Managerial Economics Applications, Strategies and Tactics, 14e James R. McGuigan R. Charles Moyer Frederick H. deB. Harris © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, 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 or school-approved learning management system for classroom use. 1 1 PART I – INTRODUCTION © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, 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 or school-approved learning management system for classroom use. 2 Chapter 1 – Introductions and Goals of the Firm Overview WHAT IS MANAGERIAL ECONOMICS? THE DECISION-MAKING MODEL THE ROLE OF PROFITS OBJECTIVE OF THE FIRM SEPARATION OF OWNERSHIP AND CONTROL: THE PRINCIPAL-AGENT PROBLEM IMPLICATIONS OF SHAREHOLDER WEALTH MAXIMIZATION © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, 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 or school-approved learning management system for classroom use. 3 Figure 1.1 – Nitrous Oxide from Coal-Fired Power Plants, pre Clean Air Act © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, 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 or school-approved learning management system for classroom use. 4 Chapter 1 – Introductions and Goals of the Firm What is Managerial Economics? (1 of 1) Managerial economics enables managers to select strategic direction, allocate efficiently, and respond effectively to tactical issues Managerial economic decision-making seeks to: Identify the alternatives, Select the choice that accomplishes the objective(s) in the most efficient manner, Taking into account the constraints, And the likely actions and reactions of rival decision-makers. © 2017 Cengage Learning® May not be scanned, copied or duplicated, or posted to a publicly accessible website, 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 or school-approved learning management system for classroom use. 5 Chapter 1 – Introductions and Goals of the Firm The Decision-Making Model (1 of 3) Making good decisions is key to successful managerial performance, and includes several elements: Establish the objectives Identify the problem Examine potential solutions Analyze the relative costs and benefits Analyze the best available alternative under a va ...

1. Managerial Economics
Applications, Strategies and Tactics, 14e
James R. McGuigan
R. Charles Moyer
Frederick H. deB. Harris
© 2017 Cengage Learning® May not be scanned, copied or
duplicated, or posted to a publicly accessible website, 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 or school-approved learning management
system for classroom use.
1
1
PART I – INTRODUCTION
© 2017 Cengage Learning® May not be scanned, copied or
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2
Chapter 1 – Introductions and Goals of the Firm
Overview
WHAT IS MANAGERIAL ECONOMICS?
THE DECISION-MAKING MODEL
THE ROLE OF PROFITS

2. OBJECTIVE OF THE FIRM
SEPARATION OF OWNERSHIP AND CONTROL: THE
PRINCIPAL-AGENT PROBLEM
IMPLICATIONS OF SHAREHOLDER WEALTH
MAXIMIZATION
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with a certain product or service or otherwise on a password-
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3
Figure 1.1 – Nitrous Oxide from Coal-Fired Power Plants, pre
Clean Air Act
© 2017 Cengage Learning® May not be scanned, copied or
duplicated, or posted to a publicly accessible website, 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-
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4
Chapter 1 – Introductions and Goals of the Firm
What is Managerial Economics? (1 of 1)
Managerial economics enables managers to select strategic
direction, allocate efficiently, and respond effectively to
tactical issues
Managerial economic decision-making seeks to:
Identify the alternatives,
Select the choice that accomplishes the objective(s) in the most
efficient manner,

3. Taking into account the constraints,
And the likely actions and reactions of rival decision-makers.
© 2017 Cengage Learning® May not be scanned, copied or
duplicated, or posted to a publicly accessible website, 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-
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system for classroom use.
5
Chapter 1 – Introductions and Goals of the Firm
The Decision-Making Model (1 of 3)
Making good decisions is key to successful managerial
performance, and includes several elements:
Establish the objectives
Identify the problem
Examine potential solutions
Analyze the relative costs and benefits
Analyze the best available alternative under a variety of
assumptions (sensitivity analysis)
Implement the decision
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or in part, except for use as permitted in a license distributed
with a certain product or service or otherwise on a password-
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system for classroom use.
6
Chapter 1 – Introductions and Goals of the Firm
The Decision-Making Model (2 of 3)
The Responsibilities of Management

4. Managers are responsible for many goals
They must proactively solve problems before they become
crises
Moral Hazard in Teams
The single most critical trait of effective managers is the ability
to motivate teams to perform to their best
To encourage team members to avoid the moral hazards of free
riding and shirking of duties;
Without penalties and sanctions, only moral duty induces full
effort teamwork
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7
Chapter 1 – Introductions and Goals of the Firm
The Decision-Making Model (3 of 3)
Managers in a capitalist economy are motivated to monitor
teamwork because of their overarching goal to maximize returns
to owners of the business:
Economic profits: the difference between total revenue and total
economic cost
Includes a “normal” rate of return on the capital contributions
of the firm’s partners
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5. protected website or school-approved learning management
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8
Figure 1.2 – Payoffs from Team Production with and without a
Supervisor
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with a certain product or service or otherwise on a password-
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9
What Went Right? ● What Went Wrong?
Saturn Corporation
Different kind of car company in 1991, but permanently closed
in 2009
It used no-haggle pricing and designed cars to compete with
Asian imports
Sales were above expectations at first because of tiny margin of
only $400 per car to GM, so that GM earned only 3% on capital
Saturn customers wanted bigger Saturn cars rather than trade up
to Buick, as GM hoped
Sales later slumped in the late 1990s through 2009
10
© 2017 Cengage Learning® May not be scanned, copied or
duplicated, or posted to a publicly accessible website, 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 or school-approved learning management
system for classroom use.

6. Chapter 1 – Introductions and Goals of the Firm
The Role of Profits (1 of 1)
Risk-Bearing Theory of Profit
Risk-bearing should lead to higher profits
Temporary Disequilibrium Theory of Profit
Firms may earn a return above or below the long-run normal
return level
Monopoly Theory of Profit
A firm which dominates the market can persistently earn above-
normal returns
Innovation Theory of Profit
These are the reward for successful innovations
Managerial Efficiency Theory of Profit
Exceptional managerial skills may lead to higher profits
© 2017 Cengage Learning® May not be scanned, copied or
duplicated, or posted to a publicly accessible website, 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-
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11
What Went Right? ● What Went Wrong?
Eli Lilly, a Pharmaceutical Company
It takes12.3 years on average to get a new drug approved.
Patents on Lilly’s Prozac created monopoly power and profits
for a widely used medication for depression
As the patent began to expire, Lilly requested a patent
“extension” because of some alterations in Prozac’s formula
But when the patent extension was overturned, generic drug
manufactures took 70% of the share of the market for anti-
depressants
Lilly missed the chance of finding a replacement in time for its
blockbuster Prozac

7. This is an example of having and losing monopoly power
12
© 2017 Cengage Learning® May not be scanned, copied or
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with a certain product or service or otherwise on a password-
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system for classroom use.
Chapter 1 – Introductions and Goals of the Firm
Objective of the Firm (1 of 1)
The Shareholder Wealth-Maximization Model
Shareholder wealth is measured by the market value of a firm’s
common stock, which is equal to the present value of all
expected future cash flows to equity owners discounted at the
shareholders’ required rate of return, plus a value for the firm’s
embedded real options:
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13
Chapter 1 – Introductions and Goals of the Firm
Separation of Ownership & Control: Principal-Agent… (1
of 2)
Divergent Objectives and Agency Conflict
Growth results in owners (principals) delegating decision-
making authority to professional managers (agents)

8. Because manager-agents have much less to lose, agents may
seek acceptable (not maximum) profit levels, pursuing their
own self-interests; Agency Conflict
Agency Problem
Problems arise from inherent unobservability of managerial
effort and random disturbances in team production
Separation of ownership (shareholders) and control
(management) in large corporations permits managers to pursue
goals that are not always in the long-term interests of
shareholders
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14
Comparison slide; see Figure 1.3, next slide
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15
Figure 1.3 –
CEO Pay Trends Reflect Corporate Performance
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9. duplicated, or posted to a publicly accessible website, in whole
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16
Chapter 1 – Introductions and Goals of the Firm
Separation of Ownership & Control: Principal-Agent… (2
of 2)
Agency Problem (cont’d)
In attempt to mitigate agency problems, firms incur agency
costs:
1. Grants of stock options or restricted stock from Treasury
stock so executive compensation aligns the incentives for
management with shareholder interests; also, many monitor
financial ratios and investment decisions of large debtor
companies; strengthens firm’s corporate governance
2. Internal audits and accounting oversight boards to monitor
actions of management
3. Bonding expenditures and fraud liability insurance to protect
shareholders
4. Complex internal approval processes to limit discretion, but
which prevent timely responses to business opportunities
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with a certain product or service or otherwise on a password-
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10. 17
Chapter 1 – Introductions and Goals of the Firm
Implications of Shareholder Wealth Maximization (1 of 4)
Critics of those who seek to align interests of managers with
equity owners allege that maximizing shareholder wealth
focuses on short-term payoffs, sometimes to detriment of long-
term profits
But evidence suggests just the opposite:
Short-term cash flows reflect only a small fraction of the firm’s
share price
In general, only about 85% of shareholder value can be
explained by even 30 years of cash flows
Managers’ value-maximizing behavior distinguishable from
satisficing behavior (hitting their targets)
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18
Chapter 1 – Introductions and Goals of the Firm
Implications of Shareholder Wealth Maximization (2 of 4)
Caveats to Maximizing Shareholder Value
Complete Markets – to directly influence a company’s cash
flows, forward or futures markets, and spot markets must be
available for firm’s inputs, outputs and by-products
No Asymmetric Information - Problems often arise because of
asymmetric information; Line managers and employees can
misunderstand what senior executives want when they challenge
employees to find a thousand different ways to save 1 percent

11. Known Recontracting Costs – Focusing exclusively on
discounted present value of future cash flows requires managers
to forecast future recontracting costs for pivotal inputs
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19
Chapter 1 – Introductions and Goals of the Firm
Implications of Shareholder Wealth Maximization (3 of 4)
Residual Claimants
Shareholders have only a residual claim on the firm’s net cash
flows after all expected contractual returns have been paid
Goals in the Public Sector and Not-for-Profit Enterprises
Profit maximization not appropriate for public sector of NFP
firms
Public goods are consumed by more than one person at a time
with little or no extra cost; expensive or impossible to exclude
those who do not pay
Not-for-Profit Objectives
Maximize: 1) quantity and equality of output subject to break-
even budget constraint; 2) outcomes preferred by NFP’s
contributors; 3) longevity of NFP’s contributors
© 2017 Cengage Learning® May not be scanned, copied or
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12. 20
Chapter 1 – Introductions and Goals of the Firm
Implications of Shareholder Wealth Maximization (4 of 4)
The Efficiency Objective in Not-for-Profit Organizations
Cost-benefit analysis is a resource-allocation model that can be
used by public sector and NFP firms to evaluate programs or
investments on the basis of the magnitude of the discounted
costs and benefits
Because such spending is constrained by a budget ceiling, goals
can be any one of these:
1. Maximize benefits for given costs
2. Minimize the costs while achieving a fixed level of benefits
3. Maximize the net benefits (benefits minus costs)
But cost-benefit analysis is only one factor in the final decision
It does not incorporate subjective considerations or less
quantifiable attributes such as fairness
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21
Please answer the following questions after reading the case
study:
· Which staffing framework do you recognize in this case study?
Explain its characteristics and the advantages to using this type
of framework?
· Would this type of staffing framework affect Paul’s ability to

13. get things done? Why, or why not?
· Explain if any of the other staffing frameworks would be any
better? What can you recommend to the company’s headquarters
in this sense?
· Why does Paul want this job? Is Paul a good candidate for this
expatriate position?
· What comments can you make on expatriate management in
general? And what comments can you make on the expatriate
recruitment policy in particular?
· What are the different expatriate compensation methods you
recognized in the text? What are the advantages and
disadvantages of these different expatriate compensation
methods?
· What do you suggest to the U.S. headquarters’ human
resources manager in order to improve the expatriate
satisfaction/compensation?
Your submission should be a minimum of three pages in length
in APA style; however, a title page, a running head, and an
abstract are not required. Be sure to cite and reference all
quoted or paraphrased material appropriately in APA style.