ECN2014 MANAGERIAL ECONOMICS

DEPARTMENT OF ECONOMICS & FINANCE, SUBS

TUTORIAL ONE
MANAGERS, PROFITS AND MARKETS
Thomas & Maurice, Applied problem 2, Chap 1 pp. 33.

A doctor spent two weeks doing charity medical work in Mexico. In calculating her
taxable income for the year, her accountant deducted as business expenses her
round‐trip airline ticket, meals, and a hotel bill for the two‐week stay. She was
surprised to learn that the accountant, following Internal Revenue Service (IRS)
rules, could not deduct as a cost of the trip the $8,000 of income she lost by being
absent from her medical practice for two weeks. She asked the accountant, “Since
lost income is not deductible as an expense, should I ignore it when I make my
decision next year to go to Mexico for charity work?” Can you give the doctor some
advice on decision making?

EXPLICIT  IMPLICIT  ECONOMIC 

COSTS COSTS COSTS
 Thomas & Maurice, Applied problem 3, Chap 1 pp. 33.

When Burton Cummings graduated with honours from the Canadian Trucking
Academy, his father gave him a $350,000 tractor‐trailer rig. Recently, Burton was
boasting to some fellow truckers that his revenues were typically $25,000 per
month, while his operating costs (fuel, maintenance, and depreciation) amounted
to only $18,000 per month. Tractor‐trailer rigs identical to Burton’s rig rent for
$15,000 per month. If Burton was driving trucks for one of the competing trucking
firms, he would earn $5,000 per month.
$18,000
a. How much are Burton Cumming’s explicit costs per month? How much are his
$20,000 implicit costs per month?
b. What is the dollar amount of the opportunity cost of the resources used by
Burton Cummings each month? $38,000
c. Burton is proud of the fact that he is generating a net cash flow of $7,000
(=$25,000 ‐ $18,000) per month, since he would be earning only $5,000 per
month if he were working for a trucking firm. What advice would you give
Burton Cummings?
Accounting Profits of $7,000 < Implicit Costs of $20,000
OR Economic Loss of $13,000
Thomas & Maurice, Applied problem 5, Chap 1 pp. 33.

An article in The Wall Street Journal discusses a trend among some large US
corporations to base the compensation of outside members of their boards of
directors partly on the performance of the corporation. “This growing practice
more closely aligns the director to the company. [Some] companies link certain
stock or stock‐option grants for directors to improved financial performance, using
a measure such as annual return on equity.”
How would such a linkage tend to reduce the agency problem between managers
and shareholders as a whole? Why could directors be more efficient than
shareholders at improving managerial performance and changing their incentives?

COMPENSATION OF  PERFORMANCE OF 
DIRECTORS &  is tied to THE 
MANAGEMENT TEAM CORPORATION
Thomas & Maurice, Applied problem 5, Chap 1 pp. 33.

An article in The Wall Street Journal discusses a trend among some large US
corporations to base the compensation of outside members of their boards of
directors partly on the performance of the corporation. “This growing practice
more closely aligns the director to the company. [Some] companies link certain
stock or stock‐option grants for directors to improved financial performance, using
a measure such as annual return on equity.”
How would such a linkage tend to reduce the agency problem between managers
and shareholders as a whole? Why could directors be more efficient than
shareholders at improving managerial performance and changing their incentives?

DIRECTORS have better,  SHAREHOLDERS are many, 
cheaper and easier access  Each holds a relatively small 
CORPORATION INFORMATION  stake of the corporation 
than Shareholders profitability.