Managerial Economics in A Global Economy - ch1 The Nature and Scope of Managerial Economics..

Ch 1: The nature and scope of Managerial Economics
Outline: What You Will Learn . . .
Department of Business Administration  Definition of Managerial Economics

 Examine the Theory of the Firm
 The Nature of Profits
 Business Ethics
The Nature and Scope of Managerial Economics  The International Framework of Managerial
Economics
 Managerial Economics and the Internet
2
Managerial Economics in a Global Economy © Dominick Salvatore; ed. 2007;2011, 2012/13, Sami Fethi, EMU, All Right Reserved.
Ch 1: The nature and scope of Managerial Economics Ch 1: The nature and scope of Managerial Economics
Managerial Decision Problems

Managerial Economics Defined
Economic theory Decision Sciences
Microeconomics Mathematical Economics
 The application of economic theory
Macroeconomics Econometrics
and the tools of decision science to
examine how an organization can
MANAGERIAL ECONOMICS
achieve its aims or objectives most Application of economic theory
efficiently. and decision science tools to solve
 The meaning of this definition can managerial decision problems
be best examined with aid of figure
below: OPTIMAL SOLUTION TO
MANAGERIAL DECISION PROBLEMS
3 4
Managerial Economics in a Global Economy © Dominick Salvatore; ed. 2007;2011, 2012/13, Sami Fethi, EMU, All Right Reserved. Managerial Economics in a Global Economy © Dominick Salvatore; ed. 2007;2011, 2012/13, Sami Fethi, EMU, All Right Reserved.
Managerial Decision Problems:

Managerial Decision Problems:
o Case of Hospital:
A ohospital may seek to treat as many patients as possible at
an adequate medical standard with its limited physical
Managerial decision problems arise in any resources (i.e. physicians, technicians, nurses, equipment,
organization (i.e. non-profit organization such beds etc.) and budget.
as a hospital or a university or government o Case of University:
agency), when they seek to achieve some goal The goal of a state university may be to provide an
or objective subject to limitations on the adequate education to as many student as possible subject
availability of essential inputs and in the face of to the physical and financial constraints it faces.
legal constraints. o Case of government agency
Similarly, a government agency may investigate to provide
a particular service to as many people as possible at the
lowest feasible cost.
5 6
Managerial Decision Problems: Economic Theory:
✓ In all these cases, the relevant ➢ Relationship to Economic Theory:

organizations face management decision The organization can solve its management
problems as it seek to accomplish their own decision problems by application of economic
goals or objective subject to the constraint theory and the tools of decision science.
they face.
➢Economic Theory refers to microeconomics
✓It is important to note that the goals and and macroeconomics. Economic theories seek
constraints may differ from case to case, to predict and explain economic behaviour
however the basic decision-making process based on a model.
is the same.
7 8
Microeconomics: Macroeconomics:
 This subject is the study of the

 On the other hand, this subject is the
economic behaviour of individuals
study of the total or aggregate level
decision-making units such as of output, income, employment,
individual consumers, resources consumption, investment and prices
owners and business firm in the free for the economy viewed as a whole.
enterprise system.
9 10
Microeconomic theory of firm The theory of firm
 Although the microeconomic theory of  The theory of firm assumes that the
firm is the single most important firm seeks to maximize profits and
element in the managerial economics, minimize cost and on the basis of that
the general macroeconomic conditions it predicts how much of a particular
of the economy (i.e. the level of commodity the firm should produce
aggregate demand, rate of inflation, under different forms of market
and interest rate) in which the firm structure or organization.
operates are also very important.
11 12
Theory of the Firm Decision Sciences
 Combines and organizes resources for the purpose  Managerial economics is very closely
of producing goods and/or services for sale. related to the decision sciences. These
use the tools of mathematical
economics and econometrics to
⚫Internalizes transactions, reducing transactions
construct and estimate decision models
costs.
aimed at determining the optimal
⚫Primary goal is to maximize the wealth or value of the firm.
behavior of the firm (i.e. how the firm
can achieve its goals most efficiently).
13 14
Mathematical Economics and Econometrics Application of economic theory and decision science
tools to solve managerial decision problems
 Mathematical Economics especially is used to Example:

 Economic theory postulates that the quantity demanded
formalize (i.e. express in equational form) the (Q) of a commodity is a function of the price the
economic model postulated by economic theory. commodity (P), the income of consumers (Y), and the
price of related (i.e. complementary and substitute)
commodities (PC and PS) respectively. So we may
⚫ Econometrics applies statistical tools (i.e. postulate the following formal model:
 Price of good or service (P), Incomes of consumers (I)
regression analysis) to real world data to estimate  Prices of related goods & services (PR), Expected future
the models postulated by economic theory and for price of product (PE), Number of consumers in market (N)
 Q= f (P,Y, PC, PS)
forecasting.  The Theory says:
 Qd=f (P, I, PR, T, PE, N)
 -, +/-, +/-,+, +, +
 N/I, S/C
15 16
Cont.. OPTIMAL SOLUTION TO MANAGERIAL DECISION PROBLEMS:

Theory of the firm
 A firm is an organization that Combines

 We can estimate this empirical relationship by
and organizes resources for the purpose of
collecting data on the variables mentioned in the producing goods and/or services for sale.
equation above. This will permit the firm to
determine how much Q would change in P, Y, PC ⚫ For instance; there are millions of firms in the United
and PS and to forecast the future demand for the States. These include proprietorship (i.e. firms owned
commodity. This information is essential in order by one individual), partnership and corporations (i.e.
owned by stockholders). Firms produce more than 80
for management to achieve the goal or objective of
percent of all good and services consumed in the U.S.A.
the firm (profit maximization) most efficiently. The remainder is produced by the government and non
profit organizations such as private college, hospitals,
museums and foundations.
17 18
Internalizes transactions, reducing transactions costs Internalizes transactions, reducing transactions costs
 Firms exist because it would be very inefficient and  This kind of contract is much less costly than
costly for entrepreneurs to enter into and enforce numerous specific contracts and is highly
contracts with workers and owners of capital, land advantageous both to entrepreneurs and to the
and the other resources for each separate step of workers and the other resource owners. The firm
production and distribution process. Instead, exists in order to save on such transaction costs. By
entrepreneurs enter into long term and broader performing many functions within the firm, the
contracts with labor to perform a number of tasks firm also saves on sales taxes and avoids price
for a specific wages and fringe benefit (ie. Such as controls and other government regulations that
house allowance, childcare, health insurance etc). apply only to transactions among firms. This is
 Bottom line is: A fee charged by a financial called internalizing transactions. Primary goal is to
intermediary such as a bank, broker, or underwriter. maximize the wealth or value of the firm.
19 20
Value of the Firm Alternative Theories
The present value of all expected future profits  Sales maximization

⚫ Adequate rate of profit
 Management utility maximization
⚫ Principle-agent problem
 Satisficing behavior
21 22
Alternative Theories Sales Maximization
 The theory of firm has also been criticized as  According to the model, managers of modern
being much narrow and unrealistic. For this corporations seek to maximize sales after an
reason, broader theories of the firm have been adequate rate of profit has been earned to
proposed. The most prominent among these are satisfy stockholder ( this model introduced by
models postulate that the primary objective of William Baumol).
the firm is the maximization of sales, the
maximization of management utility and
satisfying behavior.
23 24
Management utility maximization Satisficing behavior
 The model (introduced by Oliver Williamson)

postulates that with the advent of the modern  This stems from the great complexity of running
corporation and resulting separation of management the large modern corporation- a task often
from ownership. complicated by uncertainty and a lack of
adequate data. Manager are not able to maximize
⚫ Managers are more interested in maximizing their
profits but can only strive for some satisfactory
utility measured in terms of their compensation (i.e.
goal in terms of sales, profit, growth, market
salaries, stock options etc.), the size of their staff,
share and so on. This situation is called
extent of control over the corporation, lavish offices
satisficing behaivour.
etc. than maximizing corporate profits. This referred
to as the Principle-agent problem.
25 26
The Explicit and Implicit costs

Definitions of Profit
 The explicit or accounting costs: are the actual out of

 Business Profit: Total revenue
pocket expenditures of the firm to purchase or hire
minus the explicit or accounting inputs it requires in production. (i.e. wages to hire
costs of production. labour, interest on borrowed capital, rent on land and
 Economic Profit: Total revenue buildings and the expenditure on raw materials).
minus the explicit and implicit costs
of production. ⚫ The Implicit costs: refers to the value of the inputs
 Opportunity Cost: Implicit value of owned and used by the firm in its own production
processes.
a resource in its best alternative
use.
27 28
Theories of Profit
Function of Profit
 Risk-Bearing Theories of Profit
 Frictional Theory of Profit  Profit is a signal that guides the allocation of
- Profit stems from disturbances from long-run equilimrium society’s resources.
-Normal return adjusted for risk or zero economic profit
- Energy crises in 1970s-large profit by providing insulation materials  High profits in an industry are a signal that
- Decline in oil prices in mid 1980s- losses are incurred buyers want more of what the industry
 Monopoly Theory of Profit produces.
 Innovation Theory of Profit
 Low (or negative) profits in an industry are a
- Profit is the reward for the introduction of a successful innovation
- e.g Steven Job, the founder of the Apple comp. Company became a
signal that buyers want less of what the
millonaire in 1977 industry produces.
- successful innovation encourage the flow of technology as well as profit
 Managerial Efficiency Theory of Profit
29 30
Business Ethics The Changing Environment of Managerial Economics
 Globalization of Economic Activity

 Identifies types of behavior that businesses ⚫ Goods and Services
and their employees should not engage in. ⚫ Capital
 Source of guidance that goes beyond ⚫ Technology
enforceable laws. ⚫ Skilled Labor

⚫ How does globalization differ from colonization?
‘’sincethe collapse of the USSR, the dynamics of empire has changed.
The World is now more multipolar and mercantile, with China and
Europe emerging to compete against the US. Empire is more driven
by multinational corporations, whose interests transcend those of any
particular nation-state.’’
STEVEN HIATT—"Global Empire: The Web of Control," A Game As
Old as Empire
31 32
Theory of firm-Value of the firm-PV Theory of firm-Value of the firm-PV

Example 1 Answer 1
The owner of a firm expects to receive a profit of $ 100 in each

of the next three years and to be able to sell the firm at the end of
the third year for $ 700. The owner believes that the appropriate
discount rate for the firm is 10 percent per year.
Calculate (a) the value of the firm (PV) (b) the value of the firm
when a discount rate of 20 percent (c) what is the effect on the
value of the firm of using a higher discount rate.
33 34
Theory of firm-Value of the firm

Example 1 for the trade-off between profit and costs Answer 1 for the trade-off between profit and costs -Value of the firm
The costs of attending a state college for one year are $ 2,000 for
tuition, $ 1,500 for the room, $1,000 for meals, and $500 for (a) Expenses is the explicit costs- the expenses are $ 2,000 for tuition, $ 1,500
books and supplies. As an alternative the student could earn for the room, $ 1,000 for meals, and $ 500 for books and supplies– total
$13,000 by getting a job instead of going to college and in amout$ 5,000 per year .
adddition, earn 8 percent interest by saving the money not spent (b) The Implicit costs are the sum of $ 13,000 and 8% 0f $ 5,000 is $ 400- total
on attending. amout$ 13,400 for the year.
(c) The total economic cost =the explicit costs + the implicit costs= $ 5,000 +$
13,400= $ 18,400
Calculate (a) the explicit cost (b) the implicit costs (c) the total
economic costs that the student faces by attending the college for
one year.
35 36
Theory of firm-Value of the firm

Example 2 for the trade-off between profit and costs Answer 2 for the trade-off between profit and costs -Value of the firm
(a) Expenses is the explicit costs- the expenses are $ 10,000 for supplies, $
A person managing a dry- cleaning store for $ 30,000 per year 35,000 for salaries, $ 8,000 for rent, and $ 2,000 for utilities as well as
decides to open a new one. The revenues of the store during the interest $ 5,000 – total amout is $ 60,000.
first year of operation are $ 100,000 and the expenses are $ (b) The Implicit costs are the entrepreneeur’s foregone salary- $ 30,000.
10,000 for supplies, $ 35,000 for salaries, $ 8,000 for rent, and $
(c) the business profit= total revenues - the explicit costs = $ 100,000 - $ 60,000=
2,000 for utilities. The person also used $5,000 for interest on a $ 40,000
bank loan. Assume that income and business taxes are zero and
(d) the Economic profit= total revenues – (the explicit costs + Implicit costs) =
the repayment of the principal of the loan does not start before 100,000 – ($ 60,000 + $ 30,000) = $ 10,000
three years (suppose r=10%).
(e) normal return on investment = The Implicit costs =$ 30,000.
Calculate (a) the explicit cost (b) the implicit costs (c) the
(f) PV=10,000/1+0.10)....or roughly we can say that The person would earn
business profit, (d) the Economic profit (e) normal return on
economic profit $ 10,000 per year, therefore, the person should open the
investment and also (f) indicate whether the person should open store..
the dry-cleaning store.
37 38
Class Debate The End

According to some economists, the only
responsibility of business is to make as
much as possible within the legal and moral
rules set by society. Imposing additional
societal goals on business would not be in Thanks
the long-term interest of soicety. Critically
discuss the statement whether you agree or
disagree. Key words- allocative efficiency, profit
motive, government regulation and incentives.
39 40

Managerial Economics in A Global Economy - ch1 The Nature and Scope of Managerial Economics..

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Managerial Economics in A Global Economy - ch1 The Nature and Scope of Managerial Economics..

Uploaded by

Copyright:

Available Formats

Ch 1: The nature and scope of Managerial Economics

Outline: What You Will Learn . . .

Department of Business Administration  Definition of Managerial Economics

Managerial Decision Problems

Managerial Decision Problems:

Managerial Decision Problems: Economic Theory:

✓ In all these cases, the relevant ➢ Relationship to Economic Theory:

 This subject is the study of the

Microeconomic theory of firm The theory of firm

Theory of the Firm Decision Sciences

 Mathematical Economics especially is used to Example:

Cont.. OPTIMAL SOLUTION TO MANAGERIAL DECISION PROBLEMS:

 A firm is an organization that Combines

Value of the Firm Alternative Theories

The present value of all expected future profits  Sales maximization

Alternative Theories Sales Maximization

Management utility maximization Satisficing behavior

 The model (introduced by Oliver Williamson)

The Explicit and Implicit costs

 The explicit or accounting costs: are the actual out of

Business Ethics The Changing Environment of Managerial Economics

 Globalization of Economic Activity

 Source of guidance that goes beyond ⚫ Technology

enforceable laws. ⚫ Skilled Labor

Theory of firm-Value of the firm-PV Theory of firm-Value of the firm-PV

The owner of a firm expects to receive a profit of $ 100 in each

Theory of firm-Value of the firm

Theory of firm-Value of the firm

Class Debate The End

You might also like