Managerial economics1 (Mcgraw-Hill - Fundamentals Of Managerial Economics)
What are we going to cover here?1.- What is managerial economics?2.- Theory of the firm3.- Profit measurement4.- Why do profits vary among firms?5.- Role of business in society
1.- What is managerial economics?*Managerial economics applies economic toolsand techniques to business and administrativedecision making*Managerial economics uses economic concepts andquantitative methods to solve managerial problems*It is as relevant to the management of government,agencies, cooperatives, schools, hospitals, museums,and similar not-for-profit institutions as it is to themanagement of profit-oriented businesses
2.- Theory of the firm I*A business enterprise represents a series ofcontractual relationships that specify the rights andresponsibilities of various parties: customers,stockholders, employees, suppliers and society*Firms are a useful device for producing anddistributing goods and services* Expected Value Maximization: the primary goal of thefirm is long-term expected value maximization
2.- Theory of the firm II*The value of the firm is the present value of the firm’sexpected future net cash flows*Constraints and the Theory of the Firm: Managerialdecisions are often made in light of constraintsimposed by technology, resourcescarcity, contractual obligations, laws, and regulations.To make decisions that maximizevalue, managers must consider how externalconstraints affect their ability to achieve organizationobjectives.
2.- Theory of the firm III*Limitations of the Theory of the Firm: Some criticsquestion why the value maximization criterion is usedas a foundation for studyingfirm behavior. Do managers try to optimize (seek thebest result) or merely satisfice(seek satisfactory rather than optimal results)?*What often appears to be satisficing on the part ofmanagement can be interpreted as value maximizingbehavior once the costs of information gathering andanalysis are considered.II
3.- Profit measurement I*The free enterprise system would fail without profitsand the profit motive*Business profit: Residual of sales revenue minus theexplicit accounting costs of doing business*Normal rate of return: Average profit necessary toattract and retain investment*Economic profit: Business profit minus the implicitcosts of capital and any other owner-provided inputs
3.- Profit measurement II*Variability of Business Profits: In practice, reportedprofits fluctuate widely*Profit margin: Accounting net incomedivided by sales*Return on stockholders’equity: Accounting net incomedivided by the book value of total assetsminus total liabilities
4.- Why do profits vary among firms? I*Even after risk adjustment and modification toaccount for the effects of accounting error andbias, ROE numbers reflect significant variation ineconomic profits*Frictional profit theory: Abnormal profitsobserved following unanticipated changes in demandor cost conditions (Kindle, Amazon)*Monopoly profit theory: Above-normal profitscaused by barriers to entry that limit competition(Electricity companies)
4.- Why do profits vary among firms? II*Innovation profit theory: Above-normal profits thatfollow successful invention or modernization (Iphone,Apple)*Compensatory profit theory: Above-normal rates ofreturn that reward efficiency*Role of Profits in the Economy: above-normal profitsprovide a signal for expansion and entry, below-normalprofits provide a signal for contraction and exit.
5.- Role of business in society I*Firms exist by public consent to serve social needs. Ifsocial welfare could be measured, business firmsmight be expected to operate in a manner that wouldmaximize some index of social well-being.*In a free market economy, the economic systemproduces and allocates goods and services accordingto the forces of demand and supply.
5.- Role of business in society II*Role of Social Constraints: Although the process ofmarket-determined production and allocation of goodsand services is highly efficient, there are potentialdifficulties in an unconstrained market economy.Society hasdeveloped a variety of methods for alleviating theseproblems through the political system: that certaingroups could gain excessive economic power; if theyconspire with one another in setting prices; thepotential for worker exploitation; etc.