Chap 1
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Slide 12002 South-Western, Thomson Learning
Managerial Economics: Applications, Strategy, and Tactics, 9th Edition
by McGuigan, Moyer, & Harris
PowerPoint Lecture Slidesprepared by
Richard D. MarcusUniversity of Wisconsin - Milwaukee
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Slide 2
Chapter 1» Introduction to Managerial Economics» Structure of Decision Models» Profit’s Role» Agency Problems & Solutions» Not-for-Profit Organizations» Why Corporations Have Succeeded
Over Other Organizational Forms
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Slide 3
Managerial EconomicsAn Applied Course
Integrates the use of economics, math, and financial analysis to make good business decisions
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Slide 4
• Demand and Supply Analysis and how to estimated elasticities
• Production and Cost Analysis and how to estimate relationships
• Monopoly, Competition, and Oligopolies and how to make good pricing decisions
TOPICS
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Slide 5
Economic Decisions
• Constraints -- limitations of time, energy, money, productive capacity, regulatory climate, etc.
• Information -- forecasting, relationships, expectations, possible retaliation by rivals, etc.
CONSTRAINTS
INFORMATION
GOALS & OBJECTIVES
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Slide 6
Objectives of the Firm• Profit maximization• Shareholder wealth
The value of the firm =V0 (shares outstanding), is the present value of expected future profits or cash flows, discounted at the shareholders required rate of return, ke, ignoring taxes. V0 (shares outstanding) = t /(1+ke) t t=1
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Slide 7
Goals or Objectives
• Maximize Present Value of Profits =N(Revenuet - Costst) / (1+ke)t
t=1
• Decision Model Language:» Objective Function = sets up the goals & the
constraints» Decision Rule = shows what is optimal
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Slide 8
EXAMPLE: MAX { A, B }• simple objective function, simple decision rule
» Pick A if profit {A} > profit {B}, otherwise pick B.• Max Profit { Q} for a competitive firm
» produce where P = MCMC
P
Q
Profit = TR - TC =P•Q - TC
Q-
Q+
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Slide 9
• To make good economic decisions, managers need to be able to forecast & estimate relationships
• Will be forecasting demand » applies to for-profit corporations» non-profit organizations
• Hospital Administrators -- # patients• University Administrator -- enrollment
• Regression analysis, time series methods, and qualitative forecasting methods used for forecasting
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Slide 10
The Role of Profits• Economic Cost (or opportunity cost) is
the highest valued benefit that must be sacrificed as a result of choosing an alternative.
• Economic profit is the difference between revenues and total economic cost (including the economic or opportunity cost of owner supplied resources such as time and capital.
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Slide 11
Theories of Why Profit Varies Across Industries
• RISK-BEARING THEORY• DYNAMIC EQUILIBRIUM (or
FRICTIONAL) THEORY OF PROFIT• MONOPOLY THEORY OF PROFIT• INNOVATION THEORY OF PROFIT• MANAGERIAL EFFICIENCY THEORY
OF PROFIT
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Slide 12
Agency Problems• Modern corporations allow managers to have
no, or limited, ownership participation in the profitability of the firm.
• Shareholders may want profits, but managers may wish to relax.
• The shareholders are principals, whereas the managers are agents. » Conflicting motivations between these
groups are called agency problems.
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Slide 13
• The Principal-Agent Problem» Shareholders (principals) want profit» Managers (agents) want leisure & security
• Examples» KKR’s takeover of RJR Nabisco to refocus
on wealth-maximization» The LBO by O.M. Scott from ITT
improved Scott’s performance
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Slide 14
Solutions to Agency Problems• Compensation as incentive• Extending to all workers stock options,
bonuses, and grants of stock» Help make workers act as owners of firm
• Incentives to help the company, because that improves the value of stock options and bonuses.
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Slide 15
What Went Right? What Went Wrong?• Saturn Corporation
» Different kind of car company in 1991» No-haggle pricing» Sales were above expectations
• But, margin of only $400 per car to GM» GM earned only 3% on capital» Saturn customers wanted bigger Saturns rather than trade up to
Buick, as GM hoped.» When the dollar appreciated, Japanese firms could price their cars
more competitively.
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Slide 16
Shareholder Wealth Maximization: Conditions
• COMPLETE MARKETS - liquid markets for firm's inputs and by-products (including polluting by-products).
• NO SIGNIFICANT ASYMMETRIC INFORMATION - buyers and sellers all know the same things.
• KNOWN RECONTRACTING COSTS future input costs are part of the present value of expected cash flows.
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Slide 17
Goals in the Public Sector and the Not-For-Profit (NFP) Enterprise
Instead of profit, NFP organizations may have as their goals:1.Maximization of the quantity of output, subject to a
breakeven constraint.2.Maximization of the utility (happiness) of NFP
administrators.3. Maximization of cash flows.4. Maximization of the utility of contributors to the NFP
organization.
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Slide 18
• Which goal a NFP manager selects affects decisions made. » A food shelter manager may decide to maximize the
utility of contributors by selecting only "healthy foods"• Public sector managers are performance monitored.
» V.A. hospital administrators are rewarded by reducing the cost per bed over a year. Hence, they become efficient with respect to costs.
» The "friendliness" of the hospital staff is harder to measure, so friendliness will tend not be a high priority of the public sector manager.