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MANAGERIAL ECONOMICS
EC 952
Your instructor: Dmitri Nizovtsev
Office:
Phone:
E-mail:
Office Hours:
310N in Henderson
670-1599
[email protected]
T 5pm – 7pm,
W 4pm – 5pm,
R 12:15pm – 1:45pm
+ Open door policy
Course Web page:
http://www.washburn.edu/sobu/dnizovtsev/Econ952.html
Textbook:
Baye, Managerial Economics and Business Strategy, 7e.
Grading:
Problem sets and writing assignments :
Two Midterms:
Group project:
Final:
25%
17.5 x 2 = 35%
15%
25%
Cornerstones of (managerial) economics
1. Opportunity cost
The Opportunity cost (of a product, action etc.) is the
value of the next best alternative that has to be forgone
in order to obtain it.
The total economic cost consists of explicit (out of
pocket, monetary) and implicit (measured in lost
opportunities) costs. A good manager has to recognize
both.
2. Cost/benefit comparison.
“Net benefit” is the difference between benefits and
costs.
Example: PROFIT
(1+2): The concept of economic profit (takes both
explicit and implicit costs into account)
3. Marginal analysis
Instead of looking at the overall costs and benefits,
one can look at how costs and benefits change as a
result of the action that is being evaluated.
Benefits increased more than costs 
 your company is better off
Demand, Supply, and Market Equilibrium
We often hear that “prices are governed by forces of supply
and demand”. That is to a large extent true. (And not only
prices, but quantities, too!)
It is important for a manager to understand how those forces
work, be able to predict their direction, and in some cases
maybe even affect them.
Ideally, it should work in the following way:
• Step 1: Look at the “Big Picture” (S-D analysis)
• Step 2: What does that mean for your company?
• Step 3: Worry about details (create an action plan)
First, let us see if we agree on what supply and demand are.
Demand is a relationship between the price of a good
and the quantity of the good consumers are
expected to purchase (a. k. a. “quantity
demanded”)
relationship = a function, a graph, a formula, etc.
What is the shape of a demand relationship?
“Law of Demand”: the higher the price of a good,
the smaller the quantity demanded
Why so?
“Diminishing marginal utility”
Supply is a relationship between the price of a good
and the quantity of the good producers/sellers
will be willing and able to deliver to the
market (a. k. a. “quantity supplied”)
The shape?
Why?
Slopes upwards
(a higher selling price induces
a greater output quantity)
Increasing marginal cost
P
Market equilibrium
When put on the same graph, supply and
demand curves usually intersect.
PE
Equilibrium price
QE
The point where the two curves intersect is called the market
equilibrium. It is characterized by a price and a quantity.
In “perfect” markets
• large number of buyers and sellers;
• goods offered by different sellers are identical;
• sellers can freely enter and exit the market;
• everyone has perfect information about all the
transactions (prices, quantity, etc.),
prices charged by different sellers are usually closely
clustered around the equilibrium price.
It can be shown by using common sense that it is in no
one’s interest to try to ask or offer a price different from
the equilibrium price.
In such markets, prices can change only as a result of
changes (“shifts”) in supply and/or demand.
All the graphs are for the chicken meat market!!!
P
P
Q
PCH decreases, QCH decreases
A. The price of pork decreases
Q
PCH increases, QCH decreases
B. It is getting harder to find workers willing
to work in the chicken meat industry
P
P
Q
PCH decreases, QCH increases
C. A new feed formula helps birds gain
weight 50% faster than before
Q
PCH increases, QCH increases
D. Chicken meat is scientifically proven
to have substantial health benefits
Factors that can shift demand
(also called “determinants”, or “shifters”):
P of a “substitute good” increases –
Demand for our good increases
(shifts to the right)
P of a “complementary good” increases –
Demand for our good decreases
(shifts to the left)
Consumer income increases – Demand for our
good….
INCREASES
if it is a “normal good”.
DECREASES
if it is an “inferior good”.
Price of a good is expected to go up in the near
future – Demand for the good today …
INCREASES
There are many other, more trivial factors (# of
consumers, information about the good, prior
experience with the good, consumer demographics,
time of the year, etc.)
Factors that can shift supply:
Increase in costs (higher input prices, tax on
producers, etc.)
DECREASES
Supply ____________
(shifts left)
Decrease in costs
(cheaper inputs, subsidy to producers, technol.
progress, etc.)
INCREASES
Supply ____________
(shifts right)
Increase in the number of firms in the market
Supply INCREASES
Prices of other goods (Y) that can be produced
instead of the good of interest (X), “substitutes in
production”
Logic:
Price of Y goes up  Resources shift …
…
Or: Price of Y goes up  The opp.cost of X….
Prices of other goods (Y) that can be produced
instead of the good of interest (X), “substitutes in
production”
Logic:
Price of Y goes up  Resources shift from X into Y
…
Or: Price of Y goes up  The opp.cost of X….
Prices of other goods (Y) that can be produced
instead of the good of interest (X), “substitutes in
production”
Logic:
Price of Y goes up  Resources shift from X into Y
…Less X is produced
Or: Price of Y goes up  The opp.cost of X….
Prices of other goods (Y) that can be produced
instead of the good of interest (X), “substitutes in
production”
Logic:
Price of Y goes up  Resources shift from X into Y
…Less X is produced – a decrease in supply of X
Or: Price of Y goes up  The opp.cost of X….
Prices of other goods (Y) that can be produced
instead of the good of interest (X), “substitutes in
production”
Logic:
Price of Y goes up  Resources shift from X into Y
…Less X is produced – a decrease in supply of X
Or: Price of Y goes up  The opp.cost of X
increases 
Prices of other goods (Y) that can be produced
instead of the good of interest (X), “substitutes in
production”
Logic:
Price of Y goes up  Resources shift from X into Y
…Less X is produced – a decrease in supply of X
Or: Price of Y goes up  The opp.cost of X
increases  a decrease in supply of X
Important things to keep in mind in S-and-D
analysis:
When both curves (supply AND demand) shift, and we
are asked about the direction of change in price and
quantity, we will be able to predict only one of the two.
The other one will be indeterminate.
A common mistake is shifting too many curves too many
times (in most cases, one event causes only one shift).
A shift in a curve should occur only if we are dealing with
one of the “shifters” listed above.
A change in the price of the good in question doesn’t
cause a shift!
Buyers and sellers do react to the price of the good but
that reaction is illustrated by movement along a curve.
Why care about supply-and-demand analysis?
Example:
You manage a small firm that manufactures PCs.
•Event: The WSJ reports that the prices of PC
components are expected to fall by 5-8 percent over
the next six months.
• Step 1: Look at the “Big Picture” (S-D analysis)
• Step 2: What does that mean for your company?
• Step 3: Worry about details (create an action plan)
Often, quantitative analysis of market environment allows
to present supply and demand relationships in the form of
equations, such as
QD,X = F(Px , Py , M, HD, …),
where
QD,X = quantity demanded of good X;
Px = price of good X;
Py = price of a related good Y(can be substitute or
complement);
M = consumers’ income;
HD = any other variables affecting demand
Similarly,
QS,X = F(Px , Py , HS, …)
Example (from p.42 in the text):
An economic consultant for X Corp. recently provided the
firm’s marketing manager with this estimate of the demand
function for the firm’s product (AX represents spending on
advertising good X):
QD,X = 12,000 – 3 PX + 4 PY – M + 2 AX
Are goods X and Y substitutes or complements?
Is good X a normal or an inferior good?
Currently, good Y sells for $15 per unit, the company
spends $2000 on advertising, and the average consumer
income is $10,000.
If the price for good X is set at $200 per unit, how much of
good X will consumers purchase?
When equations for supply and demand are available,
we can make fairly accurate predictions regarding price
and quantity. (Where those equations may come from
will be discussed next week.)
Example:
Demand:
Supply:
QD = 3000 – 50 P
QS = 200 P – 500
Can we tell what the equilibrium price and quantity are?
Normally, supply and demand equations are
given in the form similar to the one above, where
quantity is expressed as a function of price.
On some occasions, we will need a different form,
known as “inverse” supply/demand, when price is
a function of quantity (price is on the left side of
the equation).
For example, the above equations can be
rewritten as…