Lecture 3: Introductory Spreadsheet Modeling

AGEC 352Spring 2012 – January 23

R. Keeney

Material to DateReview of mathematics and

economics and introduced optimization

Relating the algebra and calculus we have seen in previous courses to the economic principles from previous courses◦This is a general pattern for this

course factoring in that most of the math we do shows up in spreadsheet formulae

Spreadsheet ModelingWays to think of it…Miniature, reduced, simplified

version of an economic problemA firm plans…

◦Production schedule◦Purchase and sale activities (inputs and

outputs)◦Cost and inventory management◦Transfers within company◦Marketing and promotion◦Managerial and labor assignments

BasicsIdentification of the management

problem◦Must be clearly specified◦Goal of modeling is not to ‘solve’ the

problem—rather to guide decision makingGiven the management problem

◦ Identify the management objective◦ Identify the choice(s) under management

control◦ Identify other variables not under

management’s control Other steps as we advance in class

Price setting example (1/18)What price to charge to earn

highest profit?Under the firm’s control: PriceFirm’s objective: Maximum ProfitsNot under the firm’s control

◦Everything else… Demand (intercept and slope of equation) Cost function (intercept and slope of

equation)

Map the Problem Out

Maximum Profits

Price Charged by Firm

What comes in between?

Map the Problem Out

Maximum Profits

Price Charged by Firm

Revenue

Costs

Price charged affects revenue(P x Q)

Does price charged affect costs?C = ???

Map the Problem Out

Maximum Profits

Price Charged by Firm

Revenue

Costs

minus

Price

multiply

Quantity

Fixed Costs

plus

Variable Costs

Map the Problem Out

Maximum Profits

Price Charged by Firm

Revenue

Costs

minus

Price

multiply

Fixed Costs

plus

VC = Q x U

Q = a + bP

Map the Problem Out

Maximum Profits

Price Charged by Firm

Revenue

Costs

minus

Price

multiply

Fixed Costs

plus

VC = U x (a + bP)

Q = a + bP

SummaryFirm sets a price to influence profitsThe price chosen influences

◦Quantity sold as determined by demand curve

◦Revenue due to price and the quantity sold

◦Costs through variable costs and the quantity sold

Not of the firm’s control:◦Demand curve numbers ( a and b)◦Cost curve numbers (Fixed costs, U)

ClassificationFree/choice variable: price

◦Firm can set any value it wantsConsequence variable: quantity,

variable costs, profits◦The value depends on the choice of the

firm and some values not under its controlParameter (exogenous variable):

demand curve intercept and slope, fixed costs, unit cost of production◦These values are given and do not change

when the firm changes its choices

Building a spreadsheet modelLabeling

◦Every value entered into a spreadsheet needs an accompanying label Easy to find Clearly identifies what the cell entry is

Formula linkages◦Every calculation in a spreadsheet needs to be

attached to the simplest accurate formula E.g. quantity instead of the full demand calculation

Parameter specification◦Every parameter (fixed number value) that is

part of a formula needs to be entered into its own cell

Model Results: What is different about each section?

Consequence VariablesProfits ($) -15 -5 3 9 13 15 15 13 9 3 -5Revenue ($) 0 9 16 21 24 25 24 21 16 9 0Costs ($) 15 14 13 12 11 10 9 8 7 6 5Quantity (units) 10 9 8 7 6 5 4 3 2 1 0

ParametersDemand Intercept 10 10 10 10 10 10 10 10 10 10 10Demand Slope -1 -1 -1 -1 -1 -1 -1 -1 -1 -1 -1Fixed Costs ($) 5 5 5 5 5 5 5 5 5 5 5Variable Cost per Unit 1 1 1 1 1 1 1 1 1 1 1

Choice VariablesPrice ($) 0 1 2 3 4 5 6 7 8 9 10

Graphical Analysis

0

5

10

15

20

25

30

0 2 4 6 8 10

Dolla

rs (re

venu

e, co

st)

Price Charged by Firm

Revenue ($) Costs ($)

Modeling to help decisionsWe said a model is a

simplification of a management/economic problem

What do we do with it?◦We’ve seen how it guides price

settingWhat else?

◦Management/planning questions

Model as a labAnother way to think of an

economic model is as a laboratory for doing experiments or scenarios◦(some textbooks call this ‘what if’

analysis)Unlike physical sciences, it is rare

to see experimental trials in economics◦Agents like to earn on resources, not

randomize decisions to see which one emerges as best…

Model utilityJust like in lab experiment

settings, models of economic situations are only as useful as their proximity to actual conditions

Difficulties ◦Many interconnected decisions and

relationships at work◦Rely on historical data to express

relationships in the future

Lab tomorrowHandout will be posted on class

website by 10 AM. We’ll use Blackboard Discussion

◦1) Discussion forum is linked from the blackboard page for this class

◦2) Sign in by replying to the sign-in topic

◦3) Instructor questions will be posted between 10:50 and 11:00. If I am calling on you, your name will be in the subject line…