Professional Documents
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Fundamentals of Managerial
Economics (Chapter 1)
While there is no doubt that luck, both good
and bad, plays a role in determining the
success of firms, we believe that success is
often no accident. We believe that we can
better understand why firms succeed or fail
when we analyze decision making in terms of
consistent principles of market economics and
strategic action.
Besanko, et. Al
Economics of Strategy (2nd)
Microeconomics is the study of how individual
firms or consumers do and/or should make
economic decisions taking into account such
things as:
1. Their goals, incentives, objectives.
2. Their choices, alternatives, problems.
3. Constraints such as inputs, resources, money, time,
technology, competition.
4. All (cash & noncash) incremental or marginal
benefits and costs.
5. The time value of money.
Goals, Incentives, Objectives
A fundamental economic truth is that
individual firms or decision makers
respond to economic incentives. What
these incentives are (i.e. money,
profits, utility, etc.) and how they
influence economic decision making are
key topics for study and analysis in
business (or managerial) economics.
Managerial Choices
(examples)
Tabular P Q
$7 0
6 100
5 200
4 300
3 400
2 500
1 600
0 700
Variable Relationships
Example of Alternative Ways of Depicting
Graphical
Variable Relationships
Example of Alternative Ways of Depicting
Mathematical
Q = 700 – 100P
P = 7 – 0.01Q
Common Math Terms Used in
Economic Analysis
Term Definition
Variable Something whose value or magnitude (often Q or $
in Econ) may change (or vary); usually denoted by
letter ‘labels’ such as Y, X, TR, TC
Parameter or Something whose value does NOT change
Constant
1/2
6. x 1/a = th e a th r o o t o f x x x
= w h a t n u m b e r m u ltip l ie d b y
it s e lf " a " tim e s = x 8 1 /3 = 2 ( b e c a u s e 2 2 2 = 8 )
7. x a y a = (x y )a x 2y 2 = ( x y ) 2
8. ( x a) b = x ab ( x 2) 3 = x 6
9. ( x y ) 1 /a = x 1 / a y 1 / a ( x y ) 1 /2 = x . y
Y = a + b1X1 + …bnXn=> the value of Y
depends on the values of n different
other variables; a ‘ceteris paribus’
assumption => we assume that all X
variable values except one are held
constant so we can look at how the
value of Y depends on the value of the
one X variable that is allowed to change
Given 2 pts on a straight line, how to solve for the
specific equation of that line?
Solution procedure:
1. Solve for b = Y/X = (Y2-Y1)/(X2-X1)
Y axis intercept:
the value of Y when the value of X = 0, or
the value of Y where a line or curve
intersects the Y axis; = ‘a’ in Y = a + bX
Graphical Concepts (Variable Relationships)
X axis: a horizontal line in a graph along which
the units of measurement represent
different values of, normally, the X or
independent variable
X axis intercept:
the value of X when the value of Y = 0, or
the value of X where a line or curve
intersects the X axis
Graphical Concepts (Variable Relationships)
Slope:
= the steepness of a line or curve; a +(-) slope => the
line or curve slopes upward (downward) to the right
= the change in the value of Y divided by the change
in the value of X (between 2 pts on a line or a curve)
= Y/X = 1st derivative (in calculus)
= Y/ X using algebraic notation
= the ‘marginal’ effect, or the change in Y brought
about by a 1 unit change in X
= b if Y = a + bX
‘Slope’ Graphically
y r is e y2 y1
x ru n x2 x1
Slope Calculation Rules
(slope = Y/ X = dy / dx)
Rule Example
0 t1 t2 t3
Time Value of Money
(Basic Concept)
A dollar is worth more (or less) the sooner (later) it is
received or paid due to the ability of money to earn
interest.
present value
+ interest earned
= future value
Or
future value
- interest lost
= present value
Time Value of Money
(Applications/Uses)
1. To evaluate business decisions where
at least some of the cash flows occur
in the future
2. To project future dollar amounts such
as cash flows, incomes, prices
3. To estimate equivalent current-period
values based on projected future
values
Time Value of Money Concepts
PV = present value
= the number of $ you will be able to
borrow [or have to save] presently in
order to payback [or collect] a given
number of $ in the future
FV = future value
= the number of $ you will have to pay back
[or be able to collect] in the future as a
result of having borrowed [or saved] a
given number of $ presently
FV1 = PV + PV(r)
= PV(1+r)
FV2 = FV1+FV1(r)
= FV1(1+r)
= PV(1+r)(1+r)
= PV(1+r)2
•
•
•
•
FVn = PV(1+r)n
Time Value Problems
FVn = PV(1+r)n
Given Solve For
FVn,r,nPV=FVn[1/(1+r)n] = ‘discounting’
r PV _____ _____
r _____ FV _____
Net Present Value (NPV)
= an investment analysis concept
= PV of future net cash flows – initial
cost
= PV of MR’s – PV of MC’s
= invest if NPV > 0
= invest if PV of MR’s > PV of MC’s
Internal Rate of Return
= an investment analysis
alternative
i1
N C Fi C
Firm Valuation
The value of a firm equals the present value of all its
future profits
P V t / (1 i ) t