Chap 1: The Fundamentals of Accounting Costs

Managerial Economics
 The explicit costs of the resources
needed to produce produce goods or
services.
Manager
 Reported on the firm’s income
A person who directs resources to
statement.
achieve a stated goal.
Opportunity Cost
Economics
 The cost of the explicit and implicit
The science of making decisions in the
resources that are foregone when a
presence of scare resources.
decision is made.
Managerial Economics
The study of how to direct scarce
Profits as a Signal
resources in the way that most
efficiently achieves a managerial goal.  Profits signal to resource holders
where resources are most highly
valued by society.
Identify Goals and Constraints
 Resources will flow into industries
 Sound decision making involves that are most highly valued by
having well-defined goals. society.

 Leads to making the “right”

decisions.
Five Forces by Michael Porter

 In striking to achieve a goal, we

often face constraints.
 Constraints are an artifact of
scarcity.

Accounting Profits
 Total revenue (sales) minus dollar
cost of producing goods or services.
 Reported on the firm’s income
statement.
Economic Profits Understanding Firms’ Incentives

 Total revenue minus total  Incentives play an important role

opportunity cost. within the firm.
Incentives determine:
 How resources are utilized.
   Present value (PV) of a future value
H (FV) lump-sum amount to be
ow hard individuals work.
 Managers must understand the role
incentives play in the organization.
 Constructing proper incentives will
enhance productivity and
profitability.
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.
The Time Value of Money
received at the end of “n” periods in
the future when the per-period
interest rate is “i”:
FV
PV =
(1+i )n
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.
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
 Ifi = 0, note PV = FV.
 Asi increases, the higher is the
OCW and the lower the PV.
Present Value of a Series
 Present value of a stream of future
amounts (FVt) received at the end
of each period for “n” periods:
FV 1 FV 2 FV n
PV    . . .
1  i  1
1  i  2
1  i  n
Equivalently,
 n π1 π2 πt
FV t ∞

PV =∑ PV Firm =π 0 + + +.. .=∑

( 1+ i )t
( 1+i ) ( 1+ i ) t=1 ( 1+i )t
t =1

 A common assumption among

economist is that it is the firm’s goal
Net Present Value to maximization profits.
 Suppose a manager can purchase a  This means the present value of
stream of future receipts (FVt ) by current and future profits, so the firm is
spending “C0” dollars today. The maximizing its value.
NPV of such a decision is…

Firm Valuation With Profit Growth

FV 1 FV 2 FV n
NPV    . . .  C  If profits grow at a constant rate (g
1  i  1 1  i  2 1  i  n 0

<i) and current period profits are po,

before and after dividends are:
Decision Rule:
NPV < 0: Reject project PVFirm   0
1 i
before current profits have been paid out as dividends;
ig
NPV > 0: Accept project Ex  Dividend 1 g
PVFirm  0 immediately after current profits are paid out as dividends.
ig

Present Value of a Perpetuity

 Provided that g <i.
 An asset that perpetually generates a
stream of cash flows (CFi) at the  That is, the growth rate in profits is
end of each period is called a less than the interest rate and both
perpetuity. remain constant.
 The present value (PV) of a
perpetuity of cash flows paying the
same amount (CF = CF1 = CF2 =
…) at the end of each period is Marginal (Incremental) Analysis
Control Variable Examples:
CF CF CF  Output
PV Perpetuity = + + +. . .
( 1+i ) ( 1+i ) ( 1+i )3
2

CF
 Price
=
i  Product Quality
Firm Valuation and Profit  Advertising
Maximization
 R&D
 The value of a firm equals the
present value of current and future  Basic Managerial Question: How
profits (cash flows). much of the control variable should
be used to maximize net benefits?
 Net Benefits = Total Benefits -
Total Costs
 Profits = Revenue - Costs

Marginal Benefit (MB)

 Change in total benefits arising
from a change in the control
variable, Q:

ΔB
MB=
ΔQ
 Slope (calculus derivative) of the
total benefit curve.

Marginal Cost (MC)

 Change in total costs arising from a Chap 2: Market Forces: Demand and
change in the control variable, Q: Supply

ΔC
MC=
ΔQ Supply & Demand Analysis
 Tool that managers can use to
 Slope (calculus derivative) of the
visualize the “big picture.
total cost curve

Market Demand Curve

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.
 Shows the amount of a good that
will be purchased at alternative
prices, holding other factors
constant.
Law of Demand: The demand curve is
downward sloping.
 As the price of a good rises (falls)
and all other things remain constant,
the quantity demanded of the good
falls (rises)
PRICE & DEMAND
 Price and quantity demanded are
inversely related
The straight line connecting those
points, called the market demand
curve, interpolates the quantities
consumers would be willing and able to
purchase at prices not explicitly dealt
with in the market research.
Determinants of Demand
 Income
 Normal good
 Inferior good
 Prices of Related Goods
 Prices of substitutes
 Prices of complements
 Advertising and consumer tastes
 Population
 Consumer expectations
Demand Shifters
 Variables other than the price of a
good that influence demand
change in quantity demanded.
Changes in the price of a good lead to a
change in the quantity demanded of that
good.
 This corresponds to a movement
along a given demand curve.
change in demand. Changes in
variables other than the price of a good,
such as income or the price of another
good, lead to a change in demand.
 This corresponds to a shift of the
entire demand curve.
INCOME
 Because income affects the ability
of consumers to purchase a good,
changes in income affect how much
consumers will buy at any price.
 A good whose demand increases
(shifts to the right) when consumer
incomes rise is called a normal
good.
 A good for which an increase
(decrease) in income leads to a
decrease (increase) in the demand
for that good is called an inferior
good.
PRICES OF RELATED GOODS:
SUBSTITUES
 Goods for which an increase
(decrease) in the price of one good
leads to an increase (decrease) in the
demand for the other good.
PRICES OF RELATED GOODS:
COMPLEMENTS
 Goods for which an increase
(decrease) in the price of one good
leads to a decrease (increase) in the
demand for the other good.
ADVERTISING & CONSUMER The Demand Function
TASTES
A general equation representing the
 Advertising often provides demand curve
consumers with information about
Qx^d = f(Px , PY , M, H,)
the existence or quality of a product,
which in turn induces more Qx^d = quantity demand of good X.
consumers to buy the product.
Px = price of good X.
 These types of advertising messages
are known as informative PY = price of a related good Y.
advertising.  Substitute good.
 Complement good.
 Advertising that promotes the latest M = income.
fad in clothing may increase the
demand for a specific fashion item  Normal good.
by making consumers perceive it as  Inferior good.
“the” thing to buy.
H = any other variable affecting
 These types of advertising messages demand.
are known as persuasive
advertising.
Inverse Demand Function

POPULATION Price as a function of quantity

demanded.
 Generally, as the population rises,
more and more individuals wish to Example:
buy a given product, and this has the Demand Function
effect of shifting the demand curve
to the right. Qx^d = 10 – 2Px

*changes in composition of the

population can also affect the demand Inverse Demand Function:
for a product.
2Px = 10 – Qx^d
Px = 5 – 0.5Qx^d
CONSUMER EXPECTATION
 If consumers expect future prices to
be higher, they will substitute
current purchases for future
purchases.
 This type of consumer behavior
often is referred to as stockpiling
and generally occurs when products
are durable in nature.
Consumer Surplus:
 The value consumers get from a Qx^S = quantity supplied of good X.
good but do not have to pay for.
Px = price of good X.
 Consumer surplus will prove
PR = price of a production substitute.
particularly useful in marketing and
other disciplines emphasizing W = price of inputs (e.g., wages).
strategies like value pricing and
price discrimination. H = other variable affecting supply.

Market Supply Curve

 The supply curve shows the amount Inverse Supply Function
of a good that will be produced at Price as a function of quantity supplied.
alternative prices.
Example:

 Law of Supply:
Supply Function
 The supply curve is upward
sloping. Qx^s = 10 + 2Px

Supply Shifters Inverse Supply Function:

 Input prices 2Px = 10 + Qx^s

 Technology or government Px = 5 + 0.5Qx^s

regulations
 Number of firms Producer Surplus
 Entry  The amount producers receive in
 Exit excess of the amount necessary to
induce them to produce the good.
 Substitutes in production
Market Equilibrium
 Taxes
 The Price (P) that Balances supply
 Excise tax and demand
 Ad valorem tax  Qx^S = Qx^d
 Producer expectations  No shortage or surplus
 Steady-state
The Supply Function Price Restrictions
An equation representing the supply  Price Ceilings:The maximum legal
curve: price that can be charged.
Qx^S = f(Px , PR ,W, H,)  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.
 Minimum wage.
 Agricultural price supports.
Full Economic Price
The dollar amount paid to a firm under a
price ceiling, plus the nonpecuniary
price.
P^F = P^c + (P^F - P^C)
P^F = full economic price
P^C = price ceiling
P^F - P^C = nonpecuniary price
Comparative Static Analysis
How do the equilibrium price and
quantity change when a determinant of
supply and/or demand change?
 shows how the equilibrium price
and quantity will change when a
determinant of supply or demand
changes.
Conclusion:
 Use supply and demand analysis to
clarify the “big picture” (the general
impact of a current event on
equilibrium prices and quantities).
 organize an action plan (needed
changes in production, inventories,
raw materials, human resources,
marketing plans, etc.).
NOTE: Some GRAPHS aren’t included.
Kindly view the PPT in module. :’)
Chap 3: Quantitative Demand Analysis
THE ELASTICITY CONCEPT
• A measure of the responsiveness
of one variable to changes in
another variable; the percentage
change in one variable that arises
due to a given percentage change
in another variable
• How responsive is variable “G”
to a change in variable “S”
%ΔG
EG , S =
%ΔS
If EG,S> 0, then S and G are directly
related.
If EG,S< 0, then S and G are inversely
related.
If EG,S = 0, then S and G are unrelated.
Own Price Elasticity of Demand
• A measure of the responsiveness
of the quantity demanded of a
good to a change in the price of
that good; the percentage change
in quantity demanded divided by
the percentage change in the
price of the good
%ΔQ X d
EQ , PX =
X %ΔP X
• Negative according to the “law
of demand.”
|EQ ,P X|>1
• Elastic: X
 |EQ ,P X|<1
• Inelastic: X

|EQ |=1
• Unitary: X ,P X