ECON6032

Managerial Economics
Week 1
Fundamentals of Managerial Economics
 Outline

• Introduction
• 5 Force Model
• Concept of Demand
• Concept of Supply
• Market Equilibrium
• Price Restrictions
 References
• Michael R. Baye,. Jeffrey T. Prince,
(2013). Managerial economics and business
strategy. 8th Edition. McGraw Hill. New
York. ISBN: 9780077154509, Chapter 1 and 2
INTRODUCTION
• While there is no doubt that luck, both good
and bad, plays a role in determining the
success of firms, we believe that success is
often no accident. We believe that we can
better understand why firms succeed or fail
when we analyze decision making in terms of
consistent principles of market economics and
strategic action.
Besanko, et. Al
Economics of Strategy (2nd)
 OVERVIEW
Microeconomics is the study of how individual firms
or consumers do and/or should make economic
decisions taking into account such things as:
1. Their goals, incentives, objectives.
2. Their choices, alternatives, problems.
3. Constraints such as inputs, resources, money, time,
technology, competition.
4. All (cash & noncash) incremental or marginal benefits and
costs.
5. The time value of money.
 Goals, Incentives, Objectives

• A fundamental economic truth is that

individual firms or decision makers respond
to economic incentives. What these
incentives are (i.e. money, profits, utility,
etc.) and how they influence economic
decision making are key topics for study and
analysis in business (or managerial)
economics.
 Managerial Choices
(examples)

• Output quantity • Production processes

• Output quality (input mix)
• Output mix • Input quantity
• Output price • Production location
• Marketing and • Production incentives
advertising • Input procurement
FIVE FORCES MODEL
 Michael Porter’s “Five
Competitive Forces”
= Decision-making constraints
= Factors that influence the sustainability of firm
profits
1. market entry conditions for new firms
2. Market power of input suppliers
3. Market power of product buyers
4. Market rivalry amongst current firms
5. Price and availability of related products
including both ‘substitutes’ and ‘complements’
 Michael Porter …

“An industry’s profit potential is

largely determined by the intensity
of competitive rivalry within that
industry.”
Sources : google.co.id
CONCEPT OF DEMAND
• Market is wherever buyers and sellers
exchange goods and services, mostly for
money.

• Wherever an economic transaction takes

place—it’s a market.
In Economics, demand means your
willingness to buy backed by your
purchasing power.
Demand must satisfy two conditions:
(a) willingness to buy a good, and
(b) ability to buy that good
 LAW OF DEMAND

Law of demand says that, ceteris paribus

(other things equal), the quantity
demanded (Qd) of a good falls when the
price of the good rises, and vice versa.
Quantity demanded (Qd) means the amount
of a good that buyers are willing and able to
purchase at different prices

Quantity demanded is negatively related to price. This

implies that the demand curve is downward sloping.
 Market Demand Curve
• 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.
Price

Quantity
 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
• Tastes & preferences of consumer.
• Expectations about future price
 The Demand Function
• A general equation representing the demand curve

Qxd = f(PX , PY, I, T,E,U )

– Qxd = quantity demand of good X.
– Px = price of good X.
– PY = price of a related good Y.
• Substitute good.
• Complement good.
– I = income of consumer
• Normal good.
• Inferior good.
- T= Taste or preference of consumer
- E= Price expectation of the user
- U= All other factors
 Inverse Demand Function
• Price as a function of quantity
demanded.
• Example:
– Demand Function
• Qxd = 10 – 2Px
– Inverse Demand Function:
• 2Px = 10 – Qxd
• Px = 5 – 0.5Qxd
Change in Quantity
Demanded
 Change in Demand
Price
Change in Demand
 Consumer Surplus:

• The value consumers get from a good but do

not have to pay for.
• Consumer surplus will prove particularly
useful in marketing and other disciplines
emphasizing strategies like value pricing and
price discrimination.
 Consumer Surplus:
The Discrete Case
Price
Consumer Surplus:
10 The value received but not
8 paid for. Consumer surplus =
(8-2) + (6-2) + (4-2) = $12.
6

2
D
1 2 3 4 5 Quantity
 Consumer Surplus:
The Continuous Case
Price $

10
Value
Consumer 8 of 4 units = $24
Surplus =
$24 - $8 =
$16
6

4 Expenditure on 4 units = $2
x 4 = $8

2
D
1 2 3 4 5 Quantity
CONCEPT OF SUPPLY
 Market Supply Curve

• The supply curve shows the amount of a

good that will be produced at alternative
prices.
• Law of Supply
– The supply curve is upward sloping.
Price
S0

Quantity
 Supply Shifters

• Input prices
• Technology or government regulations
• Number of firms
– Entry
– Exit
• Substitutes in production
• Taxes
– Excise tax
– Ad valorem tax
• Producer 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

• Price as a function of quantity supplied.

• Example:
– Supply Function
• QS= 10 + 2P
– Inverse Supply Function:
• 2P = 10 + QS
• P = 5 + 0.5QS
Change in Quantity Supplied
Change in Supply
 Producer Surplus
• The amount producers receive in excess of the
amount necessary to induce them to produce the
good.
Price

S0
P*

Q* Quantity
MARKET EQUILIBRIUM
 Market Equilibrium

• The Price (P) that Balances supply and demand

– QS = QD
– No shortage or surplus
• Steady-state
 If price is too low…
Price S

7
6
5

Shortage D
12 - 6 = 6
6 12 Quantity
 If price is too high…
Surplus
Price 14 - 6 = 8 S
9
8
7

6 8 14 Quantity
PRICE RESTRICTIONS
 Price Restrictions
• Price Ceilings
– The maximum legal price that can be charged.
– Examples:
• 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.
– Examples:
• Minimum wage.
• Agricultural price supports.
 Impact of a Price Ceiling
Price S

PF

P*

P Ceiling
Shortage D

Qs Q* Qd Quantity
 Full Economic Price

• The dollar amount paid to a firm under a price

ceiling, plus the nonpecuniary price.
PF = Pc + (PF - PC)
• PF = full economic price
• PC = price ceiling
• PF - PC = nonpecuniary price
 Impact of a Price Floor
Price Surplus S
PF

P*

Qd Q* QS Quantity
Thank You