Managerial economicslecture01introduction

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Managerial economicslecture01introduction

  1. 1. Managerial Economics Lecture One: Why economics matters to managers, marketers and accountants Neoclassical theory of profit maximisation
  2. 2. Admin <ul><li>Purchase Reader </li></ul><ul><li>Check subject outline </li></ul><ul><li>Assessment: 3 parts </li></ul><ul><ul><li>Group presentation in tutorials 20% </li></ul></ul><ul><ul><li>Essay on group presentation topic 40% </li></ul></ul><ul><ul><li>Exam 40% </li></ul></ul><ul><li>My details </li></ul><ul><ul><li>Steve Keen </li></ul></ul><ul><ul><ul><li>4620-3016 </li></ul></ul></ul><ul><ul><ul><ul><li>0425 248 089 in emergency </li></ul></ul></ul></ul><ul><ul><ul><li>[email_address] </li></ul></ul></ul><ul><ul><ul><li>Thursdays 1-3pm </li></ul></ul></ul>
  3. 3. Economics as the context of business <ul><li>Management, marketing & accounting focus on specifics </li></ul><ul><ul><li>How to manage a company… </li></ul></ul><ul><ul><li>How to market a product… </li></ul></ul><ul><ul><li>How to quantify & compare corporate performance… </li></ul></ul><ul><li>Focus is your personal input to business </li></ul><ul><li>Economics is the context of business </li></ul><ul><ul><li>“ Men make their own history, but they do not make it as they please; they do not make it under self-selected circumstances, but under circumstances existing already, given and transmitted from the past” </li></ul></ul><ul><ul><ul><li>Focus on constraints on and circumstances of your input </li></ul></ul></ul><ul><ul><ul><ul><li>Both opportunities & dilemmas </li></ul></ul></ul></ul><ul><ul><li>Quick quiz: who made the above statement? </li></ul></ul>
  4. 4. Economics as the context of business Karl Marx in... The Eighteenth Brumaire of Louis Napoleon <ul><li>Often the best wisdom in economics isn’t found in standard textbooks! </li></ul><ul><ul><li>This subject takes a deeper look at economics you’ve already done (micro, macro); and </li></ul></ul><ul><ul><li>considers theories & data you haven’t seen before that are more relevant to business </li></ul></ul>
  5. 5. Economics as the context of business <ul><li>A hierarchical view: starting from the bottom & working up </li></ul><ul><ul><li>The firm </li></ul></ul><ul><ul><li>The market/industry </li></ul></ul><ul><ul><li>The economy </li></ul></ul><ul><ul><li>Finance </li></ul></ul><ul><ul><li>International business </li></ul></ul><ul><li>A critical view </li></ul><ul><ul><li>Conventional theories of above </li></ul></ul><ul><ul><ul><li>Profit maximising behaviour, types of competition, Game theory, IS-LM, Efficient Markets, Comparative advantage </li></ul></ul></ul><ul><ul><li>Different perspectives </li></ul></ul><ul><ul><ul><li>Empirical data </li></ul></ul></ul><ul><ul><ul><li>Critiques of conventional theories </li></ul></ul></ul><ul><ul><ul><li>Alternative theories </li></ul></ul></ul>
  6. 6. Economics as the context of business <ul><li>What matters most to your firm’s success may lie outside it: </li></ul><ul><ul><li>“ For companies, a central message … is that many of a company’s competitive advantages lie outside the firm…” (Porter 1998: xxiii) </li></ul></ul><ul><li>Understanding “what lies outside” may therefore be the most important thing you can do to be a successful executive </li></ul><ul><ul><li>Economics as the study of “what lies outside” </li></ul></ul><ul><ul><ul><li>Relationships with other firms </li></ul></ul></ul><ul><ul><ul><li>Interaction with the market </li></ul></ul></ul><ul><ul><ul><li>Market interaction with the macroeconomy </li></ul></ul></ul><ul><ul><ul><li>Macroeconomy’s interaction with global economy; AND… </li></ul></ul></ul><ul><ul><ul><li>Theories about the economy! Because: </li></ul></ul></ul>
  7. 7. Economics as the context of business <ul><li>Sometimes (not often enough!) theories explain how the real world works </li></ul><ul><li>Frequently (too often!) theories affect how people behave in the economy </li></ul><ul><ul><li>Government follows economic advice </li></ul></ul><ul><ul><li>Firms/unions think about economy in terms of economic models </li></ul></ul><ul><ul><li>Government bodies (e.g. ACCC Australian Competition & Consumer Commission ) apply economic theory in policies (e.g. competition policy, deregulation of telecommunications, etc.) </li></ul></ul><ul><li>So you have to understand economic theory even if it’s wrong ! </li></ul><ul><ul><li>Which it frequently is… </li></ul></ul>
  8. 8. Economics as the context of business <ul><li>Emphasis in this course is on realism </li></ul><ul><ul><li>Theories presented; but also </li></ul></ul><ul><ul><li>Empirical data examined to see whether theories actually work </li></ul></ul><ul><ul><li>Frequent conclusion: they don’t (but sometimes they do…) </li></ul></ul><ul><ul><ul><li>One consequence: can’t rely upon textbooks for this course! </li></ul></ul></ul><ul><ul><ul><li>Textbooks normally </li></ul></ul></ul><ul><ul><ul><ul><li>present theory uncritically </li></ul></ul></ul></ul><ul><ul><ul><ul><li>only include “case studies” that confirm accepted theory </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>frequently based on invented rather than real data </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><li>Normally don’t go beyond microeconomics </li></ul></ul></ul></ul>
  9. 9. Economics as the context of business <ul><li>This course </li></ul><ul><ul><li>Starts with micro (theory of firm…) </li></ul></ul><ul><ul><li>Progresses through theory of the market, economy, finance to international trade </li></ul></ul><ul><ul><li>Based heavily on readings volume </li></ul></ul><ul><ul><ul><li>You must have a copy </li></ul></ul></ul><ul><ul><ul><li>Tutorials and assessments based on contents </li></ul></ul></ul>
  10. 10. “ The firm”: real world vs economic theory <ul><li>The real world: an incredible diversity </li></ul><ul><ul><li>Size : from corner store to Microsoft </li></ul></ul><ul><ul><li>Operations : from one outlet to almost all countries </li></ul></ul><ul><ul><li>Diversity : </li></ul></ul><ul><ul><ul><li>from single product (wheat farm) to many (Sony) </li></ul></ul></ul><ul><ul><ul><li>From one industry to many </li></ul></ul></ul><ul><ul><li>Ownership : from sole proprietor to multinational listed company </li></ul></ul><ul><ul><li>Structure : </li></ul></ul><ul><ul><ul><li>from one person operations to multi-department </li></ul></ul></ul><ul><ul><ul><li>From sole operations (production to sale) to specialisation in manufacturing, wholesale, retail, marketing, consulting… </li></ul></ul></ul>
  11. 11. Economics of the firm: statistics <ul><li>Firms in the Australian economy </li></ul><ul><ul><li>Range in size from sole proprietor/employee to multi-employee institutions </li></ul></ul><ul><ul><li>From single product to diversified conglomerates </li></ul></ul><ul><ul><li>Over 610 thousand “entities” in 2000 (ABS 8140.0) </li></ul></ul><ul><ul><ul><li>3229 “large” entities employing 200 or more workers </li></ul></ul></ul><ul><ul><ul><li>607,663 “other” employing less </li></ul></ul></ul><ul><ul><ul><li>“ Average” employment 10.1 persons per firm </li></ul></ul></ul><ul><ul><ul><ul><li>“ Average” large firm employed 750 workers </li></ul></ul></ul></ul><ul><ul><ul><ul><li>“ Average” other firm employed 6.5 workers </li></ul></ul></ul></ul><ul><ul><ul><li>Legal multitude of businesses masks much smaller number of operating units: 15,870 units with 700,024 legal entities in 1998/99 </li></ul></ul></ul>
  12. 12. Economics of the firm: statistics <ul><li>Concentration obvious (ABS 8140.0.55.001) </li></ul><ul><ul><li>Top 20 units responsible for 13.9% of sales </li></ul></ul><ul><ul><li>15,850 others responsible for remaining 86.1% of sales </li></ul></ul><ul><li>Economic theory abstracts from this concentration & diversity </li></ul><ul><ul><li>Claims firms share several essential common properties </li></ul></ul><ul><ul><ul><li>Profit maximising behaviour </li></ul></ul></ul><ul><ul><ul><li>Under conditions of diminishing marginal productivity </li></ul></ul></ul><ul><ul><ul><li>Selling on “spot” market (no stocks) to anonymous buyers </li></ul></ul></ul><ul><ul><ul><ul><li>Only interest buyers have is in getting lowest price </li></ul></ul></ul></ul><ul><ul><ul><ul><li>No interest in continuing relationship between buyer/seller; “arms length” transactions </li></ul></ul></ul></ul>
  13. 13. “ The firm”: economic theory <ul><li>The economic simplification: diversity ignored to focus on alleged essence of profit maximising behavior: </li></ul><ul><ul><li>Basic model </li></ul></ul><ul><ul><ul><li>single industry & product </li></ul></ul></ul><ul><ul><ul><li>one location </li></ul></ul></ul><ul><ul><ul><li>privately owned, sole proprietor </li></ul></ul></ul><ul><ul><li>No internal structure considered </li></ul></ul><ul><ul><li>No specialisation: firm does everything from manufacturing to sales </li></ul></ul><ul><li>Some generalisations allowed later (e.g., agency theory) </li></ul><ul><ul><li>But basic theory abstracts from these details </li></ul></ul><ul><ul><li>Core model: profit maximising behaviour under conditions of diminishing marginal productivity </li></ul></ul>
  14. 14. Economic theory of the firm <ul><li>Profit maximising behavior: </li></ul><ul><ul><li>Seeking highest possible profit given constraints of </li></ul></ul><ul><ul><ul><li>Falling price as quantity offered for sale rises </li></ul></ul></ul><ul><ul><ul><li>Rising costs as quantity offered for sale rises </li></ul></ul></ul><ul><ul><li>Falling price as quantity offered for sale rises: </li></ul></ul><ul><ul><ul><li>“ Law of demand”: can only sell additional units if price is lowered </li></ul></ul></ul><ul><ul><ul><li>Mathematically: a negative relationship between price and quantity </li></ul></ul></ul><ul><ul><ul><ul><li>To  quantity sold must  price </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Simple example: linear demand curve P(Q) = a –b Q </li></ul></ul></ul></ul>
  15. 15. Economic theory of the firm <ul><li>Graphing price as a function of quantity: </li></ul><ul><li>Key consequence of “law of demand”: </li></ul><ul><li>Total revenue is price times quantity </li></ul><ul><li>Total revenue rises for a while as increase in Q more than outweighs decline in P </li></ul><ul><li>But ultimately fall in P overwhelms increase in Q: total revenue peaks and then falls… </li></ul>
  16. 16. Economic theory of the firm <ul><li>If firm produces 20,000 units, market price is 80 </li></ul><ul><ul><li>Total revenue = 80 * 20,000 = $1.6 million </li></ul></ul>20,000x80 <ul><li>40,000 units sold, price 60 </li></ul><ul><ul><li>Total revenue = 60 * 40,000 = $2.4 million </li></ul></ul><ul><ul><li>Change in total revenue $0.8 m </li></ul></ul>40,000x60 <ul><ul><li>Change in unit revenue=$0.8 m/20,000=$40 </li></ul></ul>60,000x40 <ul><li>60,000 units sold, price 40 </li></ul><ul><ul><li>Total revenue $2.4 million </li></ul></ul><ul><ul><li>Change in revenue per unit zero </li></ul></ul>Slope=40 Slope=0
  17. 17. Economic theory of the firm <ul><li>Change in revenue called “marginal revenue” </li></ul><ul><li>“ In the limit”, marginal revenue equals slope of total revenue curve: </li></ul><ul><li>Value of marginal revenue (x) equals slope of total revenue curve at same point (o) </li></ul><ul><li>Other side of profit equation is costs: </li></ul><ul><ul><li>Fixed: costs incurred regardless of how many units produced (research, development, factory construction, rent, etc.) </li></ul></ul><ul><ul><li>Variable: costs that depend on level of output: wages, raw materials, intermediate goods, etc.)… </li></ul></ul>
  18. 18. Economic theory of the firm <ul><li>Theory argues per unit costs rise as quantity offered for sale rises: </li></ul><ul><li>Slope of total cost curve is marginal cost: </li></ul><ul><li>Rises as output rises because of diminishing marginal productivity </li></ul><ul><ul><li>After some point, each new worker hired (variable input) adds less to production than previous worker </li></ul></ul><ul><ul><li>With constant wage and diminishing output per worker, unit cost of output rises </li></ul></ul><ul><ul><ul><li>“ Please explain”… </li></ul></ul></ul>
  19. 19. Economic theory of the firm <ul><li>Rising marginal cost: the argument… </li></ul><ul><ul><li>Production occurs in “the short run” </li></ul></ul><ul><ul><li>“ Short run”: period in which at least one crucial input to production can’t be varied (normally machinery) </li></ul></ul><ul><ul><li>Therefore to increase output, more “variable factors” must be added to the fixed factors </li></ul></ul><ul><ul><ul><li>Economic models normally consider just two factors: </li></ul></ul></ul><ul><ul><ul><ul><li>Labour </li></ul></ul></ul></ul><ul><ul><ul><ul><li>“ Capital”: grab-bag for all non-human inputs to production </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Factory buildings </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Machine tools </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Electrical circuitry, computers </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Raw materials and intermediate inputs (e.g., car stereo units for cars) </li></ul></ul></ul></ul></ul><ul><ul><li>As you add more & more variable factors to fixed factors… </li></ul></ul>
  20. 20. Economic theory of the firm <ul><li>There is some ideal worker:machine ratio (e.g., one worker per jackhammer) </li></ul><ul><li>In short run, firm has fixed number of jackhammers </li></ul><ul><li>To dig holes, firm has to hire workers </li></ul><ul><li>1 st worker operates all six jackhammers at once : pretty inefficient! </li></ul>? If this sounds weird to you, good ! You’re on to something… <ul><li>Additional workers might show increasing productivity per worker for a while (two workers operating 3 jackhammers each less messy than one operating 6, ditto three workers operating two each…) </li></ul>
  21. 21. Economic theory of the firm <ul><li>Eventually ideal ratio reached (6 workers for 6 jackhammers) </li></ul>? ? <ul><li>Then to dig more holes, have to have more than one worker per jackhammer: </li></ul>? ? <ul><li>More holes can be dug with 2 workers per jackhammer than with one… </li></ul><ul><li>But productivity of two workers per jackhammer less than one worker per jackhammer… </li></ul>
  22. 22. Economic theory of the firm <ul><li>So productivity per worker might rise for a while; </li></ul><ul><li>But ultimately falls as more output can only be produced by adding more variable inputs (labour) to fixed input (capital) past ideal labour:capital ratio </li></ul><ul><ul><li>Addition to output from each additional worker falls (but doesn’t become negative) </li></ul></ul><ul><ul><ul><li>“ Diminishing marginal productivity” (DMP) </li></ul></ul></ul><ul><ul><ul><li>DMP leads to rising marginal cost </li></ul></ul></ul><ul><ul><ul><li>Example: “Cobb-Douglas production function” </li></ul></ul></ul>Quantity produced Technology coefficient No. workers Amount of capital Relative labor/capital product coefficient
  23. 23. Economic theory of the firm <ul><li>Cobb-Douglas production function allegedly fits aggregate economic data well (but see Shaikh, A. M., (1974). “Laws of Algebra and Laws of Production: The Humbug Production Function”, Review of Economics and Statistics , 61: 115-20) </li></ul><ul><li>Example with  =10, K=100,  =.4, L between 0 and 250: </li></ul>With 100 workers, output is 1,000 With 250 workers, output is 1,443 Change in ouput from 1 st 100 is 1000 Change in ouput from next 250 is 443
  24. 24. Economic theory of the firm <ul><li>Each additional worker adds to output, but adds less than previous worker: diminishing marginal productivity </li></ul><ul><ul><li>As usual, this is slope of total product curve: (maths unimportant, but here it is!): </li></ul></ul><ul><li>Differentiate with respect to Labour… </li></ul><ul><li>Graphing marginal product: </li></ul>
  25. 25. Economic theory of the firm <ul><li>Output with 49 workers = 752 </li></ul><ul><li>Output with 50 workers = 758 </li></ul><ul><li>Marginal product of 50 th worker  6 </li></ul><ul><ul><li>Using formula, it’s exactly 6.063 </li></ul></ul><ul><li>Diminishing marginal product leads to rising marginal cost… </li></ul><ul><li>Output with 99 workers = 996 </li></ul><ul><li>Output with 100 workers = 1000 </li></ul><ul><li>Marginal product of 100 th worker  4.012 </li></ul><ul><ul><li>Using formula, it’s exactly 4 </li></ul></ul>
  26. 26. Economic theory of the firm <ul><li>First step is to “flip the axes”: graph labour input (on Y axis) needed to produce output (on X axis): </li></ul><ul><li>Just reads in reverse: </li></ul><ul><ul><li>1,000 units of output desired; </li></ul></ul><ul><ul><li>100 workers needed </li></ul></ul><ul><li>To get total (variable) cost, multiply Y axis by wage rate (say $12 an hour)… </li></ul>
  27. 27. Economic theory of the firm <ul><li>Rate of change of variable cost is marginal cost </li></ul><ul><li>Rising because of diminishing marginal productivity… </li></ul><ul><li>So firm trying to maximise profits is (according to economic theory) faced with </li></ul><ul><ul><li>Falling price </li></ul></ul><ul><ul><li>Rising cost… </li></ul></ul><ul><li>How to maximise profit? </li></ul><ul><li>Find biggest gap between revenue and cost </li></ul><ul><li>Production level of 1000 units has variable costs of $1200 </li></ul><ul><li>Marginal cost of 1000 th units is about $3 </li></ul>
  28. 28. Economic theory of the firm <ul><li>Graphically, it’s easy: (using earlier example) </li></ul><ul><li>But economists prefer to make it complicated by working in average & marginal revenue & cost </li></ul><ul><li>Converting diagrams to averages by dividing by quantity gives us: </li></ul>
  29. 29. Economic theory of the firm <ul><li>As economists like to show it: “maximise profit by equating marginal revenue and marginal cost” </li></ul><ul><li>What it means: “maximise profit by finding the biggest gap between revenue and cost” </li></ul><ul><li>Gap between curves is biggest when tangents (marginal revenue & marginal cost) are parallel: </li></ul>
  30. 30. Economic theory of the firm <ul><li>So it’s “really easy” to manage a firm: </li></ul><ul><ul><li>Objective is to maximise profits </li></ul></ul><ul><ul><li>Procedure is </li></ul></ul><ul><ul><ul><li>(1) Work out marginal cost </li></ul></ul></ul><ul><ul><ul><li>(2) Work out marginal revenue </li></ul></ul></ul><ul><ul><ul><li>(3) Choose output level that equates the two </li></ul></ul></ul><ul><li>For competitive firms, it’s even easier… </li></ul><ul><ul><li>Competitive firms are “price takers” </li></ul></ul><ul><ul><ul><li>Too small to affect market price/take price as “given” </li></ul></ul></ul><ul><ul><ul><li>Marginal revenue therefore equals price </li></ul></ul></ul><ul><ul><ul><ul><li>(MR less than price for less competitive industries) </li></ul></ul></ul></ul><ul><ul><li>Profit maximisation rule is “produce output level at which marginal cost equals price”: </li></ul></ul>
  31. 31. Economic theory of the firm <ul><li>“ Perfect competition” </li></ul>Demand Supply Q e P e Marginal Cost q e P e Downward sloping market demand curve Horizontal demand curve for single firm quantity Price Quantity Price
  32. 32. Economic theory of the firm <ul><li>So the economic theory rules are: </li></ul><ul><ul><li>If you’re a monopoly or oligopoly </li></ul></ul><ul><ul><ul><li>Work out your marginal cost and marginal revenue </li></ul></ul></ul><ul><ul><ul><li>Produce the output level at which they are equal </li></ul></ul></ul><ul><ul><li>If you’re in a competitive industry </li></ul></ul><ul><ul><ul><li>Work out your marginal cost </li></ul></ul></ul><ul><ul><ul><li>Produce output level at which marginal cost equals price </li></ul></ul></ul><ul><ul><li>If you’re in an industry with a small number of large firms </li></ul></ul><ul><ul><ul><li>More complicated: game theory… </li></ul></ul></ul><ul><ul><ul><ul><li>More on this later </li></ul></ul></ul></ul><ul><ul><li>As a typical text (Thomas & Maurice 2003, Managerial Economics , McGraw-Hill, Boston) summarises it: </li></ul></ul>
  33. 33. Economic theory of the firm <ul><li>It’s a breeze for competitive industries (p. 450): </li></ul><ul><li>A bit more complicated for monopoly (p. 500): </li></ul><ul><li>And a real pain for oligopoly (p. 560)… </li></ul>
  34. 34. Economic theory of the firm <ul><li>What to do? So many choices… </li></ul><ul><li>How does theory stack up against reality? </li></ul>Reality check time!
  35. 35. Economic facts of the firm <ul><li>Theory makes many predictions; e.g. </li></ul><ul><ul><li>Firms should have rising marginal costs </li></ul></ul><ul><ul><li>Competitive firms should have elastic demand curves: </li></ul></ul><ul><ul><ul><li>Elasticity: how much demand changes for a change in price: </li></ul></ul></ul><ul><ul><ul><ul><li>Value of E can be low (less than 1) for an industry, but in limit is infinity for competitive firms (horizontal demand curve…) </li></ul></ul></ul></ul><ul><ul><li>Relative prices should move frequently as supply & demand shift </li></ul></ul><ul><ul><ul><li>Problem: not observed in reality </li></ul></ul></ul><ul><ul><ul><ul><li>Relative prices seem stable </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Money prices tend to move up, not down… </li></ul></ul></ul></ul><ul><ul><ul><ul><li>“ Price stickiness” </li></ul></ul></ul></ul>
  36. 36. Economic facts of the firm <ul><li>Dispute in economics over whether prices “sticky” or “flexible” </li></ul><ul><li>Ideological division in dispute </li></ul><ul><ul><li>Neoclassicals/Free marketeers believe prices “flexible” </li></ul></ul><ul><ul><ul><li>Prices adjust rapidly to changes in demand, supply </li></ul></ul></ul>Demand Supply Quantity Price Q e P e <ul><li>Economic problems caused by government, union, monopoly behavior that makes some prices (e.g. wages) more rigid than others </li></ul>
  37. 37. Economic facts of the firm <ul><ul><li>Keynesians/Mixed economy supporters believe “sticky” </li></ul></ul><ul><ul><ul><li>Prices adjust sluggishly </li></ul></ul></ul><ul><ul><ul><li>Key markets (e.g. labour) can’t be “cleared” (unemployment eliminated) simply by price movements </li></ul></ul></ul><ul><ul><ul><li>Can have underemployment for substantial time; government intervention needed for full employment </li></ul></ul></ul><ul><li>Ideological dispute continues, but statistical results imply “sluggish” price adjustments the rule </li></ul><ul><li>Theory implies rapid adjustments should occur </li></ul><ul><li>Why the difference? </li></ul><ul><li>Plenty of theories as to why prices are sticky; </li></ul><ul><li>Alan Blinder (in Readings ) decided to ask firms “Why?” </li></ul><ul><ul><li>Alan S. Blinder et al. , (1998). Asking About Prices: a new approach to understanding price stickiness, Russell Sage Foundation , New York. </li></ul></ul>
  38. 38. Economic facts of the firm <ul><li>Enormous volume of theoretical research in economics </li></ul><ul><li>Huge amount of statistical (“ econometric ”) research too </li></ul><ul><li>Relatively little empirical research </li></ul><ul><ul><li>Finding out what actually happens at firm/consumer level </li></ul></ul><ul><ul><li>Also asking firms why they do what they do </li></ul></ul><ul><ul><ul><li>Frequency and rapidity of price changes etc. </li></ul></ul></ul><ul><ul><ul><li>How behavior compares to different theories of price stickiness </li></ul></ul></ul>
  39. 39. Economic facts of the firm <ul><li>Blinder’s procedure </li></ul><ul><ul><li>Survey random sample of GDP so that results statistically applicable to whole US economy </li></ul></ul><ul><ul><ul><li>200 firms surveyed </li></ul></ul></ul><ul><ul><li>Structured survey to ensure objectivity </li></ul></ul><ul><ul><ul><li>Questions tailored to test economic theory </li></ul></ul></ul><ul><ul><ul><li>Key economists consulted on design of questions </li></ul></ul></ul><ul><ul><li>Face to face interviews of top executives (25% President/CEO, 45% Vice President, 20% Manager) by Economics PhD students </li></ul></ul><ul><ul><ul><li>Questionnaire taken seriously, informed answers </li></ul></ul></ul><ul><ul><ul><li>Interviewers could help clarify questions </li></ul></ul></ul><ul><ul><ul><li>Interviews took 45-70 minutes for 30 questions </li></ul></ul></ul><ul><ul><ul><li>Trial surveys undertaken prior to real thing to improve uniformity of presentation, interpretation </li></ul></ul></ul>
  40. 40. Economic facts of the firm <ul><ul><li>Sample representative of private, for profit, unregulated, non-farm industry (71% of US GDP) </li></ul></ul><ul><ul><ul><li>Reflects relative weight of industries in US GDP </li></ul></ul></ul><ul><ul><ul><li>Excluded companies with < $10 million in sales </li></ul></ul></ul><ul><ul><ul><ul><li>Excluded group represents 25-50% of GDP </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Weight of industries in which small firms common increased to compensate </li></ul></ul></ul></ul><ul><ul><ul><li>Farms excluded because “no-one believes farm prices to be sticky” (60) </li></ul></ul></ul><ul><ul><ul><ul><li>Perhaps price dynamics of farm sector different to manufacturing? </li></ul></ul></ul></ul><ul><ul><li>Random sample selected, of those approached 61% took part to yield 200 firms—high response rate </li></ul></ul>
  41. 41. Economic facts of the firm <ul><li>Distribution of sample differs from GDP with respect to firm size: </li></ul><ul><li>But big firms overwhelmingly important component: </li></ul><ul><ul><li>Average sales of firms surveyed $3.2 billion ! </li></ul></ul><ul><ul><ul><li>(even though 36% of surveyed firms had sales < $ 50 m) </li></ul></ul></ul><ul><ul><ul><li>7 biggest firms had sales > $20 billion each & represented 58 per cent of total sales by sample </li></ul></ul></ul><ul><ul><li>Firms surveyed represent 7.6% of US GDP </li></ul></ul><ul><ul><li>“ we interviewed an astounding 10 to 15 per cent of the target population—a large fraction by any standard.” (68) </li></ul></ul>67% 64% > $50 m 12.7% 13.5% $25-$50 m 7.1% 22.5% $10-$25 m 26.4% 0% < $10 m GDP Sample Size
  42. 42. Economic facts of the firm <ul><li>Blinder’s survey serious coverage of US economy </li></ul><ul><li>Results give serious evaluation of economic theory </li></ul><ul><li>If survey results consistent with theory, theory a good guide to functioning of economy & to how managers should manage </li></ul><ul><li>If survey results inconsistent with theory, relevance of economic theory seriously jeopardised: could be irrelevant to functioning of economy (& how managers should manage) </li></ul><ul><li>Results contradict most of economic theory </li></ul><ul><ul><li>Most sales to other businesses, not end consumers </li></ul></ul><ul><ul><li>Most sales to repeat customers, not “impersonal” </li></ul></ul><ul><ul><li>Marginal costs fall for most firms, not rise </li></ul></ul><ul><ul><li>Most firms face inelastic demand (E<1), not elastic </li></ul></ul><ul><ul><li>Fixed costs more important than variable costs </li></ul></ul>What do you think the results were? Write your answer down And the correct answer is...

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