parker

- Please refer to the module’s outline and the

• N Gregory Mankiw and Mark P Taylor,

Copyright © 2010 Cengage Learning

….. Economics is the study of how society manages its scarce

…... Microeconomists study decision making by households and

….. Here we will look at decision making within the firm ….

Copyright © 2010 Cengage Learning

• Economics: analytical and objective

• Makes appropriate assumptions and build simplified models (graphs

• Collects, and analyses data to evaluate the theories

Society and Scarce Resources:

• The management of society’s (firm’s) resources is

• Scarcity. . . means that society has limited resources

Copyright © 2010 Cengage Learning

• Centrally planned/command economy

Question: Can you think of example of countries and

Copyright © 2010 Cengage Learning

Ø Question of the week 2

Copyright © 2010 Cengage Learning

Copyright © 2010 Cengage Learning

• Law of demand: the claim that the quantity

Copyright © 2010 Cengage Learning

P Suppose the number

Copyright © 2010 Cengage Learning

Copyright © 2010 Cengage Learning

• Law of supply: the claim that the quantity

Copyright © 2010 Cengage Learning

Copyright © 2010 Cengage Learning

Variable A change in this variable…

Copyright © 2010 Cengage Learning

Copyright © 2010 Cengage Learning

- Old and new equilibrium

- Process of adjustment from the old to the

Copyright © 2010 Cengage Learning

To determine the effects of any event (shock):

3. Use supply—demand diagram to see

Understand the dynamics as well as where the

Copyright © 2010 Cengage Learning

Copyright © 2010 Cengage Learning

Picture source: Alex Ex via http://commons.wikimedia.org/wiki/File:Italian_olive_oil_2007.jpg

² Unfortunately for consumers, the price of olive oil is soaring

Bread and Olive Oil

“Slope coefficients provide estimates of

• Olive oil represents 20% of your food budget

Copyright © 2010 Cengage Learning

• Threshold concept in Economics

• Are market outcomes fair?

Copyright © 2010 Cengage Learning

• Welfare economics studies how the allocation of

Copyright © 2010 Cengage Learning

P The demand for shoes

PS is the area b/w 50

Copyright © 2010 Cengage Learning

PS = (amount received by sellers) – (cost to sellers)

Copyright © 2010 Cengage Learning