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7/28/2019 Managerial Economics Chapter 1 the McGraw-Hill
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MANAGERIAL ECONOMICS
CLASS-01 TERM 13-1
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GY005 MANAGERIAL ECONOMICS:
Course InformationTeaching Team:
1. Dr. Ir. Leonard Tampubolon, MA ([email protected])
2. Ir. Tarcius Sunaryo,MA., Ph.D. ([email protected])
Text :
1. Baye. M (2010). Managerial Economics, and Business Strategy,(7th edition). McGraw-Hill.In
2. Besanko, D., Dranove, D., Schaefer, S. and Ark Shanley (2007).
Economics of Strategy (4th edition). John Wiley & Sons.
Assessment Description:1. Class Paticipation 10%
2. Quizzess 20%
3. Mid Term Exam 30%
4. Final Exam 40%
mailto:[email protected]:[email protected]7/28/2019 Managerial Economics Chapter 1 the McGraw-Hill
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MANAGERIAL ECONOMICS &
BUSINESS STRATEGYChapter 1:
The Fundamentals of ManagerialEconomics
McGraw-Hill/IrwinMichael R. Baye, Managerial Economics andBusiness Strategy Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
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OVERVIEW
I. Introduction
II. 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
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MANAGERIAL ECONOMICS
ManagerA person who directs resources to achieve a stated goal.
EconomicsThe science of making decisions in the presence of scare resources.
Managerial Economics
The study of how to direct scarce resources in the way that mostefficiently achieves a managerial goal.
Efective Manager must:1. Identify goals and constraints
2. Recognize the nature and imprtance of profits3. understand incentives4. understand markets5. recognize the time value of money6. use marginal anaysis
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IDENTIFY GOALS AND CONSTRAINTS:
Sound decision making involves havingwell-defined goals. Leads to making the right decisions.
In striking to achieve a goal, we oftenface constraints.
Constraints are an artifact of scarcity.
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RECOGNIZE THE NATURE AND IMPRTANCE OF PROFITS:
Accounting Profits
Total revenue (sales) minus dollar cost of producing goods orservices.
Reported on the firms income statement.
Economic Profits
Total revenue minus total 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.
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ECONOMIC VS. ACCOUNTING PROFITS
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The Five Forces Framework
1-8
Sustainable
Industry
Profits
Power of
Input Suppliers
Supplier Concentration
Price/Productivity of Alternative
Inputs
Relationship-Specific Investments
Supplier Switching CostsGovernment Restraints
Power of
Buyers
Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific Investments
Customer Switching CostsGovernment Restraints
EntryEntry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale
Network Effects
Reputation
Switching Costs
Government Restraints
Substitutes & Complements
Price/Value of Surrogate Products or
Services
Price/Value of Complementary
Products or Services
Network Effects
Government
Restraints
Industry Rivalry
Switching Costs
Timing of Decisions
Information
Government Restraints
Concentration
Price, Quantity, Quality, or Service
Competition
Degree of Differentiation
PROFITS AS A SIGNALProfits signal to resource holders where resources are most highlyvalued by societyResources will flow into industries that are mosthighly valued by society.
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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.
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UNDERSTAND MARKETS:
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.
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RECOGNIZE 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 interestrate is i:
PVFV
i
n
1
Examples:
Lotto winner choosing between a single lump-sum payout of $104million in the 1st year or $198 million in the 25th year.
Determining damages in a patent infringement case.
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THE TIME VALUE OF MONEY
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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
OCWIfi= 0, note PV= FV.
As i increases, the higher is the OCWand 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,
PV
FV
i
FV
i
FV
i
n
n
1
1
2
21 1 1...
n
t
t
t
i
FVPV
1 1
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NET PRESENT VALUE
Suppose a manager can purchase a stream of future receipts (FVt) by
spending C0 dollars today. The NPVof such a decision is
NPV
FV
i
FV
i
FV
iC
n
n
1
1
2
2 0
1 1 1...
Decision Rule: If NPV < 0: Reject project ---If NPV > 0: Accept project
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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
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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 firms goal to maximization profits. This means the present value of current and future profits, so the firm
is maximizing its value.
1
21
0
1...
11 tt
t
Firm
iiiPV
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Control Variable Examples: Output Price Product Quality Advertising R&D
Basic Managerial Question: How much of the controlvariable should be used to maximize net benefits?
USE MARGINAL ANAYSIS:1-15
NET BENEFITS
Net Benefits = Total Benefits - Total Costs
Profits = Revenue - Costs
MARGINAL (INCREMENTAL) ANALYSIS
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1-16MARGINAL 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
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
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MARGINAL PRINCIPLE
To maximize net benefits, the managerial
control variable should be increased up to
the point whereMB =MC.
MB >MCmeans the last unit of the control
variable increased benefits more than it
increased costs.
MB
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THE GEOMETRY OF OPTIMIZATION:TOTAL BENEFIT AND COST
Q
Total Benefits& Total Costs
Benefits
Costs
Q*
B
CSlope = MC
Slope =MB
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THE GEOMETRY OF OPTIMIZATION:NET BENEFITS
Q
Net Benefits
Maximum net benefits
Q*
Slope =MNB
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Conclusion
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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MANAGERIAL ECONOMICS &
BUSINESS STRATEGYChapter 2
Market Forces: Demand and Supply
McGraw-Hill/IrwinMichael R. Baye, Managerial Economics andBusiness Strategy Copyright 2008 by the McGraw-Hill Companies, Inc. All rights reserved.
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OVERVIEW
III. Market Equilibrium
IV. Price Restrictions
V. Comparative Statics
II. Market Supply Curve
The Supply Function Supply Shifters
Producer Surplus
I. Market Demand Curve The Demand Function
Determinants of Demand
Consumer Surplus
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MARKET DEMAND CURVE
Shows the amount of a
good that will be purchasedat alternative prices,holding other factorsconstant.
Law of Demand The demand curve is
downward sloping.
Quantity
D
Price
2-23
DETERMINANTS OF
DEMAND
Income Normal good Inferior good
Prices of RelatedGoods Prices of substitutes Prices of complements
Advertising andconsumer tastes Population
Consumer
expectations
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THE DEMAND FUNCTION
A general equation representing the demand curve
Qxd = f(Px ,PY , M, H,)
Qxd = quantity demand of good X. Px = price of good X.
PY = price of a related good Y.
Substitute good.
Complement good.
M = income.
Normal good.
Inferior good.
H = any other variable affecting demand.
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INVERSE DEMAND FUNCTION
Price as a function of quantity
demanded.
Example: Demand Function
Qxd = 102Px
Inverse Demand Function: 2Px = 10Qx
d
Px = 50.5Qxd
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CHANGE IN QUANTITY DEMANDED
Price
Quantity
D0
4 7
6
A to B: Increase in quantity demanded
B
10A
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Price
Quantity
D0
D1
6
7
D0 to D1: Increase inDemand
CHANGE IN DEMAND
13
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CONSUMER SURPLUS
The value consumers get from a good but
do not have to pay for.
Consumer surplus will prove particularlyuseful in marketing and other disciplines
emphasizing strategies like value pricing
and price discrimination.
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Price
Quantity
D
10
8
6
4
2
1 2 3 4 5
Consumer Surplus:
The value received but not
paid for. Consumer surplus =
(8-2) + (6-2) + (4-2) = $12.
CONSUMER SURPLUS:THE DISCRETE CASE
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Consumer Surplus
1 2 3 4 5
5
6
7
8
9
10
Market Price = 5
The 1st good:
The Value for consumer = 9
The consumer surplus = 9-5 = 4
The 2nd good:
The Value for consumer = 8
The consumer surplus = 8-5 = 3
The 3rd good:
The Value for consumer =7
The consumer surplus = 7-5 = 2
The 4th good:
The Value for consumer = 6
The consumer surplus = 6-5 = 1
Q
P
D
S
CS= (5X5)/2 =12.5
C N MER RPL
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CONSUMER SURPLUS:THE CONTINUOUS CASE
Price $
Quantity
D
10
8
6
4
2
1 2 3 4 5
Value
of 4 units = $24ConsumerSurplus =
$24 - $8 =
$16
Expenditure on 4 units =
$2 x 4 = $8
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MARKET SUPPLY CURVE
The supply curve shows the amount of a good
that will be produced at alternative prices.
Law of Supply The supply curve is upward sloping.
Price
Quantity
S0
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SUPPLY SHIFTERS
Input prices
Technology or
government regulations
Number of firms Entry
Exit
Substitutes in production
Taxes Excise tax
Ad valorem tax
Producer expectations
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THE SUPPLY FUNCTION
An equation representing the supply curve:
QxS = f(Px ,PR,W, H,)
QxS = quantity supplied of good X.
Px = price of good X.
PR= price of a production substitute.
W = price of inputs (e.g., wages).
H = other variable affecting supply.
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INVERSE SUPPLY FUNCTION
Price as a function of quantity
supplied.
Example: Supply Function
Qxs = 10 + 2Px
Inverse Supply Function: 2Px = 10 + Qx
s
Px = 5 + 0.5Qxs
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CHANGE IN QUANTITY SUPPLIED
Price
Quantity
S0
20
10
B
A
5 10
A to B: Increase in quantity supplied
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Price
Quantity
S0
S1
8
75
S0 to S1: Increase in supply
CHANGE IN SUPPLY
6
2-37
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PRODUCER SURPLUS
The amount producers receive in excess of the amountnecessary to induce them to produce the good.
Price
Quantity
S0
Q*
P*
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Producer Surplus
1 2 3 4 5
5
1
2
3
4
P
Q
D
S
Market Price = 5
The 1st good:
The cost for Producer = 1
The producer surplus = 5-1 = 4
The 2nd good:
The cost for producer = 2
The producer surplus = 5-2 = 3
The 3rd good:
The cost for producer =3
The producer surplus = 5-3 = 2
The 4th good:
The cost for producer = 4
The producer surplus = 5-4 = 1
PS= (5X5)/2 =12.5
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MARKET EQUILIBRIUM
The Price (P) that Balances
supply and demand Qx
S = Qxd
No shortage or surplus
Steady-state
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Price
Quantity
S
D
5
6 12
Shortage
12 - 6 = 6
6
If price is too low
7
2-41
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Price
Quantity
S
D
9
14
Surplus
14 - 6 = 8
6
8
8
If price is too high
7
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PRICE RESTRICTIONS
Price Ceilings The maximum legal price that can be charged.
Examples:
Gasoline prices in the 1970s.
Housing in New York City. Proposed restrictions on ATM fees.
Price Floors
The minimum legal price that can be charged. Examples:
Minimum wage.
Agricultural price supports.
2-43
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Price
Quantity
S
D
P*
Q*
P Ceiling
Q s
PF
IMPACT OF A PRICE CEILING
Shortage
Q d
2-44
Suppose the equilibrium
price for the product is $5
1. What will be happened if
government determined
the ceiling price for thisproduct is $3?
2. What will be happened if
government determined
the ceiling price for this
product is $7?
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FULL ECONOMIC PRICE
The dollar amount paid to a firm under a price
ceiling, plus the nonpecuniary price.
PF = Pc + (PF - PC) PF = full economic price
PC = price ceiling
PF - PC = nonpecuniary price
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AN EXAMPLE FROM THE 1970S
Ceiling price of gasoline: $1.
3 hours in line to buy 15 gallons of gasoline
Opportunity cost: $5/hr.
Total value of time spent in line: 3 $5 = $15.
Non-pecuniary price per gallon: $15/15=$1.
Full economic price of a gallon of gasoline:
$1+$1=2.
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IMPACT OF A PRICE FLOOR
Price
Quantity
S
D
P*
Q*
Surplus
PF
Qd QS
2-47
Suppose the equilibrium
price for the product is $5
1. What will be happened if
government determined
the price floor for this
product is $3?
2. What will be happened if
government determined
the price floor for this
product is $7?
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COMPARATIVE STATIC ANALYSIS
How do the equilibrium price and quantitychange when a determinant of supply and/ordemand change?
Comparative static analysisshows how the
equilibrium price and quantity will changewhen a determinant of supply or demandchanges.
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Priceof
PCs
Quantity of PCs
S
D
S*
P0
P*
Q0 Q*
SUPPLY CHANGE
2 49
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Priceof Software
Quantity of
S
D
Q0
D*
P1
Q1
DEMAND CHANGE
P0