Baye CH01 - The Fundamentals of Managerial Economics

8/4/2019 Baye CH01 - The Fundamentals of Managerial Economics

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Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999

Managerial Economics &

Business StrategyChapter 1

The Fundamentals of ManagerialEconomics


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Overview

I. Introduction

II. The Economics of Effective Management

Identify Goals and Constraints Recognize the Role of Profits

Understand Incentives

Understand Markets

Recognize the Time Value of Money

Use Marginal Analysis


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Managerial Economics

Manager A person who directs resources to achieve a stated goal.

Economics The science of making decisions in the presence of

scare resources.

Managerial Economics The study of how to direct scarce resources in the way

that most efficiently achieves a managerial goal.


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Economic vs. Accounting

Profits

Accounting Profits Total revenue (sales) minus dollar cost of producing

goods or services

Reported on the firms income statement

Economic Profits Total revenue minus total opportunity cost


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Opportunity Cost

Accounting Costs The explicit costs of the resources needed to produce

produce goods or services

Reported on the firms income statement

Opportunity Cost The cost of the explicit andimplicit resources that are

foregone when a decision is made

Economic Profits Total revenue minus total opportunity cost


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Market Interactions

Consumer-Producer Rivalry Consumers attempt to locate low prices, while producers

attempt to charge high prices

Consumer-Consumer Rivalry Scarcity of goods reduces the negotiating power of

consumers as they compete for the right to those goods

Producer-Producer Rivalry Scarcity of consumers causes producers to compete with

one another for the right to service customers

The Role of Government

Disciplines the market process


7/20Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999

Porters Five forces affecting sustainable

industry profits




industry profits Entry

- entry costs

- speed of adjustment

- sunk costs

- economies of scale

- network effects

- reputation

- government regulation

Power of Buyers

- buyer concentration- price of substitutes

- switching costs

- government restraints




industry profits Power of input supplier

- supplier concentration

- price of alternative inputs

- switching costs

- government restraints Substitutes and complements

- price of substitutes / complements

- network effect

government restraints

Industry rivalry

- concentration- product differentiation

- switching cost

- government restraints



The Time Value of Money

Present value (PV) of an amount (FV) to be

received at the end of n periods when the

per-period interest rate is i:

PV

FV

i n

1

Examples?



Present Value of a Series

Present value of a stream of future amounts

(FVt) received at the end of each period for

n periods:

PV

FV

i

FV

i

FV

i

n

n

1

1

2

2

1 1 1

...



Net Present Value Suppose a manager can purchase a stream of

future receipts (FVt ) by spending C0 dollarstoday. The NPV of such a decision is

NPV C

FV

i

FV

i

FV

i

nn

0

11

22

1 1 1...

NPV < 0: RejectNPV > 0: Accept



Firm Valuation

The value of a firm equals the present value

of all its future profits

PV = Spt / (1 + i)t

If profits grow at a constant rate, g < i, then: PV = po 1i) / ( i - g), po current profit level.

Maximizing Short-Term Profits If the growth rate in profits < interest rate and both

remain constant, maximizing the present value of all

future profits is the same as maximizing current profits.


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Control Variables Output

Price

Product Quality

Advertising

R&D

Basic Managerial Question: How much ofthe control variable should be used to

maximize net benefits?

Marginal (Incremental)

Analysis


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Net Benefits

Net Benefits = Total Benefits - Total Costs

Profits = Revenue - Costs


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Marginal Benefit (MB)

Change in total benefits arising from a

change in the control variable, Q:

MB = DB /DQ

Slope (calculus derivative) of the total

benefit curve


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Marginal Cost (MC)

Change in total costs arising from a change

in the control variable, Q:

MC = DC /DQ

Slope (calculus derivative) of the total cost

curve


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Marginal Principle

To maximize net benefits, the managerial

control variable should be increased up to

the point where MB = MC

MB > MC means the last unit of the control

variable increased benefits more than it

increased costs

MB < MC means the last unit of the controlvariable increased costs more than it

increased benefits


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The Geometry of Optimization

Q

Benefits & Costs

Benefits

Costs

Q*

B

CSlope = MC

Slope =MB


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Michael R Baye Managerial Economics and Business Strategy 3e The McGraw-Hill Companies Inc 1999

Summary

Make sure you include all costs and benefits

when making decisions (opportunity cost)

When decisions span time, make sure youare comparing apples to apples (PV

analysis)

Optimal economic decisions are made at themargin (marginal analysis)

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Baye CH01 - The Fundamentals of Managerial Economics