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BY

NASUHA NORDIN

FUNDAMENTALS
OF MA NA GERI AL
ECONOMI CS

MODULE 1A

WHAT IS BUSINESS ECONOMICS


A person who directs resources to
achieve a stated goal

MANAGER

BUSINESS
ECONOMICS
The science of making decisions in the
presence of scarce resources

MANAGERIAL
ECONOMICS

How to
direct scarce
resources in
achieving
managerial
goals in most
efficient way

Identifying goals
and constraints

Recognize the
nature and
importance of
profits

Understand
incentives

Understand
markets

Recognize the
time value of
money

Use marginal
analysis

F U N DA M E N TA L S
O F M A N AG E R I A L
ECONOMICS

Basic principles of
effective management

IDENTIFYING GOALS AND


CONSTRAINTS
Beneficiary

GOAL

Maximize benefit

Students of MBA

Maximize overall grade

Manager

Maximize wealth of shareholders

CONSTRAINTS

Scarcity of resources

Time Allocation for respective


courses
Available technology
Prices of inputs used in
production

RECOGNIZE THE NATURE AND


IMPORTANCE OF PROFITS
AC C O U N T I N G P RO F I T
(-)

REVENUE
COST

$100 X 10 units

ACCOUNTING PROFIT

$1,000

$ 600

$ 400

Total amount of money taken in from sales


(total revenue) minus the dollar cost of
producing goods or services

E C O N O M I C P RO F I T
(-)

REVENUE

$100 X 10 units

OPPORTUNITY COST

ECONOMIC PROFIT

$1,000

$ 600

$ 400

OPPORTUNITY COST:
The explicit cost of resources plus the implicit
cost of giving up its best alternatives

FIVE FORCES AND INDUSTRY PROFITABILITY


Entry

Entry Costs
Speed of Adjustment
Sunk Costs
Economies of Scale

Power of
Input Suppliers

Supplier Concentration
Price/Productivity of
Alternative Inputs
Relationship-Specific
Investments
Supplier Switching Costs
Government Restraints

Level, Growth,
and Sustainability
of Industry Profits

Industry Rivalry

Concentration
Price, Quantity, Quality,
or Service Competition
Degree of Differentiation

Network Effects
Reputation
Switching Costs
Government Restraints

Switching Costs
Timing of Decisions
Information
Government
Restraints

Power of
Buyers

Buyer Concentration
Price/Value of Substitute
Products or Services
Relationship-Specific
Investments
Customer Switching Costs
Government Restraints

Substitutes & Complements

Price/Value of Surrogate Products Network Effects


or Services
Government
Price/Value of Complementary
Restraints
Products or Services

HUMAN
RESOURCES

INCENTIVES

PROFIT

U N D E R S TA N D
INCENTIVES

Changes in profits
provide an incentive to
how resource holders
use their resources.

Within a firm, incentives


impact how resources
are used and how hard
workers work.

One role of a manager is


to construct incentives
to induce maximal effort
from employees.

UNDERSTAND MARKETS
PRODUCER

PRODUCER

MARKET
CONSUMER

CONSUMER

RIVALRY
PRODUCER CONSUMER
PRODUCER PRODUCER
CONSUMER - CONSUMER

RECOGNIZE THE TIME VALUE OF MONEY


PRESENT VALUE

The amount that would have to be invested today at the prevailing interest rate (i) to
generate the given future value (FV)

NET PRESENT VALUE

The present value of the income stream generated by a project minus the current
cost of the project (C0)

PRESENT VALUE OF
INDEFINITELY LIVE ASSETS Present value of decisions that indefinitely generate cash flow

RECOGNIZE THE TIME VALUE OF MONEY


PRESENT VALUE
AND PROFIT
MAXIMIZATION

Maximizing profits means maximizing the value of the firm,


which is the presnt value of current and future benefit

PRESENT VALUE
AND ESTIMATING When dividend are immediately paid out of current profits,
VALUES OF FIRM the present value of the firm is ( at ex-dividend)

USE MARGINAL ANALYSIS


NET BENEFIT

MARGINAL BENEFIT

Managers objective is to maximize net benefits


The change in total benefits arising from a change in the managerial control
variable, Q

MB(Q) = B(Q)
MARGINAL COST

The change in the total cost form a change in the managerial control variable

MC(Q) = C(Q)

MNB(Q) = MB(Q) MC(Q)

B(Q)

MARGINAL NET
BENEFIT

N(Q)

C(Q)

Control
Variable

Total Net Benefit MNB(Q) Marginal Net


Benefit
Total Benefit

MB(Q)

Total Cost

(MC(Q)

Marginal
Benefit

Marginal Cost

Marginal Analysis Principle I

Marginal principle

To maximize net benefits, the manager should increase the managerial control
variable up to the point where marginal benefits equal marginal costs.

This level of the managerial control variable corresponds to the level at which
marginal net benefits are zero; nothing more can be gained by further changes
in that variable.

MB(Q) = MC(Q),

No more gain after it reaches this stage

MARGINAL ANALYSIS IN ACTION


It is estimated that the benefit and cost structure of a firm is:
Find the

and

What value of

makes

functions.
zero?

Determining the Optimal Level of a Control Variable

Total benefits
Total costs

Maximum total benefits

Maximum net
benefits

Quantity

(Control Variable)

DETERMINING THE OPTIMAL LEVEL OF A CONTROL


VARIABLE II

Net benefits

Maximum
net benefits
Slope =

( )

=0

Quantity

(Control Variable)

Determining the Optimal Level of a Control Variable III

Marginal
benefits, costs
and net benefits

Maximum net
benefits

Quantity

(Control Variable)

Incremental Decisions

Incremental revenues

The additional revenues that stem from a yes-or-no decision.

Incremental costs

The additional costs that stem from a yes-or-no decision.

Thumbs up decision

>

<

Thumbs down decision

CONCLUSION
Make sure you include all costs and benefits when making decisions
(opportunity costs).

When decisions span time, make sure you are comparing apples to apples
(present value analysis).
Optimal economic decisions are made at the margin (marginal analysis).