The Fundamentals Of Managerial Economics

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The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

Task:
Read: Chapter 1, The Fundamentals Of Managerial Economics. Page 1 - 33

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

Many students taking managerial economics ask: Why I should I study economics? Will it tell me what the stock market will do tomorrow? Will it tell me where to invest my money or how to get rich.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

The Manager

A person who directs resources to achieve a stated goal.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

Economics

The science of making decisions in the presence of scare resources.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

Managerial Economics Defined

The study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

The Economics Of Effective Management

At least an effective manager must: 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.
The Fundamentals Of Managerial Economics Ir. Muhril A., M.Sc., Ph.D.

Identify Goals And Constraints

Have well defined goals. Face constraints.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

Recognize The Nature And Importance Of Profits

The overall goal of most firm is to maximize profits or the firms value. Economic profits (p): The difference between total revenue (TR) and total opportunity cost (TC).

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

p = TR TC TR = P . Q TC = TFC + TVC p = profit TR = total revenue P = price of output Q = quantity sold of output TC = total cost TFC = total fixed cost TVC = total variable cost

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Recognize The Nature And Importance Of Profits (continued)

Opportunity cost: The cost of the explicit and implicit resources that are forgone when a decision is made.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Recognize The Nature And Importance Of Profits (continued)

The five forces framework and industry profitability: 1. Entry. 2. Power of input suppliers. 3. Power of buyer. 4. Industry rivalry. 5. Substitutes and complements.
Ir. Muhril A., M.Sc., Ph.D.

The Fundamentals Of Managerial Economics

12

Recognize The Nature And Importance Of Profits (continued)

The five forces framework and industry profitability: Entry (1st):: - Entry costs. - Speed of adjustment. - Sunk costs. - Economies of scale. - Network effects. - Reputation. - Switching costs. - Government restraints.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

13

Recognize The Nature And Importance Of Profits (continued)

The five forces framework and industry profitability: Power of input suppliers(2nd):: - Supplier concentration. - Price/productivity of alternative inputs. - Relationship specific investments. - Supplier switching costs. - Government restraints.
Ir. Muhril A., M.Sc., Ph.D.

The Fundamentals Of Managerial Economics

14

Recognize The Nature And Importance Of Profits (continued)

The five forces framework and industry profitability: Power of Buyers(3rd):: - Buyer concentration. - Price/value of substitute products or services. - Relationship specific investment. - Customer switching costs. - Government restraints.
Ir. Muhril A., M.Sc., Ph.D.

The Fundamentals Of Managerial Economics

15

Recognize The Nature And Importance Of Profits (continued)

The five forces framework and industry profitability: Substitutes and complements(4th):: - Price/value of surrogate products or services. - Price/value of complementary products or services. - Network effects. - Government restraints.
Ir. Muhril A., M.Sc., Ph.D.

The Fundamentals Of Managerial Economics

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Recognize The Nature And Importance Of Profits (continued)

The five forces framework and industry profitability: Industry rivalry(5th):: - Concentration. - Price, quantity, quality, or service competition. - Degree of differentiation. - Switching costs. - Timing of decisions. - Information. - Government restraints.
Ir. Muhril A., M.Sc., Ph.D.

The Fundamentals Of Managerial Economics

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Understand Incentives

Incentives affect how resources are used and how hard workers work. No reward for working hard? and incurs no penalty if he fails to make sound managerial decisions?

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Understand Markets:
1. Consumer-Producer Rivalry. - Consumers attempt to negotiate or locate low prices. - Producers attempt to negotiate high prices.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Understand Markets (continued):

2. Consumer-Consumer Rivalry. - When limited quantities of goods are available, consumers will compete with one another for the right to purchase the available goods. - An example: auction.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

20

Understand Markets (continued):

3. Producer-Producer Rivalry. - Given that consumers are scarce, producers compete with one another for the right to service the customers available.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Understand Markets (continued):

4. Government And The Market.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Use Marginal Analysis

Marginal analysis: States that optimal managerial decisions involve comparing the marginal benefits of a decision with the marginal costs.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

23

Marginal Revenue (MR):

The change in Total Revenue (TR) arising from a change in the managerial control variable Output (Q). MR = D TR / D Q MR = marginal revenue TR = total revenue = P. Q P = price Q = output D = change

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

24

Marginal Cost (MC):

The change in Total Cost (TC) arising from a change in the managerial control Output (Q).
MC = D TC / D Q MC = marginal cost TC = total cost Q = output

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Maximum Profit: MC = MB Figure 1-2 Page 23.

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Q (output) (1) 0

TR (Total Revenue) (2) 0

TC (Total Cost) (3) 0

Profit (4) 0

MR (Marginal Revenue) (5) -

MC (Marginal Cost) (6) -

MP (Marginal Profit) (7) -

90

10

80

90

10

80

170

30

140

80

20

60

240

60

180

70

30

40

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Case:
An engineering firm recently conducted a study to determine its revenue and cost structure. The results of the study are as follows: TR(Q) = 300 Q 6 Q2 TR = Total Revenue Q = Output
TC(Q) = 4 Q2 TC = Total Cost Q = Output

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Case (continued):
MR (Marginal Revenue) =? MC (Marginal Cost) =? Optimal Y? (when MR?MC?). Profit?

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Case (continued):
MR (Marginal Revenue) =? MC (Marginal Cost) =? Optimal Y? (when MR?MC?). Profit?
MR = 300 12Q MC = 8Q MR = MC 300 -12Q = 8Q

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Case (continued):
300 -12Q = 8Q -12Q-8Q = -300 -20Q = -300 20Q = 300 Q = 300/20 = 15

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

31

Case (continued):
Profit = TR TC TR = 300Q 6Q2 TR = (300.15) (6.152) TR =
TC = 4Q2 TC = 4(15)2 TC = Profit = 2250

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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Homework:
Submit Wednesday June 11, 2008
Suppose that Total Revenue and Total Cost from an activity are, respectively given by the following equations: TR = 150 + 28Q 5Q2 TC = 100 + 0.8Q a. What level of Q maximizes profit? b. What level of profit maximize?

The Fundamentals Of Managerial Economics

Ir. Muhril A., M.Sc., Ph.D.

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