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E303. Spring 2006. Test 1 Review
I. Chapter 1. The Fundamentals of Managerial Economics
A. Definition of Topic.
1. Economics
2. Managerial Decisions
B. Components of Effective Decision Making
1. Identify Goals and Constraints:
2. Recognize the Nature and Importance of Profits: Economic profits differ from
Accounting profits. . Good decision-making involves the maximization of economic
profits.
Acct =
TR
TCExplicit
Econ =
TR
-
(TCExplicit + TCImplicit)
3. Understanding Incentives. .Compensation and the structure of organizations
affects importantly organizations.
a. Organizational Incentives
b. Incentives for Motivating Individuals
4. Understand Markets. Market forces represent a series of rivalries. In any
problem, you must appreciate your position relative to other agents.
5. Recognize the Time Value of Money
PV
=
 FVt
(1+i)t
NPV
=
 FVt
-
Co
(1+i)t
6. Appreciate Marginal Analysis. Marginal decisions are an easy way to optimize
totals. Calculus is just a formal expression of marginal analysis.
a. Discrete Decisions.
b. Continuous Decisions and the calculus
Note: You should be able to graphically illustrate why the point where Marginal Benefits
equals Marginal Costs maximizes the difference between Total Benefits and Total Costs.
c. Incremental Analysis
1. Pay attention to incremental costs and incremental benefits.
2. Ignore sunk costs. .
II. Chapter Market Forces: Demand and Supply
A. Introduction and Overview.
1. Overview
2. The structure of the supply and demand model.
B. The Demand Side.
1. Motivation: Diminishing marginal utility:
2. Definition of Demand Curve
3. Determinants of Demand.
4. Changes in demand vs. changes in qty demanded.
5. The Notion of Consumer Surplus
6. An Analytical Example
C. The Supply Side.
1. Driving Force. The Law of Diminishing Returns
2. Definition of Supply Curve
3. Determinants of supply:
4. Changes in supply vs. changes in quantity supplied.
5. Producer Surplus.
6. An Analytical Example.
Note: You should be able to look at a linear demand or supply function, and, with
appropriate information about the nonprice parameters, be able to generate demand and
supply curves. Given a price you should be able to calculate consumer and producer
surplus.
D. Equilibrium. Putting Supply and Demand Together
1. Definition.
2. Binding the market.
Price floors
Price Ceilings
E. Comparative Statics.
1. Supply or Demand Shifts
2. Supply and Demand Shifts
III. Quantitative Demand Analysis
A. Price Elasticity of Demand
1. Motivation
2. Calculations
a. Arc price elasticity of demand
 = (Q1-Q0)(P1+P0)
(P1-P0)(Q1+Q0).
b. Point price elasticity of demand
 = (dQ/dP)(P/Q)
c. Percentage Changes
 = %Qd/%P
3. A Graphical Interpretation of Price Elasticity.
4. Some Observations about Price Elasticity of Demand
a. Most Demand curves have elastic and inelastic segments
b. Exceptions
c. Elasticity and the Slope of Demand Curves
5. Price Elasticity, MR and TR.
TR is maximized at the point where || = 1
No firm maximizes profits on the inelastic portion of their demand
curve.
6. Determinants of price elasticity of demand
a. Availability of substitutes
b. Price Relative to Income
c. Time
B. Other Demand Elasticities
1. Cross Price Elasticities
xy = %Qx/%Py
xy> 0
implies substitutes
xy< 0
implies complements
xy = 0
implies unrelated goods.
2. Income Elasticities
I = %Q/%I
I > 1
normal, cyclical good
1> I > 0
normal, noncyclical good
I< 0
inferior good.
3.Other Elasticites. Advertising elasticity
A = %Q/%A
For any successful advertising campaign, A >0
C. Elasticities and demand functions
1. Linear Demand functions. Given
Qx = a + bP + cI + dPy
 = b(Q/P)
I = c(Q/I)
xy =d(Qx/Py)
2. Logrithmic Demand. Given
Qx
=b
=
I = c
aPbIcPyd
xy =d
Note: An equivalent expression for this function is
ln Qx =
lna + blnP+ clnI + dlnPy