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CHAPTER 2: Economic management theories

Exhibit 2–1 Major Approaches to Management

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2–2

Historical Background of Management

• Ancient Management
Ø Egypt (pyramids) and China (Great Wall)
Ø Venetians (floating warship assembly lines)
• Adam Smith
Ø Published The Wealth of Nations in 1776
v Advocated the division of labor (job specialization) to increase the
productivity of workers
• Industrial Revolution
Ø Substituted machine power for human labor
Ø Created large organizations in need of management
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2–3

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Major Approaches to Management

• Classical
• Quantitative
• Behavioral
• Contemporary

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2–4

Scientific Management

• Fredrick Winslow Taylor

Ø The “father” of scientific management
Ø Published Principles of Scientific Management (1911)
v The theory of scientific management
– Using scientific methods to define the “one best way” for a job to be done:
• Putting the right person on the job with the correct tools and equipment.
• Having a standardized method of doing the job.
• Providing an economic incentive to the worker.

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2–5

Exhibit 2–2 Taylor’s Scientific Management Principles

1. Develop a science for each element of an individual’s

work, which will replace the old rule-of-thumb method.
2. Scientifically select and then train, teach, and develop
the worker.
3. Heartily cooperate with the workers so as to ensure that
all work is done in accordance with the principles of the
science that has been developed.
4. Divide work and responsibility almost equally between
management and workers. Management takes over all
work for which it is better fitted than the workers.

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2–6

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General Administrative Theory

• Henri Fayol
Ø Believed that the practice of management was distinct from other
organizational functions
Ø Developed principles of management that applied to all organizational
situations
• Max Weber
Ø Developed a theory of authority based on an ideal type of organization
(bureaucracy)
v Emphasized rationality, predictability, impersonality, technical competence, and
authoritarianism

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2–7

Scientific Management (cont’d)

• Frank and Lillian Gilbreth

Ø Focused on increasing worker productivity through the reduction of wasted
motion
Ø Developed the microchronometer to time worker motions and optimize work
performance
• How Do Today’s Managers Use Scientific Management?
Ø Use time and motion studies to increase productivity
Ø Hire the best qualified employees
Ø Design incentive systems based on output

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2–8

Exhibit 2–3 Fayol’s 14 Principles of

Management
1. Division of work 7. Remuneration

2. Authority 8. Centralization

3. Discipline 9. Scalar chain

4. Unity of command 10. Order

5. Unity of direction 11. Equity

6. Subordination of 12. Stability of tenure

individual interests of personnel
to the general 13. Initiative
interest
14. Esprit de corps
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2–9

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Exhibit 2–4Weber’s Bureaucracy

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2–10

Quantitative Approach to
Management
• Quantitative Approach
Ø Also called operations research or management science
Ø Evolved from mathematical and statistical methods
developed to solve WWII military logistics and quality
control problems
Ø Focuses on improving managerial decision making by
applying:
v Statistics, optimization models, information models, and computer
simulations

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2–11

Exhibit 2–5 What Is Quality Management?

Intense focus on the customer
Concern for continual improvement
Process-focused
Improvement in the quality of everything
Accurate measurement
Empowerment of employees

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2–12

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Understanding Organizational
Behavior
• Organizational Behavior (OB)
Ø The study of the actions of people at work; people are the
most important asset of an organization
• Early OB Advocates
Ø Robert Owen
Ø Hugo Munsterberg
Ø Mary Parker Follett
Ø Chester Barnard

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2–13

Exhibit 2–6 Early Advocates of OB

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2–14

The Hawthorne Studies

•A series of productivity experiments conducted
at Western Electric from 1924 to 1932.

•Experimental findings
ØProductivity unexpectedly increased under imposed
adverse working conditions.
ØThe effect of incentive plans was less than expected.

•Research conclusion
ØSocial norms, group standards and attitudes more
strongly influence individual output and work behavior
than do monetary incentives.

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2–15

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The Systems Approach

• System Defined
Ø A set of interrelated and interdependent parts arranged in a manner that
produces a unified whole.
• Basic Types of Systems
Ø Closed systems
v Are not influenced by and do not interact with their environment (all system input and
output is internal).
Ø Open systems
v Dynamically interact to their environments by taking in inputs and transforming them into
outputs that are distributed into their environments.

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2–16

Exhibit 2–7 The Organization as an Open

System

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2–17

Implications of the Systems Approach

• Coordination of the organization’s parts is essential

for proper functioning of the entire organization.
• Decisions and actions taken in one area of the
organization will have an effect in other areas of the
organization.
• Organizations are not self-contained and, therefore,
must adapt to changes in their external environment.

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2–18

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The Contingency Approach

• Contingency Approach Defined

Ø Also sometimes called the situational approach.
Ø There is no one universally applicable set of management principles (rules) by
which to manage organizations.
Ø Organizations are individually different, face different situations (contingency
variables), and require different ways of managing.

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2–19

Exhibit 2–8Popular Contingency Variables

• Organization size
• As size increases, so do the problems of coordination.
• Routineness of task technology
• Routine technologies require organizational structures,
leadership styles, and control systems that differ from
those required by customized or non-routine technologies.
• Environmental uncertainty
• What works best in a stable and predictable environment
may be totally inappropriate in a rapidly changing and
unpredictable environment.
• Individual differences
• Individuals differ in terms of their desire for growth,
autonomy, tolerance of ambiguity, and expectations.

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2–20

Studying management history is important

• Prepare theoretical background: general understanding of
management ideas and theories of different scholars and schools
• Apply in practice: rely on historical lessons to improve management
reality
Why did management theories appear over time?

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Long-term and short-run economic factors

• The long run in economics usually refers to an approach of studying an economy,
industry, or enterprise where all inputs are variable. Determinants of long-run
growth include growth of productivity, demographic changes, and labor force
participation.
• The short run refers to a period of time during which at least one input (factor of
production) is fixed or cannot be changed. In the short run, a firm can adjust its
production level by varying the variable factors, such as labour and raw materials.
• Short-term economic growth is realised when an economy's aggregate demand is
increased, leading to high levels of real GDP. Long-term growth, on the other hand,
is realised when an economy's potential of production is increased.

IS-LM model (Hicks-Hansen, 1936)

• IS: Investment-Savings
• LM: Liquidity preference-Money supply
- The Keynesian macroeconomic model shows how the economic
goods market (IS) interacts with the capital market or money
market (LM).
- IS-LM intersection: short-term balance between interest rate and
output.

IS-LM model
•v

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IS-LM model
• Describe changes in market tastes that change the equilibrium level of
gross domestic product (GDP) and market interest rates.
• Three exogenous variables: liquidity, investment and consumption. In
theory, liquidity is determined by the size and speed of money supply.
The levels of investment and consumption are determined by the
marginal decisions of individual agents.
• Limitations: lacks accuracy and realism to become a useful indicator for
economic policy.

The Mundell-Fleming model

(Robert Mundell & John Marcus Fleming, 1960s)

Main assumptions of the model:

• Small open economy
• Short term analysis – constant prices and wages
• An extended version of the IS-LM model with
balance of payments

The Phillips Curve

   e   (u  u n )  v
The Phillips curve the deviation of and supply shocks.
states that inflation unemployment from the
depends on expected natural rate (cyclical
inflation… unemployment)…

The Phillips curve demonstrates

the inflation-unemployment
tradeoff that policy makers face.

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Building the Phillips Curve

The Phillips curve is derived
from aggregate supply.
P  Pe  (1/  )(Y Y )

First we add an exogenous

supply shock term to the right P  Pe  (1/  )(Y Y )  v
hand side.

Then we subtract last year’s P  P1  ( P e  P1 )  (1/  )(Y  Y )  v

price level P-1 from both sides.

We can write inflation as    e  (1/  )(Y  Y )  v

π=(P–P-1) and expected
inflation as πe=(Pe–P-1).
(1/  )(Y  Y )    (u  u n )
Recall Okun’s law. Which states that By substituting we obtain the
deviation of output from its natural rate is Phillips curve.
inversely related to deviation of
unemployment from its natural rate.    e   (u  u n )  v
Phillips curve and the short run aggregate supply curve essentially represent the same economic ideas.

Adaptive Expectations and Inflation Inertia

• The Phillips curve shows the trade-off facing policy makers in terms of
unemployment and inflation.
• To make the Phillips curve more useful we need to say what causes
expected inflation.
A simple and plausible assumption might be
that people form expectations about future  e  1
inflation based on recent inflation.

In this case, we can write the

    1   (u  u n )  v
Phillips curve as...
The first term in the Phillips curve implies
which states that inflation
that inflation has inertia and that inflation
depends on past inflation,
keeps going unless something acts to
cyclical unemployment, and a
stop it. In essence we have inflation
supply shock.
because we expect it and we expect it
because we have it.

Inertia in AD-AS
In the AD-AS framework inflation P
inertia is characterized by
persistent upward shifts of both AS
AD and AS.

AD

Q
Most often the upward shifting
aggregate demand curve is caused by
persistent growth in the money supply.

Aggregate supply shifts up

because of expected inflation.

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Inertia in AD-AS
AS would stop
Suppose the central bank is pursuing an shifting up.
expansionary monetary policy causing
AD to shift out. P

If prices have been rising quickly, people AS

will expect them to continue to do so.
Because AS depends on expected
inflation the AS curve will continue to
shift upward.
AD
It will continue to shift upward until some
Y
event, such as a recession or a supply
shock, changes inflation and thereby
changes expectations of inflation. P  P e  (1/  )(Y  Y )

This would cause a recession.

If for example the central bank High unemployment would reduce
tightened the money supply, AD inflation and expected inflation,
would shift back. causing inflation inertia to subside.

Two Causes of Rising and Falling Inflation

    1   (u  u n )  v

The second term shows that The third term shows that
cyclical unemployment exerts inflation also rises and
upward or downward pressure falls with supply shocks.
on inflation. Low An adverse supply shock
unemployment pulls inflation would push production
up. This is called demand- prices up. This type of
pull inflation because high inflation is called cost-
AD is the cause. push inflation.

The Short Run Tradeoff Between Inflation and

Unemployment
• While expected inflation and supply shocks π
are beyond the policy maker’s control, in the
short-run the policy maker can use
monetary or fiscal policy to shift the AD β
curve thus affecting output, unemployment, 1
and inflation. πe+v
• A plot of the Phillips curve shows the short-
u
run tradeoff between inflation and un
unemployment.

A policymaker who controls AD can choose a

combination of inflation and unemployment on
this short-run Phillips curve.

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The Short Run Tradeoff Between Inflation and

Unemployment
• Because people adjust their expectations π
of inflation over time, the tradeoff between
inflation and unemployment holds only in
the short run. β
1
• In the long run, expectations adapt,
πe+v
inflation returns to whatever rate the
policymaker has chosen, and u
unemployment returns to the natural rate. un

An increase in expected inflation

causes the curve to shift upward.

So that at any unemployment rate

there will be higher inflation.

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