Ch. 1-nature-and-scope-of-m.e

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright 2007 by Oxford University Press, Inc. (Adapted by OUP India, 2008) Slide 1



Managerial Economics Defined

• The application of economic theory and the tools of decision science to examine how an organization can achieve its aims or objectives most efficiently.– applications of economic theory– quantitative methods– statistical methods– computational methods



Economic Theory

• Microeconomics– Study of the economic behavior of

individual decision-making units.– Relevance to Managerial Economics

• Macroeconomics– Study of the total or aggregate level of

output, income, employment, consumption, investment, and prices for the economy viewed as a whole.


Decision Sciences

• Mathematical Economics– Expresses and analyzes economic models

using the tools of mathematics.

• Econometrics– Employs statistical methods to estimate

and test economic models using empirical data.


Economic Methodology

• Economic Models– Abstract from details– Focus on most important determinants of

economic behavior – cause and effect

• Evaluating Economic Models– A model is accepted if it predicts accurately

and if the predictions follow logically from the assumptions.



Theory of the Firm

• Combines and organizes resources for the purpose of producing goods and/or services for sale.

• Internalizes transactions, reducing transactions costs.

• Economic theory assumes that the primary goal of managers is to maximize the value of the firm.


Value of the Firm

The present value of all expected future profits

1 21 2

1(1 ) (1 ) (1 ) (1 )

nn tn t

t

PVr r r r

1 1(1 ) (1 )

n nt t tt t

t t

TR TCValueof Firm

r r


Alternative Theories

• Sales maximization– Adequate rate of profit

• Management utility maximization– Principle-agent problem

• Satisficing behavior


Definitions of Profit

• Business or Accounting Profit: Total revenue minus the explicit or accounting costs of production.

• Economic Profit: Total revenue minus the explicit and implicit costs of production.

• Opportunity Cost: Implicit value of a resource in its best alternative use.


Theories of Profit

• Risk-Bearing Theories of Profit

• Frictional Theory of Profit

• Monopoly Theory of Profit

• Innovation Theory of Profit

• Managerial Efficiency Theory of Profit


Social Function of Profit

• Profit is a signal that guides the allocation of society’s resources.

• High profits in an industry are a signal that buyers want more of what the industry produces.

• Low (or negative) profits in an industry are a signal that buyers want less of what the industry produces.


Business Ethics

• Identifies types of behavior that businesses and their employees should not engage in.

• Source of guidance that goes beyond enforceable laws.


The Changing Environment of Managerial Economics

• Globalization of Economic Activity– Goods and Services– Capital– Technology– Skilled Labor

• Technological Change– Telecommunications Advances– The Internet and the World Wide Web



Contd


(contd)


Appendix to Chapter 1


Law of Demand

• A decrease in the price of a good, all other things held constant, will cause an increase in the quantity demanded of the good.

• An increase in the price of a good, all other things held constant, will cause a decrease in the quantity demanded of the good.


Change in Quantity Demanded

Quantity

Price

P0

Q0

P1

Q1

An increase in price causes a decrease in quantity demanded.


Change in Quantity Demanded

Quantity

Price

P0

Q0

P1

Q1

A decrease in price causes an increase in quantity demanded.


Changes in Demand

• Change in Buyers’ Tastes

• Change in Buyers’ Incomes– Normal Goods– Inferior Goods

• Change in the Number of Buyers

• Change in the Price of Related Goods– Substitute Goods– Complementary Goods


Change in Demand

Quantity

Price

P0

Q0 Q1

An increase in demand refers to a rightward shift in the market demand curve.


Change in Demand

Quantity

Price

P0

Q1 Q0

A decrease in demand refers to a leftward shift in the market demand curve.


Law of Supply

• A decrease in the price of a good, all other things held constant, will cause a decrease in the quantity supplied of the good.

• An increase in the price of a good, all other things held constant, will cause an increase in the quantity supplied of the good.


Change in Quantity Supplied

Quantity

Price

P1

Q1

P0

Q0

A decrease in price causes a decrease in quantity supplied.


Change in Quantity Supplied

Quantity

Price

P0

Q0

P1

Q1

An increase in price causes an increase in quantity supplied.


Changes in Supply

• Change in Production Technology

• Change in Input Prices

• Change in the Number of Sellers


Change in Supply

Quantity

Price

P0

Q1Q0

An increase in supply refers to a rightward shift in the market supply curve.


Change in Supply

Quantity

Price

P0

Q1 Q0

A decrease in supply refers to a leftward shift in the market supply curve.


Market Equilibrium

• Market equilibrium is determined at the intersection of the market demand curve and the market supply curve.

• The equilibrium price causes quantity demanded to be equal to quantity supplied.


Market Equilibrium

Quantity

Price

P

Q

D S


Market Equilibrium

Quantity

Price

P0

Q0

D0 S0

Q1

P1

D1

An increase in demand will cause the market equilibrium price and quantity to increase.


Market Equilibrium

Quantity

Price

P1

Q1

S0

Q0

P0

D0D1

A decrease in demand will cause the market equilibrium price and quantity to decrease.


Market Equilibrium

Quantity

Price

P0

Q0

D0 S0

Q1

P1

An increase in supply will cause the market equilibrium price to decrease and quantity to increase.

S1


Market Equilibrium

Quantity

Price

P1

Q1

D0

Q0

P0

A decrease in supply will cause the market equilibrium price to increase and quantity to decrease.

S1 S0







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Ch. 1-nature-and-scope-of-m.e