MANAGERIAL ECONOMICS

PRELIMINARIES CHAPTER 1: MANAGERS, PROFITS AND MARKETS

Prepared by:

Dr Ramakant Agrawal
XISS, Ranchi ramakantagrawal@yahoo.com 9431109076
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CHAPTER 1 OUTLINE
1.1: CENTRAL PROBLEMS OF AN ECONOMY 1.2: THE THEMES OF MICROECONOMICS 1.2.1 MICROECONOMICS AND MACROECONOMICS

1.2.2 POSITIVE AND NORMATIVE ECONOMICS

1.3: THE SUBJECT MATTER OF MANAGERIAL ECONOMICS 1.4: MEASURING AND MAXIMISING ECONOMIC PROFIT 1.4.1: OPPORTUNITY COST 1.4.2: MARKET-SUPPLIED AND OWNER-SUPPLIED RESOURCES 1.4.3: EXPLICIT, IMPLICIT AND TOTAL ECONOMIC COSTS

1.4.4: EQUITY CAPITAL

1.4.5: ECONOMIC PROFIT VERSUS ACCOUNTING PROFIT 1.4.6: MAXIMISING THE VALUE OF THE FIRM
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CHAPTER 1 OUTLINE (CONTINUED)

1.5: SEPARATION OF OWNERSHIP AND CONTROL 1.5.1: THE PRINCIPAL AGENT PROBLEM

1.5.2: CORPORATE CONTROL MECHANISMS

1.6: MARKET STRUCTURE AND MANAGERIAL DECISION MAKING 1.6.1: WHAT IS MARKET 1.6.2: PRICE TAKER VERSUS PRICE MAKER 1.6.3: MARKET POWER 1.6.4: GLOBALISATION OF MARKETS 1.7: REAL VS. NOMINAL PRICES

1.7.1: DIFFERENCE BETWEEN REAL AND NOMINAL PRICES

1.7.2: CONSUMER AND PRODUCER PRICE INDEX 1.7.3: NUMERICAL EXAMPLES
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CENTRAL PROBLEMS OF AN ECONOMY

PROBLEM OF ALLOCATION OF RESOURCES PROBLEM OF SCARCITY AND CHOICE WHAT TO PRODUCE HOW TO PRODUCE FOR WHOM TO PRODUCE PROBLEM OF UNEMPLOYMENT OF RESOURCES RECESSION PROBLEM OF GROWTH OF RESOURCES THE PRODUCTION POSSIBILITY CURVE APPROACH

THEMES OF MICROECONOMICS
Microeconomics Branch of economics that deals with the behavior of individual economic unitsconsumers, firms, workers, and investorsas well as the markets that these units comprise. Macroeconomics Branch of economics that deals with aggregate economic variables, such as the level and growth rate of national output, interest rates, unemployment, and inflation. Positive analysis Analysis describing relationships of cause and effect. . Normative analysis Analysis examining questions of what ought to be. SUBJECT MATTER OF MANAGERIAL ECONOMICS IS POSITIVE MICROECONOMICS

THE THEMES OF MICROECONOMICS

Prices and Markets

Microeconomics describes how prices are determined. In a centrally planned economy, prices are set by the government. In a market economy, prices are determined by the interactions of consumers, workers, and firms. These interactions occur in marketscollections of buyers and sellers that together determine the price of a good.

THE THEMES OF MICROECONOMICS

Trade Offs
CONSUMERS Consumers have limited incomes, which can be spent on a wide variety of goods and services, or saved for the future. WORKERS

Workers also face constraints and make trade-offs. First, people must decide whether and when to enter the workforce. Second, workers face trade-offs in their choice of employment. Finally, workers must sometimes decide how many hours per week they wish to work, thereby trading off labor for leisure. FIRMS
Firms also face limits in terms of the kinds of products that they can produce, and the resources available to produce them.
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MEASURING AND MAXIMISING ECONOMICS PROFIT OPPORTUNITY COST: WHAT A FIRMS OWNERS GIVE UP TO USE RESOURCES TO PRODUCE GOODS AND SERVICES MARKET-SUPPLIED RESOURCES: RESOURCES OWNED BY OTHERS AND HIRED, RENTED OR LEASED IN RESOURCE MARKETS. OWNER-SUPPLIED RESOURCES: RESOURCES OWNED AND USED BY A FIRM TOTAL ECONOMIC COST=TOTAL EXPLICIT COST + TOTAL IMPLICIT COST EXPLICIT COSTS: MONETARY COSTS OF USING MARKET SUPPLIED RESOURCES IMPLICIT COSTS: NONMONETARY COSTS OF USING OWNER SUPPLIED RESOURCES EQUITY CAPITAL: MONEY PROVIDED TO BUSINESSES BY OWNERS
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MEASURING AND MAXIMISING ECONOMICS PROFIT ECONOMIC PROFIT= TOTAL REVENUE-TOTAL ECONOMIC COST = TOTAL REVENUE-TOTAL EXPLICIT COST-TOTAL IMPLICIT COST ACCOUNTING PROFIT= TOTAL REVENUE-EXPLICIT COSTS MAXIMISING THE VALUE OF THE FIRM PROFIT OR VALUE? VALUE OF A FIRM IS THE PRICE FOR WHICH IT CAN BE SOLD AND DEPENDS ON PRESENT VALUE OF THE FUTURE ECONOMIC PROFITS EXPECTED TO BE GENERATED BY THE FIRM

SEPARATION OF OWNERSHIP AND MANAGEMENT

THE PRINCIPAL AGENT PROBLEM:THE CONFLICT THAT ARISES WHEN THE GOALS OF MANAGEMENT (AGENT) DO NOT MATCH THE GOALS OF THE OWNER (THE PRINCIPAL). MORAL HAZARD: IT EXISTS WHEN EITHER PARTY TO AN AGREEMENT HAS AN INCENTIVE NOT TO ABIDE BY ALL PROVISIONS OF THE AGREEMENT AND ONE PARTY CANNOT COST EFFECTIVELY MONITOR THE AGREEMENT ALIGNING THE INTERESTS OF AGENT WITH THOSE OF THE PRINCIPAL THROUGH STOCK OPTIONS CORPORATE CONTROL MECHANISM: STOCK OPTIONS MORE OUTSIDE OR INDEPENDENT DIRECTORS FINANCING CORPORATES THROUGH DEBT THAN EQUITY
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MARKET STRUCTURE AND MANAGERIAL DECISION MAKING WHAT IS A MARKET? ANY ARRANGEMENT THROUGH WHICH BUYERS AND SELLERS EXCHANGE ANYTHING OF VALUE PRICE TAKER: A FIRM THAT CAN NOT SET THE PRICE OF THE PRODUCT IT SELLS, SINCE PRICE IS DETERMINED BY THE MARKET FORCES OF DEMAND AND SUPPLY. PRICE MAKER: A FIRM THAT CAN RAISE ITS PRICE WITHOUT LOSING ALL ITS SALES MARKET POWER: A FIRMS ABILITY TO RAISE THE PRICE WITHOU LOSING ALL ITS CUSTOMERS. DIFFERENT MARKET STRUCTURES: PERFECT COMPETITION, MONOPOLY, MONOPOLISTIC COMPETITION AND OLIGOPOLY

GLOBALISED MARKET:ECONOMIC INTEGRATION OF MARKETS LOCATED IN NATIONS AROUND THE WORLD

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REAL VERSUS NOMINAL PRICES

Nominal price inflation.

Absolute price of a good, unadjusted for

Real price Price of a good relative to an aggregate measure of prices; price adjusted for inflation. Consumer Price Index level. Measure of the aggregate price

Producer Price Index Measure of the aggregate price level for intermediate products and wholesale goods.

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REAL VERSUS NOMINAL PRICES: A NUMERICAL EXAMPLE

Table 1.1 The Real Prices of Eggs and of a College Education 1970
Consumer Price Index Nominal Prices
Grade A large eggs $0.61 $0.84 $1.01 $0.91 $1.64

1980
82.4

1990
130.7

2000
172.2

2007
205.8

38.8

College education
Real Prices ($1970) Grade A large eggs College education

$2530
$0.61 $2,530

$4912
$0.40 $2,313

$12,018
$0.30 $3,568

$20,186
$0.21 $4,548

$27,560
$0.31 $5,196

THE REAL PRICE OF EGGS IN 1970 DOLLARS IS CALCULATED AS FOLLOWS

Re al price of eggs in 1980 Re al price of eggs in 1990

CPI1970 nominal price in 1980 38.8 $0.84 $0.40 CPI1980 82.4

38.8 CPI1970 $1.01 $0.30 nominal price in 1990 130.7 CPI1990

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While the nominal price of eggs rose during these years, the real price of eggs actually fell .

REAL VERSUS NOMINAL PRICES: A NUMERICAL EXAMPLE

Table 1.1 The Real Prices of Eggs and of a College Education
1970 Consumer Price Index Nominal Prices Grade A large eggs College education Real Prices ($1980) Grade A large eggs $2.05 $1.33 $1.01 $0.69 $1.04 $0.61 $2530 $0.84 $4912 $1.01 $12,018 $0.91 $20,186 $1.64 $27,560 38.8 1980 82.4 1990 130.7 2000 172.2 2007 205.8

THE REAL PRICE OF EGGS IN 1990 DOLLARS IS CALCULATED AS FOLLOWS

130.7 CPI1990 $0.61 $2.05 Re al price of eggs in 1970 nominal price in 1970 38.8 CPI1970 CPI1990 130.7 Re al price of eggs in 2007 nominal price in 2007 $1.64 $1.04 CPI 2007 205.8
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THANK YOU

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