Overview of the salient topics relative to Managerial Economics. A good intro and summary for a semester course.

1. Managerial Economics
Overview
Summary
Recapitulation

2. The Economics of Effective Management
• Identify Goals and Constraints
• Recognize the Role of Profits
• Five Forces Model
• Understand Incentives
• Understand Markets
• Recognize the Time Value of Money
• Use Marginal Analysis

3. Managerial Economics
• Manager
– A person who directs resources to achieve a stated
goal.
• Economics
– The science of making decisions in the presence of
scare resources.
• Managerial Economics
– The study of how to direct scarce resources in the
way that most efficiently achieves a managerial
goal.

4. Take Aways
• Make sure you include all costs and benefits
when making decisions (opportunity cost).
• When decisions span time, make sure you are
comparing apples to apples (PV analysis).
• Optimal economic decisions are made at the
margin (marginal analysis).

5. Supply & Demand
I. Market Demand Curve
– The Demand Function
– Determinants of Demand
– Consumer Surplus
II. Market Supply Curve
– The Supply Function
– Supply Shifters
– Producer Surplus
III. Market Equilibrium
IV. Price Restrictions
V. Comparative Statics

6. 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.
Quantity
D
Price

7. 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

8. Supply & Demand Conclusion
• Use supply and demand analysis to
– clarify the “big picture” (the general impact of
a current event on equilibrium prices and
quantities).
– organize an action plan (needed changes in
production, inventories, raw materials, human
resources, marketing plans, etc.).

9. Elasticity
I. The Elasticity Concept
– Own Price Elasticity
– Elasticity and Total Revenue
– Cross-Price Elasticity
– Income Elasticity
II. Demand Functions
– Linear
– Log-Linear
III. Regression Analysis

10. Elasticity, Total Revenue
and Linear Demand
QQ
P
TR
100
80
800
60 1200
40
20
Elastic
Elastic
0 10 20 30 40 500 10 20 30 40 50

11. Quantitative Demand Function
• Elasticities are tools you can use to quantify the
impact of changes in prices, income, and
advertising on sales and revenues.
• Given market or survey data, regression analysis
can be used to estimate:
– Demand functions.
– Elasticities.
– A host of other things, including cost functions.
• Managers can quantify the impact of changes in
prices, income, advertising, etc.

12. Consumers
I. Consumer Behavior
– Indifference Curve Analysis.
– Consumer Preference Ordering.
II. Constraints
– The Budget Constraint.
– Changes in Income.
– Changes in Prices.
III. Consumer Equilibrium
IV. Indifference Curve Analysis & Demand Curves
– Individual Demand.
– Market Demand.

13. Indifference Curve Analysis
Indifference Curve
– A curve that defines the
combinations of 2 or more goods
that give a consumer the same
level of satisfaction.
Marginal Rate of
Substitution
– The rate at which a consumer is
willing to substitute one good for
another and maintain the same
satisfaction level.
I.
II.
III.
Good Y
Good X

14. Individual Demand and Behavior
• Indifference curve properties reveal information
about consumers’ preferences between bundles of
goods.
– Completeness.
– More is better.
– Diminishing marginal rate of substitution.
– Transitivity.
• Indifference curves along with price changes
determine individuals’ demand curves.
• Market demand is the horizontal summation of
individuals’ demands.

15. The Firm
I. Production Analysis
– Total Product, Marginal Product, Average Product.
– Isoquants.
– Isocosts.
– Cost Minimization
II. Cost Analysis
– Total Cost, Variable Cost, Fixed Costs.
– Cubic Cost Function.
– Cost Relations.
III. Multi-Product Cost Functions

16. Production Analysis
• Production Function
– Q = F(K,L)
• Q is quantity of output produced.
• K is capital input.
• L is labor input.
• F is a functional form relating the inputs to output.
– The maximum amount of output that can be
produced with K units of capital and L units of
labor.
• Short-Run vs. Long-Run Decisions
• Fixed vs. Variable Inputs

17. The Firm
Take Aways
• To maximize profits (minimize costs) managers
must use inputs such that the value of marginal of
each input reflects price the firm must pay to
employ the input.
• The optimal mix of inputs is achieved when the
MRTSKL = (w/r).
• Cost functions are the foundation for helping to
determine profit-maximizing behavior in future
chapters.

18. Production
I. Methods of Procuring Inputs
– Spot Exchange
– Contracts
– Vertical Integration
II. Transaction Costs
– Specialized Investments
III. Optimal Procurement Input
IV. Principal-Agent Problem
– Owners-Managers
– Managers-Workers

19. Production and Agency Issues
• The optimal method for acquiring inputs depends
on the nature of the transactions costs and
specialized nature of the inputs being procured.
• To overcome the principal-agent problem,
principals must devise plans to align the agents’
interests with the principals.

20. Nature of Industry
I. Market Structure
– Measures of Industry Concentration
II. Conduct
– Pricing Behavior
– Integration and Merger Activity
III. Performance
– Dansby-Willig Index
– Structure-Conduct-Performance Paradigm
IV. Preview of Coming Attractions

21. Relating the Five Forces to the SCP Paradigm
and the Feedback Critique
Power of
Input Suppliers
•Supplier Concentration
•Price/Productivity of
Alternative Inputs
•Relationship-Specific
Investments
•Supplier Switching Costs
•Government Restraints
Power of
Buyers
•Buyer Concentration
•Price/Value of Substitute
Products or Services
•Relationship-Specific
Investments
•Customer Switching Costs
•Government Restraints
Entry•Entry Costs
•Speed of Adjustment
•Sunk Costs
•Economies of Scale
•Network Effects
•Reputation
•Switching Costs
•Government Restraints
Substitutes & Complements
•Price/Value of Surrogate
Products or Services
•Price/Value of Complementary
Products or Services
•Network Effects
•Government
Restraints
Industry Rivalry
•Switching Costs
•Timing of Decisions
•Information
•Government Restraints
•Concentration
•Price, Quantity, Quality,
or Service Competition
•Degree of Differentiation
Level, Growth,
and Sustainability
Of Industry Profits

22. Industry Analysis
• Modern approach to studying industries involves
examining the interrelationship between
structure, conduct, and performance.
• Industries dramatically vary with respect to
concentration levels.
– The four-firm concentration ratio and Herfindahl-
Hirschman index measure industry concentration.
• The Lerner index measures the degree to which
firms can markup price above marginal cost; it is a
measure of a firm’s market power.
• Industry performance is measured by industry
profitability and social welfare.

23. Competition
I. Perfect Competition
– Characteristics and profit outlook.
– Effect of new entrants.
II. Monopolies
– Sources of monopoly power.
– Maximizing monopoly profits.
– Pros and cons.
III. Monopolistic Competition
– Profit maximization.
– Long run equilibrium.

24. Market Power
• Firms operating in a perfectly competitive market
take the market price as given.
– Produce output where P = MC.
– Firms may earn profits or losses in the short run.
– … but, in the long run, entry or exit forces profits to zero.
• A monopoly firm, in contrast, can earn persistent
profits provided that source of monopoly power is
not eliminated.
• A monopolistically competitive firm can earn profits
in the short run, but entry by competing brands will
erode these profits over time.

25. Role of Strategic Interaction
• Your actions affect
the profits of your
rivals.
• Your rivals’ actions
affect your profits.
• How will rivals
respond to your
actions?

26. Conclusion
• Different oligopoly scenarios give rise to different
optimal strategies and different outcomes.
• Your optimal price and output depends on …
– Beliefs about the reactions of rivals.
– Your choice variable (P or Q) and the nature of the
product market (differentiated or homogeneous
products).
– Your ability to credibly commit prior to your rivals.

27. Game Theory
I. Introduction to Game Theory
II. Simultaneous-Move, One-Shot Games
III. Infinitely Repeated Games
IV. Finitely Repeated Games
V. Multistage Games

28. Two-Player Nash Equilibrium
• The Nash equilibrium is a condition describing
the set of strategies in which no player can
improve her payoff by unilaterally changing her
own strategy, given the other player’s strategy.
• Formally,
– π1(s1
*
,s2
*
) ≥ π1(s1,s2
*
) for all s1.
– π1(s1
*
,s2
*
) ≥ π1(s1
*
,s2) for all s2.

29. Key Insights
• Look for dominant strategies.
• Put yourself in your rival’s shoes.

30. Coordination Games
• In many games, players have competing
objectives: One firm gains at the expense of its
rivals.
• However, some games result in higher profits by
each firm when they “coordinate” decisions.

31. Examples of Coordination Games
• Industry standards
– size of floppy disks.
– size of CDs.
• National standards
– electric current.
– traffic laws.

32. Pricing Overview
I. Basic Pricing Strategies
– Monopoly & Monopolistic Competition
– Cournot Oligopoly
II. Extracting Consumer Surplus
– Price Discrimination Two-Part Pricing
– Block Pricing Commodity Bundling
III. Pricing for Special Cost and Demand Structures
– Peak-Load Pricing Transfer Pricing
– Cross Subsidies
IV. Pricing in Markets with Intense Price
Competition
– Price Matching Randomized Pricing
– Brand Loyalty

33. Standard Pricing and Profits for Firms
with Market Power
Price
Quantity
P = 10 - 2Q
10
8
6
4
2
1 2 3 4 5
MC
MR = 10 - 4Q
Profits from standard pricing
= $8

34. Uncertainty and Consumer Behavior
• Risk Aversion
– Risk Averse: An individual who prefers a sure amount of
$M to a risky prospect with an expected value, E[x], of
$M.
– Risk Loving: An individual who prefers a risky prospect
with an expected value, E[x], of $M to a sure amount of
$M.
– Risk Neutral: An individual who is indifferent between a
risky prospect where E[x] = $M and a sure amount of $M.

35. Asymmetric Information
• Situation that exists when some people have
better information than others.
• Example: Insider trading

36. Moral Hazard
• Situation where one party to a contract takes
a hidden action that benefits him or her at the
expense of another party.
• Examples
– The principal-agent problem.
– Care taken with rental cars.

37. Auctions
• Uses
– Art
– Treasury bills
– Spectrum rights
– Consumer goods (eBay and other Internet auction sites)
– Oil leases
• Major types of Auction
– English
– First-price, sealed-bid
– Second-price, sealed-bid
– Dutch

38. Asymmetric Information
• Information plays an important role in how
economic agents make decisions.
– When information is costly to acquire, consumers will continue to
search for price information as long as the observed price is greater
than the consumer’s reservation price.
– When there is uncertainty surrounding the price a firm can charge, a
firm maximizes profit at the point where the expected marginal
revenue equals marginal cost.
• Many items are sold via auctions
– English auction
– First-price, sealed bid auction
– Second-price, sealed bid auction
– Dutch auction

39. Government’s Role
I. Market Failure
– Market Power
– Externalities
– Public Goods
– Incomplete Information
II. Rent Seeking
III. Government Policy and International Markets
– Quotas
– Tariffs
– Regulations

40. Antitrust Policies
• Administered by the DOJ and FTC
• Goals:
– To eliminate deadweight loss of monopoly and
promote social welfare.
– Make it illegal for managers to pursue strategies that
foster monopoly power.

41. Sherman Act (1890)
• Sections 1 and 2 prohibits price-fixing, market
sharing and other collusive practices designed
to “monopolize, or attempt to monopolize” a
market.

42. Government Policies Designed to
Mitigate Incomplete Information
• OSHA
• SEC
• Certification
• Truth in lending
• Truth in advertising
• Contract enforcement

43. Conclusion
• Market power, externalities, public goods,
and incomplete information create a potential
role for government in the marketplace.
• Government’s presence creates rent-seeking
incentives, which may undermine its ability to
improve matters.

44. Congratulations!!