Download 1. intro econ


Economics

What’s Economics about?
♦ Science of making decisions to allocate scarce resources to
alternative uses.
♦ Three fundamental questions:
– What?
– How?
– To whom?
♦ Microeconomics vs Macroeconomics.

Managerial Economics vs Micro Economics
A market economy
• Microeconomics vs Macroeconomics
♦ Microeconomics:
– Studies decision making and interactions of individual
agents;
– Concentrates on Demand, Supply and Markets.
♦ Macroeconomics:
– Studies the evolution of the aggregate economy, as a
result of individual decisions and interactions;
– Concentrates on Product, Unemployment and Inflation.
• Managerial Economics vs Micro economics
• Managerial economics applies
microeconomic theory to business
problems
– How to use economic analysis to make
decisions to achieve firm’s goal of profit
maximization
• Microeconomics
– Study of behavior of individual economic
agents
• Why Managerial Economics?
The Fundamentals of Managerial Economics
• Use economic profits;
• Identify objectives and constraints;
• Understand markets;
• Conduct marginal analysis;
• Consider incentives and signaling;
• Recognize time value of money
Economic Cost of Resources
• Opportunity cost of using any resource
is:
– What firm owners must give up to use the
resource
• Market-supplied resources
– Owned by others & hired, rented, or leased
• Owner-supplied resources
– Owned & used by the firm
Total Economic Cost
• Total Economic Cost
– Sum of opportunity costs of both marketsupplied resources & owner-supplied
resources
• Explicit Costs
– Monetary payments to owners of marketsupplied resources
• Implicit Costs
– Nonmonetary opportunity costs of using
owner-supplied resources
Economic Cost of Using
Resources
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Types of Implicit Costs
• Opportunity cost of cash provided by
owners
– Equity capital
• Opportunity cost of using land or capital
owned by the firm
• Opportunity cost of owner’s time spent
managing or working for the firm
Economic Profit versus
Accounting Profit
• Economic profit = Total revenue – Total economic cost
= Total revenue – Explicit costs – Implicit costs
• Accounting profit = Total revenue – Explicit costs
• Accounting profitdoes not subtract implicit costs
from total revenue
• Firm owners must cover all costs of all resources
used by the firm
– Objective is to maximize economic profit
3. Use economic profits
♦ Accounting profits
♦ Economic profits:
– Oportunity costs.
♦ Example: Operation of a small pizzeria.
♦ Objective: maximize shareholders value.
Operation of a small pizzeria (I)
♦ Mike runs a small pizzeria in his hometown.
♦ He owns the building.
♦ Annual revenues are €100000 euros.
♦ Annual costs are €20000.
♦ Annual profit is €80000 euros.
♦ This is not the economic profit!
Operation of a small pizzeria (II)
♦ Mike could have a job earning €30000.
♦ Mike could have rented the space for
€100000.
♦ The economic profit is just:
∏ = 80000-30000-100000= -50000
♦ CONCLUSION: Mike should close the
pizzeria, rent the space and get the
alternative job.
2. Identify objectives and constraints
♦ The role of objectives:
– Choices are made to achieve objectives;
– Objectives of the unit and objectives of the
sub-units.
♦ Resources are scarce:
– Impose constraints;
– Limit possibilities.
Maximizing the Value of a Firm
• Value of a firm
– Price for which it can be sold
– Equal to net present value of expected future
profit
• Risk premium
– Accounts for risk of not knowing future profits
– The larger the rise, the higher the risk
premium, & the lower the firm’s value
Maximizing the Value of a Firm
• Maximize firm’s value by maximizing
profit in each time period
– Cost & revenue conditions must be
independent across time periods
• Value of a firm =
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3. What is a Market?
• A market is any arrangement through
which buyers & sellers exchange goods &
services
• Markets reduce transaction costs
– Costs of making a transaction other than the
price of the good or service
Price-Takers vs. Price-Setters
• Price-taking firm
– Cannot set price of its product
– Price is determined strictly by market forces of
demand & supply
• Price-setting firm
– Can set price of its product
– Has a degree of market power, which is ability
to raise price without losing all sales
Market Structures
• Market characteristics that determine the
economic environment in which a firm
operates
– Number & size of firms in market
– Degree of product differentiation
– Likelihood of new firms entering market
Perfect Competition
• Large number of relatively small firms
• Undifferentiated product
• No barriers to entry
Monopoly
• Single firm
• Produces product with no close substitutes
• Protected by a barrier to entry
Monopolistic Competition
• Large number of relatively small firms
• Differentiated products
• No barriers to entry
Oligopoly
• Few firms produce all or most of market
output
• Profits are interdependent
– Actions by any one firm will affect sales &
profits of the other firms
Globalization of Markets
• Economic integration of markets located in
nations around the world
– Provides opportunity to sell more goods &
services to foreign buyers
– Presents threat of increased competition from
foreign producers
Recognize the time value of money
♦ Many decisions have monetary implications
throughout a long period of time (R&D is a
typical example). This raises specific problems.
♦ 1€ today is worth more that 1€ one year from
now.
– Opportunity cost of capital;
– Use present values.
♦ Example: R&D of new drugs.
•
4. Conduct marginal analysis
♦ Why and how marginal analysis:
– Decide on the basis of marginal benefits
and marginal costs.
♦ Examples:
– Discrete decisions: How many machines
(Labor) to buy?
3. Use economic profits
♦ Accounting profits
♦ Economic profits:
– Oportunity costs.