Chapter 1

CHAPTER
1 Introduction:
What This Book is About
©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a
password-protected website for classroom use. ©Kamira/Shutterstock Images
Luke M. Froeb
● , an economist and professor, emphasizes the

importance of managerial economics in decision-
making and organizational success.
● managerial economics provides valuable insights and
tools that enable managers to make informed
decisions, navigate complex business environments,
and optimize resource allocation.
©2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or
otherwise on a password-protected website for classroom use. ©Kamira/Shutterstock Images 2
Key reasons why managerial economics is important, as
per Luke Froeb:
● Understanding Market Dynamics

● Cost and Production Analysis
● Demand Analysis
● Decision Making under Uncertainty
● Policy and Regulatory Analysis
● Strategic Planning
● Performance Evaluation
Understanding Market Dynamics:
● Managerial economics helps managers comprehend

the forces shaping markets, including supply and
demand, competition, and pricing.
● It provides a framework to analyze market
conditions, identify opportunities, and develop
effective strategies to gain a competitive advantage.
Cost and Production Analysis
● : Managerial economics equips managers with tools

to analyze costs, production processes, and
efficiency. By understanding cost structures,
managers can make informed decisions regarding
pricing, resource allocation, and operational
improvements, leading to enhanced profitability and
competitiveness.
● Demand Analysis: Managerial economics enables
managers to assess consumer behavior, market
demand, and factors influencing demand elasticity.
This knowledge assists in forecasting, pricing
decisions, product development, and effective
marketing strategies.
● Decision Making under Uncertainty: Business
decisions often involve uncertainty and risk.
Managerial economics provides decision-making
techniques, such as risk analysis and game theory, to
evaluate potential outcomes and make informed
choices that maximize expected value.
● Policy and Regulatory Analysis: Managers operate within
a broader economic and regulatory environment. Managerial
economics helps analyze government policies, market
regulations, and their implications on business operations. This
understanding allows managers to adapt strategies, anticipate
changes, and navigate regulatory challenges effectively.
● Strategic Planning: Managerial economics supports strategic
decision-making by analyzing market trends, competitive
forces, and industry dynamics. It aids in formulating effective
business strategies, including market entry, diversification, and
resource allocation, based on a thorough understanding of
economic principles.
● Performance Evaluation: Managerial economics provides
tools to assess and evaluate the performance of business units,
departments, and projects. By applying economic analysis,
managers can identify areas of improvement, optimize
resource allocation, and measure the effectiveness of strategic
initiatives.
Overall, managerial economics offers a systematic approach to
decision-making, enabling managers to make informed choices,
optimize resources, and navigate complex business
environments. According to Luke Froeb, integrating economic
principles into managerial decision-making enhances
organizational performance and competitive advantage.
Problem: Over-bidding OVI gas tract
● A young geologist was preparing a bid

recommendation for an oil tract in the Gulf of
Mexico.
● The geologist knew the productivity of nearby
tracts also owned by the company.
● Knowing this, he recommended a bid of $5 million.
● Senior management bid $20 million – far over the
next highest bid of $750,000.
● What, if anything, is wrong?
Possible Questions
Problem solving
● The goal of this text is to provide tools to help

identify and solve problems like this.
● Two distinct steps:
1) Figure out what’s wrong
• i.e., why overbidding occurred
2) Figure out how to fix it
Model of Behavior
● Both steps require a model of behavior

• Why are people making mistakes?
• What can we do to make them change?
● Economists use the rational-actor paradigm to model
behavior.
● The rational actor paradigm states:
• People act rationally, optimally, self-interestedly
• Meaning, they respond to incentives – to change
behavior you must change incentives.
Rational Actor Paradigm Model
Answer to Overbidding Problem
● Answer the three questions:

1) Senior management made the bad decision to overbid.
2) They had enough information to make the right
decision.
3) They didn’t have the incentive to do so.
● A bonus system created incentives to over-bid.
• Senior managers were rewarded for acquiring reserves
regardless of their profitabilit.y
• They had the young geologist “do what he could” to
increase the size of estimated reserves.
• Bonuses also created an incentive to manipulate the
reserve estimate.
Solution to Overbidding Problem
Now that we know what is wrong, how do we fix it?

● Let someone else decide? NO
● Change information flow? NO
● Change incentives? YES
• Change performance evaluation metric
• Ex: Increased profitability as measurement of success instead of
increased acquired reserves
• Reward scheme
• Ex: Make bonuses tied to profitability, not acquired reserves
NAR Problem
● In 2006, a TV reporter was sent into a National

Auto Repair (NAR) shop with a perfectly good
car
● The reporter came out with a new muffler and
transmission – and a bill for over $8,000
● The news story badly hurt NAR’s profits
● How do you solve this problem?
Problem-Solving Algorithm
1) Who is making the bad decision?

• The mechanic recommended unnecessary repairs.
2) Does the decision maker have enough information
to make a good decision?
• Yes, in fact, the mechanic is the only one with enough
information to know whether repairs are necessary.
Problem-Solving Algorithm
3) Does the decision maker have the incentive to

make a good decision?
• No, the mechanic is evaluated based on the amount
of repair work he does, and receives bonuses or
commissions tied to the amount of repair work.
NAR Solution
● There was an incentive issue

● NAR tried two solutions
1) reorganized into two division – led to colluding
2) adopted flat pay – led to less incentive to work hard
● Suggested resolution: add an additional performance
evaluation metric to original commission scheme
• Ex: Sporadically send in “secret shoppers” like the
news reporter
● This shows the trade-offs you face when creating
solutions
Economics Interview Questions

Chapter 1

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

Chapter 1

Uploaded by

Copyright:

Available Formats

CHAPTER

● , an economist and professor, emphasizes the

● Understanding Market Dynamics

● Managerial economics helps managers comprehend

● : Managerial economics equips managers with tools

● A young geologist was preparing a bid

● The goal of this text is to provide tools to help

2) Figure out how to fix it

● Both steps require a model of behavior

● Answer the three questions:

Now that we know what is wrong, how do we fix it?

● In 2006, a TV reporter was sent into a National

1) Who is making the bad decision?

3) Does the decision maker have the incentive to

● There was an incentive issue

You might also like