Chapter 1: The Fundamentals of price times quantity sold) minus the dollar
Managerial Economics cost of producing goods or services.
A manager is a person who directs Economic profits are the difference between
resources to achieve a stated goal. This the total revenue and the total opportunity
definition cost of producing the firm’s goods or
services.
Includes all individuals who (1) direct the
efforts of others, including those who Opportunity cost The explicit cost of a
delegate tasks within an organization such as resource plus the implicit cost of giving up its
a firm, a family, or a club; (2) purchase best alternative use.
*Inputs to be used in the production of goods
Profits Are a Signal Profits signal to resource
and services such as the output of a firm,
holders where resources are most highly
Food for the needy, or shelter for the
valued by society
homeless; or (3) are in charge of making
other Decisions, such as product price or The Five Forces Framework
quality
Five forces” framework pioneered by Michael
Economics is the science of making decisions Porter. This framework organizes many
in the presence of scarce resources. complex managerial economics issues into
five Categories or “forces” that impact the
Resources are simply anything used to
sustainability of industry profits.
produce a good or service or, more
generally, to achieve a goal. Entry the ability of existing firms to
sustain profits depends on how
Managerial economics, is the study of how to
barriers entry affect the ease with
direct scarce resources in The way that most
which other firms can enter the
efficiently achieves a managerial goal. It is a
industry.
very broad discipline in that it describes
Power of input supplier Industry
methods useful for directing everything from
profits tend to be lower when suppliers
the
have
*Resources of a household to maximize the power to negotiate favorable
household welfare to the resources of a firm terms for their inputs.
To maximize profits Power of buyer industry profits tend
to be lower when customers or buyers
THE ECONOMICS OF EFFECTIVE
have the power to negotiate favorable
MANAGEMENT
terms for the products or services
Identify Goals and Constraints The first step produced in the industry.
in making sound decisions is to have well- Industry Rivalry The sustainability
defined goals because Achieving different of industry profits also depends on the
goals entails making different decisions. nature And intensity of rivalry among
firms competing in the industry.
Recognize the Nature and Importance of Substitute and complement
Profits The overall goal of most firms is to The level and sustainability of industry
maximize profits or the firm’s value, and the profits
Remainder of this book will detail strategies Also depend on the price and value of
managers can use to achieve this goal. interrelated products and services.
Accounting profit is the total amount of
money taken in from sales (total revenue, or Understand Incentives
Incentives affect how resources are The timing of many decisions involves a gap
used and how hard workers Work. between the time when the costs of a Project
are borne and the time when the benefits of
Understand Markets the project are received.
In studying microeconomics in
Present Value Analysis
general, and managerial economics in
particular, it Present value The amount that Would have
is important to bear in mind that there to be Invested today at The prevailing
are two sides to every transaction Interest rate to Generate the given Future
in a market: value.
For every buyer of a good there is
a corresponding seller. The final Formula (Present Value).
outcome of The present value (PV) of a future value (FV)
the market process, then, depends on the
relative power of buyers and sellers in the
marketplace.
Three sources of rivalry that exist in
economic transactions: received
Consumer–Producer Rivalry occurs Net present value The present value Of the
because of the competing interests of income Stream generated By a project minus
consumers And producers. Consumers The current cost of The project
attempt to negotiate or locate low prices,
Value of a firm takes into account the long-
while producers Attempt to negotiate high
term impact of managerial decisions on
prices.
profits.
Consumer–Consumer Rivalry among consumers
Profit Maximization Maximizing profits means
occurs due to scarcity, where limited goods
lead to competition for purchase, reducing maximizing the value of the firm, which is
individual negotiating power in the the present value of Current and future
marketplace. profits.
Producer–Producer Rivalry third source of
Maximizing Short-Term Profits May
rivalry in the marketplace is producer–
Maximize Long-Term Profits If the growth
producer rivalry. Occurs when multiple sellers
rate in profits is less than the interest rate
compete for limited customers. Producers
and both are constant, maximizing Current
strive to offer the best quality at the lowest
(short-term) profits is the same as
price to attract customers, with the most
maximizing long-term profits.
competitive firms earning the right to serve
them. Use Marginal Analysis Marginal analysis is
one of the most important managerial tools—
Government and the Market When agents on
a tool we will use Repeatedly throughout this
either side of the market find themselves
text in alternative contexts.
disadvantaged in the Market process, they
frequently attempt to induce government to
intervene on their Behalf.
Recognize the Time Value of Money
CHAPTER 3 increase (decrease) in price will lead to an
increase (decrease) in
Elasticity
A measure of the Responsiveness of
Total revenue. Finally, total revenue is
One variable to Changes in another
maximized at the point where demand is
Variable; the percentage change in unitary elastic.
One variable that Arises due to a
Given percentage Change in another
Variable.
Formula:
Own price elasticity of Demand, which
measures the responsiveness of quantity
Perfectly elastic Demand
demanded to a change in Price.
Demand is Perfectly elastic if The own price
First, demand is said to be elastic if the
Elasticity is Infinite in absolute Value. In this
absolute value of the own price elasticity is
case The demand curve Is horizontal.
greater than 1:
Perfectly inelastic Demand
>1
Demand is Perfectly inelastic If the own price
Second, demand is said to be inelastic if the
Elasticity is zero. In this case the Demand
absolute value of the own price Elasticity is
curve is Vertical.
less than 1:
Available Substitutes One key determinant of
<1
the elasticity of demand for a good is the
Finally, demand is said to be unitary elastic if number of close Substitutes for that good.
the absolute value of the own Price elasticity
Time Demand tends to be more inelastic in
is equal to 1:
the short term than in the long term.
=1
Expenditure Share Goods that comprise a
relatively small share of consumers’ budgets
tend to be More inelastic than goods for
Total Revenue Test
which consumers spend a sizable portion of f
If demand is elastic, an increase (decrease) their Incomes.
in price will lead to a decrease (increase) in
total revenue. If demand is inelastic, an
