ECON 65A ○ Total revenue minus total

CHAPTER 1 opportunity cost.

THE FUNDAMENTALS OF MANAGERIAL
ECONOMICS Profits as a Signal

Managerial Economics ➢ Profits signal to resource holders where

➢ Manager resources are most highly valued by
○ A person who directs resources to society.
achieve a stated goal. ○ Resources will flow into industries
➢ Economics that are most highly valued by
○ The science of making decisions in society.
the presence of scarce resources.
○ bridge the gap between unlimited Marginal (Incremental) Analysis
wants/needs and unlimited
resources ➢ Control Variable Examples:
➢ Managerial Economics ○ Output
○ The study of how to direct scarce ○ Price
resources in the way that most ○ Product Quality
efficiently achieves a managerial ○ Advertising
goal. ○ R&D

Economic vs. Accounting Profits ➢ Basic Managerial Question: How much of

the control variable should be used to
➢ Accounting Profits maximize net benefits?
○ Total revenue (sales) minus dollar
cost of producing goods or services. Net Benefits
○ Reported on the firm's income
statement. ➢ Net Benefits (Economic Analysis) = Total
➢ Economic Profits Benefits - Total Costs
○ Total revenue minus total *Revenue is just part of total benefits.
opportunity cost.
➢ Profits = (Accounting Analysis) Revenue -
Opportunity Cost Costs

➢ Accounting Costs Marginal Benefit (MB)

○ The explicit costs of the resources
needed to produce goods or ➢ Change in total benefits arising from a
services. change in the control variable,
○ Reported on the firm's income
statement.
➢ Opportunity Cost
○ The cost of the explicit and implicit Q:
resources that are foregone when a
decision is made. ∆ - Delta/Change
➢ Economic Profits B - Benefit / Total Benefit
Q - Control Variable
 The Geometry of Optimization: Net
➢ Slope (calculus derivative) of the total Benefits
benefit curve.

Marginal Cost (MC)

➢ Change in total costs arising from a change

in the control variable, Q:

∆ - Delta/Change Maximum Net Benefit - MB=MC

C - Cost / Total Cost
Q - Control Variable CHAPTER 2
MARKET FORCES: DEMAND AND SUPPLY
➢ Slope (calculus derivative) of the total cost
curve Market Demand Curve
➢ Shows the amount of a good that will be
Marginal Principle purchased at alternative prices, holding
other factors constant. (Ceteris Paribus -
➢ To maximize net benefits, the managerial assuming or holding other factors constant)
control variable should be increased up to ➢ Law of Demand
the point where MB = MC. ○ The demand curve is downward
➢ MB > MC means the last unit of the control sloping.
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.

The Geometry of Optimization:Total Determinants of Demand

Benefit and Cost
➢ Income
○ Normal good - the condition is if the
income increases, demand or
consumption for normal goods
increases (e.g. luncheon meat. If
income is low, you tend to not buy
luncheon meat)
○ Inferior good - if income increases,
demand for inferior goods decreases
(e.g. canned goods.)
*Giffen goods - low income, non luxury product for Inverse Demand Function
which demand increases as the price increases
and vice versa. ● Price as a function of quantity demanded.
● Example:
➢ Prices of Related Goods ○ Demand Function
○ Prices of substitutes - (e.g. ■ Qxd= 10 – 2Px
substitutes of Coca cola is Pepsi or ○ Inverse Demand Function:
RC ■ 2Px= 10 – Qxd
○ Prices of complements - products ■ Px= 5 – 0.5Qxd
you demand or consume together Q is the independent variable, P is
(e.g. shoes and socks),(e.g. the dependent variable.
toothpaste and toothbrush, the
demand of toothbrush is affected by
the price of toothpaste) Change in Quantity Demanded
➢ Advertising and consumer tastes - the
demand for the product is affected by the
advertisement. Your taste may differ from
time to time depending on external factors
influencing the change in your preferences.
➢ Population - more population = more
demand. The number of consumers affect
the demand of the product.
➢ Consumer expectations - e.g. price and
time. If consumers expect the prices to
decrease tomorrow, consumption today will
be postponed and they will buy the product
tomorrow.
*There's an increase in demand as a result of
The Demand Function reduction to price.
*The movement from point A to B is termed as
➢ A general equation representing the Quantity Demanded.
demand curve
Qxd= f(Px,Py,M,H,) Change in Demand - the shift in the entire demand
curve as a result of change in decision or control
➢ Qxd= quantity demand of good X. variable other than price.
➢ Px= price of good X.
➢ Py= price of a related good Y.
○ Substitute good.
○ Complement good.
➢ M = income.
○ Normal good.
○ Inferior good.
➢ H = any other variable affecting demand.
Consumer Surplus:
Consumer Surplus:
● The value consumers get from a good but The Continuous Case*
do not have to pay for. *there are prices in between 10 and 8 like 9 or 9.5.
● Consumer surplus will prove particularly
useful in marketing and other disciplines
emphasizing strategies like value pricing
and price discrimination.

I got a great deal!

● That company offers a lot of bang for the

buck!
● Dell provides good value.
● Total value greatly exceeds total amount
paid.
● Consumer surplus is large. Market Supply Curve

I got a lousy deal! ➢ The supply curve shows the amount of a

good that will be produced at alternative
● That car dealer drives a hard bargain! prices.
● I almost decided not to buy it! ➢ Law of Supply
● They tried to squeeze the very last cent ○ The supply curve is upward sloping.
from me! ○ As the price increases, supply
● Total amount paid is close to total value. increases.
● Consumer surplus is low. ○

Supply Shifters

Consumer Surplus: ➢ Input prices - if prices of raw materials

The Discrete Case* increase, supplies or producers produce
*discrete meaning the variable cannot be less (e.g. sugar. If the price of sugar
subdivided into smaller units increases, the supply of Coca cola is
affected)
➢ Technology or government regulations -
Technologies are designed to maximize
production, to result in efficient production
and higher productivity will affect the
available supply in the market.
Governments may impose quantitative
restrictions, quotas, and subsidies to
suppliers which may affect the willingness of
suppliers to supply.
➢ Number of firms
 ○ Supply Function
■ Qxs= 10 + 2Px
○ Inverse Supply Function:
■ 2Px= 10 + Qxs
■ Px= 5 + 0.5Qxs

Change in Quantity Supplied - change along the

○ Entry - entrance of new players in supply curve
industry may begin to increase
supply
○ Exit - exit of some suppliers may
decrease the supply
➢ Substitutes in production - the supply of a
good increases if the price of one of its
substitute in production falls
➢ Taxes - affects the willingness of suppliers
to produce because of the taxes imposed
upon them
○ Excise tax -
○ Ad valorem tax
➢ Producer expectations - if producers expect
the prices to increase tomorrow, they will
suspend the supply today and supply the
products tomorrow. Another producer's Change in Supply
expectations are market expectations.

The Supply Function

➢ An equation representing the supply curve:

Qxs= f(Px,Pr,W,H,)

● Qxs= quantity supplied of good X.

● Px= price of good X.
● Pr= price of a production substitute.
● W = price of inputs (e.g., wages).
● H = other variable affecting supply.

Inverse Supply Function

*it is the quantity that influences the price
Producer Surplus
● Price as a function of quantity supplied. ● The amount producers receive in excess of
the amount necessary to induce them to
● Example: produce the good.
 ● Area above the supply curve and below the
price line. If price is too high…
● Not a monetary benefit but an economic
benefit

The surplus will later on be diminished up to the

point where the price will converge to the
equilibrium price (7).

Market Equilibrium
● The Price (P) that balances supply and Price Restrictions
demand Price Ceilings - the maximum legal price
○ Qxs= Qxd that can be charged.
○ No shortage or surplus - setting a certain price where
● Steady-state suppliers cannot go beyond
● intersection between the demand curve and
supply curve Examples: Gasoline prices in the
1970s.
If price is too low… Housing in NewYork City. Proposed
restrictions on ATM fees.

Price Floors - the minimum legal price that

can be charged.
Examples: Minimum wage.
Agricultural price supports.

Impact of a Price Ceiling

The shortage will later on be diminished up to the

point where the price of the product will converge to
the equilibrium price (7) because the supply side of
the market has the tendency to produce more due
to shortage.
Impact of a Price Floor

Comparative Static Analysis

Comparative static analysis shows how the
equilibrium price and quantity will change
when a determinant of supply or demand
changes.