MANAGERIAL

ECONOMICS
L2

Dr. Rashmi Ahuja

Theory of Firm
• What is a Firm ?
• Neoclassical Theory
• Resources transformed products demanded by Consumers
• Cost of production – governed by available technology
• Output produced and selling price determined by market structure
• Aim of firm – Maximize profit
 Why do Firm exists???

• Why can’t we offer separate contracts for each function of the firm ????

• Ronald Coase [ Heavy Transaction Costs]

Principle Agent Relationship

• The decision to hire professional managers creates a separation

between business ownership and its management.

• Principle Agent Problem . Eg ?????

Q1 : What is the present value of a firm with a five-year life span that earns the following
stream of expected profit? (Treat all profits as being received at year-end.) Use a risk
adjusted discount rate of 12 percent.
• Year Expected profit
1 $10,000
2 20,000
3 50,000
4 75,000
5 50,000
Q2. Your firm has discovered a cheap and efficient technology of turning used plastic
bottles and bags into various products. You limit your attention to the following two
production opportunities: you can produce plastic utensils or helmets for Boilermakers'
fans. In the first case your estimated annual revenue is $25,000, while the production will
cost you $8,000. However, in your second option, you expect to sell 2000 helmets every
year at $10 each, and the average total cost of every helmet will be $2.
a.Which production opportunity will you choose and why?
b.If you do so, what will be your economic profit?
Q3 : The managers of the XYZ Company are in a position to organize production Q
in a way that will generate the following two net income streams, where πi,j
designates the ith production process in the jth production period.
π1,1 (Q) = $100 , π1,2 (Q) = $330
π2,1 (Q) = $300 , π2,2 (Q) = $121
If the anticipated discount rate for both production periods is 10%, which of these
two net income streams will generate greater net profit for the company?
 Case 2 :Samsung and Hynix Semiconductor to Cut Chip Production

• Sam Robbins, owner and CEO of PC Solutions, arrived at the office and glanced at the
front page of The Wall Street Journal waiting on his desk.
• One of the articles contained statements from executives of two of South Korea’s largest
semiconductor manufacturers— Samsung Electronic Company and Hynix Semiconductor
—indicating that they would suspend all their memory chip production for one week.
The article went on to say that another large semiconductor manufacturer was likely to
follow suit. Collectively, these three chip manufacturers produce about 30 percent of the
world’s basic semiconductor chips.
• PC Solutions is a small but growing company that assembles PCs and sells them in the
highly competitive market for “clones.”
• PC Solutions experienced 100 percent growth last year and is in the process of
interviewing recent graduates in an attempt to double its workforce.
• After reading the article, Sam picked up the phone and called a few of his business
contacts to verify for himself the information contained in the Journal. Satisfied that
the information was correct, he called the director of personnel, Jane Remak.

• What do you think Sam and Jane discussed?

Market forces : Supply and Demand

• Qualitative tool to visualize “Big picture”

• Imp. to know about future trend in sales and prices.

[Why ??? ]
Demand
• Individual demand vs Market Demand
Individual Demand curve
Why demand curve slope downward ?????
• Diminishing marginal utility
• Substitution Effect
• Income Effect
• New buyers
Suppose that the total market demand for a product comprises the demand of
three individuals with identical demand equations.
Q1= Q2= Q3 =50-25P
Can you calculate Market Demand ??
Determinants of Demand
• Price of Good
• Income
• Normal good
• Inferior good

• Prices of Related Goods

• Prices of substitutes
• Prices of complements

• Advertising and consumer tastes

• Population
• Consumer expectations
Demand Relation

• General Demand Function

• Direct Demand function
• Inverse Demand Function
General Demand Function
• A general equation representing the demand curve
Qxd = f(P,M, PR ,T, PE ,N )

• Qxd = quantity demand of good X.

• Ceteris paribus
• Change in price of Good [Law of Demand ]

• Change in income [Normal vs Inferior ]

• Change in Price of related Goods - [Substitutes vs Complements]

• Change in taste and preferences

• Change in expectations

• Change in Number of Consumers

Linear function defined as :-

Qxd = a + bP + cM + dPR + e T + fPE +g N
Direct Demand function

• The relation between price and quantity demanded per period of time,
when all other factors that affect consumer demand are held constant, is
called a direct demand function.
 Can you derive direct Demand function from the
given general Demand Function ????
• Qxd = 3200 -10P + 0.05M -24PR , Assuming consumer income is $60,000 and
the price of a related good is $200.
Inverse Demand Function

• Price as a function of quantity demanded.

• Example:
• Demand Function
• Qxd = 10 – 2Px
• Inverse Demand Function:
• 2Px = 10 – Qxd
• Px = 5 – 0.5Qxd