Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Managerial Economics &
Business Strategy
Chapter 1
The Fundamentals of Managerial
Economics
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Overview
I,Introduction
II,The Economics of Effective Management
? Identify Goals and Constraints
? Recognize the Role of Profits
? Understand Incentives
? Understand Markets
? Recognize the Time Value of Money
? Use Marginal Analysis
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
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,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Economic vs,Accounting
Profits
? Accounting Profits
? Total revenue (sales) minus dollar cost of producing
goods or services
? Reported on the firm’s income statement
? Economic Profits
? Total revenue minus total opportunity cost
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Opportunity Cost
? Accounting Costs
? The explicit costs of the resources needed to produce
produce goods or services
? Reported on the firm’s income statement
? Opportunity Cost
? The cost of the explicit and implicit resources that are
foregone when a decision is made
? Economic Profits
? Total revenue minus total opportunity cost
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Market Interactions
? Consumer-Producer Rivalry
? Consumers attempt to locate low prices,while producers
attempt to charge high prices
? Consumer-Consumer Rivalry
? Scarcity of goods reduces the negotiating power of
consumers as they compete for the right to those goods
? Producer-Producer Rivalry
? Scarcity of consumers causes producers to compete with
one another for the right to service customers
? The Role of Government
? Disciplines the market process
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
The Time Value of Money
? Present value (PV) of an amount (FV) to be
received at the end of,n” periods when the
per-period interest rate is,i”,
? ?
PV
FV
i
n?
?1
Examples?
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Present Value of a Series
? Present value of a stream of future amounts
(FVt) received at the end of each period for
“n” periods,
? ? ? ? ? ?
PV
FV
i
FV
i
FV
i
n
n?
?
?
?
? ?
?
1
1
2
2
1 1 1
.,,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Net Present Value
? Suppose a manager can purchase a stream of
future receipts (FVt ) by spending,C0” dollars
today,The NPV of such a decision is
? ? ? ? ? ?N P V C
FV
i
FV
i
FV
i
n
n? ? ? ? ? ? ? ? ?0
1
1
2
21 1 1.,,
NPV < 0,Reject
NPV > 0,Accept
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Firm Valuation
? The value of a firm equals the present value
of all its future profits
? PV = S pt / (1 + i)t
? If profits grow at a constant rate,g < i,then,
? PV = po ? 1?i) / ( i - g),po ? current profit level,
? Maximizing Short-Term Profits
? If the growth rate in profits < interest rate and both
remain constant,maximizing the present value of all
future profits is the same as maximizing current profits,
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
? Control Variables
? Output
? Price
? Product Quality
? Advertising
? R&D
? Basic Managerial Question,How much of
the control variable should be used to
maximize net benefits?
Marginal (Incremental)
Analysis
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Net Benefits
? Net Benefits = Total Benefits - Total Costs
? Profits = Revenue - Costs
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Benefit (MB)
? Change in total benefits arising from a
change in the control variable,Q,
MB = DB / DQ
? Slope (calculus derivative) of the total
benefit curve
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Cost (MC)
? Change in total costs arising from a change
in the control variable,Q,
MC = DC / DQ
? Slope (calculus derivative) of the total cost
curve
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Marginal Principle
? To maximize net benefits,the managerial
control variable should be increased up to
the point where MB = MC
? MB > MC means the last unit of the control
variable increased benefits more than it
increased costs
? MB < MC means the last unit of the control
variable increased costs more than it
increased benefits
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
The Geometry of Optimization
Q
Benefits & Costs
Benefits
Costs
Q*
B
C Slope = MC
Slope =MB
Michael R,Baye,Managerial Economics and Business Strategy,3e,?The McGraw-Hill Companies,Inc.,1999
Summary
? 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)