1. CENTRE FOR POLICY STUDIES
UNIVERSITY COLLEGE CORK
EC2204
TUTORIAL #2 W/S 22/10/2012
Academic Year: 2012/2013
Instructors: Brenda Lynch/P J Hunt
Contact: brendalynch@ucc.ie or p.hunt@ucc.ie

2. The Decision-Making Model
Decision making is the responsibility of
management. It involves
a; establishing objectives
b; reviewing possible strategies
C; evaluating the costs/benefits of each
strategy

3. •d; selecting the best strategy
•e; implement and monitor the strategy
•f; are the objectives being met
•(See p9 of course book).

4. Objectives of the Firm
Firms can have several objectives, one of
which is to maximise profits. Profit is the
difference between total revenue and total
costs. Profits can be maximised by using
the concepts of marginal cost (MC) and
marginal revenue (MR).
•MC is the change in total cost resulting
from a decision
•MR is the change in total revenue
resulting from a decision

5. Using the above a decision to allocate
resources by management in a specific way
will be profitable if;
•MR increases more than MC
•Some MC’s decrease more than others
increase assuming MR remains the same
•Some MR’s increases more than others
decrease assuming MC remains the same.
The profit maximisation model treats all
profits the same i.e. €1,000 in one years
time is the same as €1,000 now. This is
clearly not the case. Also risk is not taken
into account.

6. Both of these shortcomings are overcome by
… The Shareholder Wealth-Maximisation
Model of the Firm...
Which states that the objectives of a firm’s
management is to maximise the present
value of all expected future cash flows to
the firm’s owners (the shareholders). In other
word this profits are discounted (reduced) for
time and risk. The mathematical formula is;

7. i. V 0 * Shares Outstanding = 1
1
2
2
3
3
... =
(1 k e ) (1 k e ) (1 k e ) (1 k e )
t
t
(1.1)
t 1 (1 k e )
See p10 of course book
And is composed of
V0 is the current value of a share
Π is the profit expected in each future
period
k is the investors required rate of return

8. t takes into account the time issue of
payments with each increasing time period
attracts an increasing power value.
Also k increases in value if perceived risk
increases or decreased if risk has decreases
allowing an investor to place a lower value
on a high-risk investment and vice versa.

9. Profit
Economic profit is the difference between
total revenue and economic cost.
Economic cost includes a ‘normal’ rate of
profit
Types of Profits
•Dynamic Equilibrium (Friction) Theory of
Profit
A long-run equilibrium normal rate of profit
exists. However at any time an individual
firm in an individual industry can earn a profit
above or below this level. Examples; Airlines
after 9/11 or oil producers at the moment.

10. Profits eventually return to normal.
•Monopoly Theory of Profit
A firm can earn above normal profits for a
long time due to dominance in the market.
Example; Sky TV, OECD
•Innovation Theory of Profit
A firm with a successful innovation can earn
above normal profits. Example; Pfizer and
Viagra

11. •Managerial Efficiency Theory of Profit
Exceptional managerial skills can give rise
to abnormal profits.
•Risk Bearing Theory of Profit
The greater the risk the higher the potential
profit and vice versa.