chapter 1 the fundamentals of managerial economics
DESCRIPTION
Chapter 1 The Fundamentals of Managerial Economics. Cambodian Mekong University. Sar Sopheap. 1- 2. Overview. I. Introduction II. The Economics of Effective Management Identify Goals and Constraints Recognize the Role of Profits Five Forces Model Understand Incentives - PowerPoint PPT PresentationTRANSCRIPT
Chapter 1The Fundamentals of Managerial Economics
Sar Sopheap Cambodian Mekong University
Overview
I. IntroductionII. The Economics of Effective
Management Identify Goals and Constraints Recognize the Role of Profits Five Forces Model Understand Incentives Understand Markets Recognize the Time Value of Money Use Marginal Analysis
1-2
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.
1-3
Identify Goals and Constraints Sound decision making involves having
well-defined goals. Leads to making the “right” decisions.
In striking to achieve a goal, we often face constraints. Constraints are an artifact of scarcity.
1-4
Economic vs. Accounting Profits
Accounting Profits Total revenue (sales) minus dollar cost of
producing goods or services. Reported on the firm’s income
statement. Economic Profits
Total revenue minus total opportunity cost.
1-5
Opportunity Cost
Accounting Costs The explicit costs of the resources needed to
produce produce goods or services. Reported on the firm’s income statement.
Opportunity Cost The cost of the explicit and implicit resources
that are foregone when a decision is made. Economic Profits
Total revenue minus total opportunity cost.
1-6
Profits as a Signal
Profits signal to resource holders where resources are most highly valued by society. Resources will flow into industries that are
most highly valued by society.
1-7
Sustainable IndustryProfitsPower of
Input SuppliersSupplier ConcentrationPrice/Productivity of Alternative InputsRelationship-Specific InvestmentsSupplier Switching CostsGovernment Restraints
Power ofBuyers
Buyer ConcentrationPrice/Value of Substitute Products or ServicesRelationship-Specific InvestmentsCustomer Switching CostsGovernment Restraints
EntryEntry CostsSpeed of AdjustmentSunk CostsEconomies of Scale
Network EffectsReputationSwitching CostsGovernment Restraints
Substitutes & ComplementsPrice/Value of Surrogate Products or ServicesPrice/Value of Complementary Products or Services
Network EffectsGovernment Restraints
Industry RivalrySwitching CostsTiming of DecisionsInformationGovernment Restraints
ConcentrationPrice, Quantity, Quality, or Service CompetitionDegree of Differentiation
The Five Forces Framework 1-8
Understanding Firms’ Incentives Incentives play an important role within
the firm. Incentives determine:
How resources are utilized. How hard individuals work.
Managers must understand the role incentives play in the organization.
Constructing proper incentives will enhance productivity and profitability.
1-9
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.
1-10
The Time Value of Money
Present value (PV) of a future value (FV) lump-sum amount to be received at the end of “n” periods in the future when the per-period interest rate is “i”:
PV
FV
i n1
• Examples: Lotto winner choosing between a single lump-sum payout of $104
million or $198 million over 25 years. Determining damages in a patent infringement case.
1-11
Present Value vs. Future Value The present value (PV) reflects the
difference between the future value and the opportunity cost of waiting (OCW).
Succinctly,PV = FV – OCW
If i = 0, note PV = FV. As i increases, the higher is the OCW and
the lower the PV.
1-12
Present Value of a Series
Present value of a stream of future amounts (FVt) received at the end of each period for “n” periods:
Equivalently,
n
ttt
i
FVPV
1 1
PV
FV
i
FV
i
FV
inn
1
12
21 1 1. . .
1-13
Net Present Value
Suppose a manager can purchase a stream of future receipts (FVt ) by spending “C0” dollars today. The NPV of such a decision is
NPV
FV
i
FV
i
FV
iCn
n
11
22 01 1 1
. . .
Decision Rule:If NPV < 0: Reject project
NPV > 0: Accept project
1-14
Present Value of a Perpetuity An asset that perpetually generates a stream of cash
flows (CFi) at the end of each period is called a perpetuity.
The present value (PV) of a perpetuity of cash flows paying the same amount (CF = CF1 = CF2 = …) at the end of each period is
i
CF
i
CF
i
CF
i
CFPVPerpetuity
...111 32
1-15
Firm Valuation and Profit Maximization
The value of a firm equals the present value of current and future profits (cash flows).
A common assumption among economist is that it is the firm’s goal to maximization profits. This means the present value of current and future
profits, so the firm is maximizing its value.
1
210
1...
11 tt
tFirm
iiiPV
1-16
Firm Valuation With Profit Growth
If profits grow at a constant rate (g < i) and current period profits are before and after dividends are:
Provided that g < i. That is, the growth rate in profits is less than the
interest rate and both remain constant.
0
0
1 before current profits have been paid out as dividends;
1 immediately after current profits are paid out as dividends.
Firm
Ex DividendFirm
iPV
i g
gPV
i g
1-17
Control Variable Examples: Output Price Product Quality Advertising R&D
Basic Managerial Question: How much of the control variable should be used to maximize net benefits?
Marginal (Incremental) Analysis
1-18
Net Benefits
Net Benefits = Total Benefits - Total Costs
Profits = Revenue - Costs
1-19
Table 1-1 Determining the Optimal Level of a Control Variable: The Discrete Case(1) (2) (3) (4)=(2)-(3) (5) (6) (7) )=(5)-(6)
Control Variable
Total Benefits
Total Costs Net BenefitsMarginal Benefit
Marginal Cost
Marginal Net Benefit
Q B(Q) C(Q) N(Q) MB(Q) MC(Q) MNB(Q)
0 0 0 0 -- -- --1 90 10 80 90 10 802 170 30 140 80 20 603 240 60 180 70 30 404 300 100 200 60 40 205 350 150 200 50 50 06 390 210 180 40 60 -207 420 280 140 30 70 -408 440 360 80 20 80 -609 450 450 0 10 90 -80
10 450 550 -100 0 100 -100
Marginal Benefit (MB)
Change in total benefits arising from a change in the control variable, Q:
Slope (calculus derivative) of the total benefit curve.
Q
BMB
1-20
Marginal Cost (MC)
Change in total costs arising from a change in the control variable, Q:
Slope (calculus derivative) of the total cost curve
Q
CMC
1-21
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 control variable increased costs more than it increased benefits.
1-22
The Geometry of Optimization: Total Benefit and Cost
Q
Total Benefits & Total Costs
Benefits
Costs
Q*
B
CSlope = MC
Slope =MB
1-23
The Geometry of Optimization: Net Benefits
Q
Net Benefits
Maximum net benefits
Q*
Slope = MNB
1-24
Conclusion
Make sure you include all costs and benefits when making decisions (opportunity cost).
When decisions span time, make sure you are comparing apples to apples (PV analysis).
Optimal economic decisions are made at the margin (marginal analysis).
1-25