MANECON – MODULE 1: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena
MANAGER
- A person who directs resources to achieve a
stated goal:
• Directs the effort of others
• Purchases inputs used in the production
of the firm’s output
• Directs the product price or quality
decisions
ECONOMICS
- The science of making decisions in the presence
of scarce resources.
o Resources are anything used to produce
a good or service, or achieve a goal.
o Decisions are important because scarcity
implies trade-offs.
MANAGERIAL ECONOMICS
- Economics applied in decision making.
- Is a branch of economics that applies: Economic
theory and decision science methodology?
ECONOMICS OF EFFECTIVE MANAGEMENT
(6) Basic principles of comprising effective management:
1. Identify goals and constraints
2. Recognize the nature and importance of profits
3. Understand incentives
4. Understand markets
5. Recognize the time value of money
6. Use marginal analysis
1. Identify goals and constraints
• The first step in making sound decisions
varies on the underlying goals of the
manager;
• Achieving different goals entails making
different decisions;
• Different units within a firm may be given
different goals
• However, constraints make it difficult for
managers to achieve such goals as
maximizing profits or increasing market
share;
• These constraints include: available
technology, availability of capital, labor
and the price of inputs used in production.
ex. Marketing department
- use their resources to maximize sales
or market share.
Finance department
- might focus on earnings growth or risk
reduction strategies.
2. An effective manager must recognize the Nature
and Importance of Profits
- Accounting Profit
Total amount of money taken in from
sales (total revenue) minus cost of
producing goods or services.
Formula: AP = TR – Explicit Costs
- Economic Profit
The difference between total revenue and
opportunity cost.
o Opportunity cost is the explicit
cost of a resource plus the
implicit cost of giving up its best
alternative.
o Explicit costs – wages, rent and
cost of materials
o Implicit costs – forgone salary or
forgone rent.
Formula: EP = TR – Opportunity costs
Note: Economic Costs (Explicit Costs +
Implicit Costs)
Profits are a signal to resource holders where
resources are most highly valued by society.
- Smith mentioned that by pursuing its self-
interest-the goal of maximizing profits, a firm
ultimately meets the needs of society.
- This includes new firms to enter the markets in
which economic profits are available. As more
firms enter the industry, the market price falls,
and economic profit declines.
MANECON – MODULE 1: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena
FIVE FORCES FRAMEWORK
- Pioneered by Michael Porter explained
that his framework can be used to identify:
state of competition and profitability of an
industry.
1. Entry
- Heightens competition and reduces the
margins of existing firms in a wide variety
of industry settings.
- A number of economic factors affect the
ability of entrants to erode existing
industry profits: Entry costs, sunk costs,
economies of scale, network effects,
reputation, switching costs and
government restraints.
2. Power of Input Suppliers
- Industry profits tend to be lower when
suppliers have the power to negotiate
favorable terms for their inputs.
- Supplier power tends to be low when:
▪ Inputs are relatively standardized
▪ Input markets are not highly
concentrated
▪ Alternative inputs are available with
similar marginal productivity.
3. Power of Buyers
- Industry profits tend to be lower when
customers or buyers have the power to
negotiate favorable terms for the
products or services produced in the
industry.
▪ If the buyer is price sensitive and well-
educated about the product, then buyer
power is high.
▪ Then if the customer purchases large
volumes of standardized products from
the seller, buyer bargaining power is high.
▪ If substitute products are available in the
market, buyer power is high.
4. Industry Rivalry
- The sustainability of industry profits also
depends on the nature and intensity of
rivalry among firms competing in the
industry.
- Rivalry tends to be less intense (and
hence the likelihood of sustaining profits
is higher) in concentrated industries –
that is, those with relatively few firms
5. Threat of Substitutes and Complements
- The level and sustainability of industry
profits also depend on the price and value
of interrelated products and services.
Porter’s five forces framework
emphasized that the presence of close
substitutes erodes industry profitability.
- The availability of substitute affects the
profitability of an industry because
consumers can choose to purchase the
low-priced substitute of the industry’s
product.
3. Understand Incentives
- Within a firm, incentives affect how
resources are used and how hard
workers work.
4. Understand Markets
- Bargaining position of consumers and
producers is limited by three rivalries in
economic transactions:
1. Consumer-Productivity rivalry
2. Consumer-Consumer rivalry
3. Producer-Producer rivalry
(1) Consumer-Producer rivalry
- Consumers attempt to negotiate or locate
low prices, while producers attempt to
negotiate high prices.
- In a very loose sense, consumers attempt
to “rip off” producers, and producer
attempt to “rip off” consumers.
MANECON – MODULE 1: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena
(2) Consumer-Consumer rivalry
- It arises because of the economic
doctrine of scarcity.
- When limited quantities of goods are
available, consumers will compete with
one another for the right to purchase the
available goods.
(3) Producer-Producer rivalry
- Those firms that offer the best-quality
product at the lowest price earn the right
to serve the customers.
- When two gas stations are located across
the street from one another compete on
price, they are engaged in producer-
producer rivalry.
GOVERNMENT AND THE MARKET
- When agents on either side of the market find
themselves disadvantaged in the market process,
they frequently attempt to induce government to
intervene on their behalf.
- Government plays a key role in disciplining the
market process.
FIVE FORCES FRAMEWORK
1. Entry
- Entry costs
- Sunk costs
- Network effects
- Switching costs
- Speed of adjustment
- Economies of scale
- Reputation
- Government restraints
2. Power of Input Suppliers
- Supplier concentration
- Price/productivity of alternative inputs
- Relationship-specific investments
- Supplier switching costs
- Government restraints
3. Power of Buyers
- Buyer concentration
- Price/value of substitute products or
services
- Relationship-specific investments
- Customer switching costs
- Government restraints
4. Industry Rivalry
- Concentration
- Price, quantity, quality, or service
competition
- Degree of differentiation
- Switching costs
- Timing of decisions
- Information
- Government restraints
5. Substitutes and Complements
- Price/value of surrogate products or
services
- Price/value of complementary products
or services
- Network effects
- Government restraints
TIME VALUE OF MONEY
- The timing of decision involves a gap between the
time when costs are borne and benefits received.
- Managers can use present value analysis to properly
account for the timing of receipts and expenditures.
- “How much money you need to invest today so that
investment could earn in the future”
Five Formulas:
(1) Present value of a single future value;
(2) Present value of a stream of future values;
(3) Future value and the opportunity cost of waiting;
(4) Present value of indefinitely lived assets; and
(5) Present value and Profit maximization
1. Present value of a single future value
- The amount that would have to be invested
- today at the prevailing interest rate to generate the
given future value:
MANECON – MODULE 1: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena
2. Present value of a stream of future values
- The cumulative present value of future cash flows
can be calculated by summing the contributions
of FVₜ ; the value of cash flow at time t:
3. Net present value of a project
- Is simply the present value (PV) of the income
stream generated by the project minus the current
cost of the project:
OCW – Opportunity Cost of Waiting
When:
net present value is (+)
- the project is profitable
net present value is (-)
- should reject a project that has a negative NPV since
the cost of such a project exceeds the PV of the income
stream that project generates.
4. Present Value of Indefinitely Lived Assets
- Some decisions generate cash flows that continue
indefinitely.
- Consider an asset that generates a cash flow from
one to three years for an indefinite period of time.
- The asset generates a perpetual stream of
identical cash flows at the end of each period.
5. Present Value of a Firm
- Present value analysis is also useful in
determining the value of a firm since the value of
a firm is the PV of the stream of profits (cash flow)
generated by the firm’s physical, human and
intangible asset;
- In other words, the value of the firm today is the
present value of its current and future profits.
- The PV of the firm takes the long-term impact of
managerial decisions on profits.
When economists say that the goal of the firm is
to maximize profit, it should be understood that
the firm’s goal is to maximize its value, which is
the present value of current and future profits.
i – interest rate
g – growth rate
Note: The formula above explains that the profits of the
firm have not yet been paid out to stockholders as
dividends.
MARGINAL ANALYSIS
- One of the most important managerial tools
- Business decisions should be made and actions
should be taken
- States optimal managerial decisions involve
comparing the marginal benefits and marginal costs
Given a control variable, Q, of a managerial objective,
denote the
- Total benefit as B(Q)
- Total cost as C(Q)
Manager’s objective is to maximize net benefits:
Formula: N(Q) = B(Q) – C(Q)
MANECON – MODULE 1: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena

MARGINAL PRINCIPLE

- To maximize net benefits, the manager should

increase the managerial control variable up to the
point where marginal benefits equal marginal costs.

Marginal Benefit: MB(Q)

- The change in total benefits arising from a change in

the managerial control variable, Q.

Marginal Cost: MC(Q)

- The change in the total costs arising from a change

in the managerial control variable, Q.

Marginal Net Benefits: MNB(Q)

MNB (Q) = MB(Q) – MC(Q)

Marginal Value Curves are the Slopes of Total Value

Curves

- A calculus alternative
o Slope of a continuous function is the
derivative/marginal value of that function

In summary (Module 1):

1. Goals, constraints, incentives, and market rivalry affect

economic decisions.

2. Economic profit, accounting profit and costs.

3. The role of profits in a market economy.

4. The five forces framework to analyze the sustainability

of an industry’s profits.

5. Present value analysis to make decisions and value

assets.

6. Marginal analysis to determine the optimal level of a

managerial control variable.
MANECON – MODULE 1: FUNDAMENTALS OF MANAGERIAL ECONOMICS
Professor: Prof. Cecilia Flores
Transcribed by: Tyrone Villena