Managerial Economics Introduction to the Course Aalto University School of Science Department of Industrial Engineering and Management January 12 28, 2016 Dr. Arto Kovanen, Ph.D. Visiting Lecturer I am a Finn, but I have spent over 30 years in the United States to study and work I received my doctoral degree in economics from Purdue University, but I have also studied in Finland I have taught economics at universities in the U.S. Most of my career, I have spent in institutions that deal with economic policy issues, including Bank of Finland, the IMF, and the Institute of International Finance Currently, I own a consulting company and advise policy makers on macro- and monetary policy matters, conduct economic research, and teach economics A little bit about me What kind of course is this? we apply economic thinking to everyday problems of firms Pre-requisite: principles of economics or similar, some basic math is also required The course is taught in English! What is expected of you in this course? Class participation / attendance is not monitored, but not everything is in the course textbook! Complete individual homework assignments on time! Do well in the final exam! What are you in for? The course will comprise 6 lectures, on three Tuesdays and Thursdays, from 14 17 (15 minutes break in the middle) There will be 2 individual homework exercises and a final exam FINAL EXAM (first attempt): February 18, 2016 Grades will be based on (maximum 100 points): Final exam: 60 points Individual exercises (2 exercises): 40 points (2 x 20 points) Minimum requirement to pass: 60 points, of which at least 20 points must come from homework! Grading scale: 5 90; 4 80; 3 70; 2 60; 1 50; 0 < 50 General information Individual homework exercises: Goal: apply economic thinking to firms decision-making Homework 1 is due Tuesday, January 19, 2016 in class (review session on Wednesday, January 20, 2016; time to be confirmed) Homework 2 is due Tuesday, January 26, 2016 in class (review session on Wednesday, January 27, 2016; time to be confirmed) No late submissions accepted (i.e., after the class) Must be completed/submitted individually Lecture slides and exercises will be posted on the web Assistant : Mr. Joosef Valli General information (cont.) Course text: Managerial Economics; Economic Tools for Todays Decision Makers; 7 th Edition; Keat-Young-Erfle (earlier editions of the textbook are fine) Additional material will be covered in the classroom Everything is not in the course textbook (so attend the class and read the additional handouts) The course is divided into three segments: Decision-making within the firm Competing with markets Decision-making applications Content of the Course Segment 1: Decision-making within the Firm Optimal decisions using marginal analysis (1 st week) Production and cost analysis (1 st week) Demand analysis and optimal pricing (1 st week) Estimating and forecasting demand (2 nd week) These topics roughly correspond to chapters 1 through 7 in the course textbook and will be covered during the first and second weeks of classes Content of the Course (cont.) Segment 2: Competing with Markets Perfect competition (2 nd week) Monopoly and oligopoly (2 nd week) Game theory and competitive strategies (2 nd week) Market failure and government intervention (3 rd week) These topics roughly correspond to chapters 8 through 11, and 14 in the course textboo k and will be covered during the second and third weeks of classes Content of the Course (cont.) Segment 3: Decision-making Applications Linear programming (3 rd week) Asymmetric information (3 rd week) Decision-making under uncertainty (3 rd week) Segment 3 materials are not covered in the course text and will be covered during the third week of classes Other useful textbooks to read: Hall Varian, Intermediate Microeconomics Thomas J. Webster, Managerial Economics Samuelson and Marks, Managerial Economics Content of the Course (cont.) What is managerial economics? It is all about economics! Mankiw, Principles of Economics Managerial economics is the application of economic concepts and economic analysis to the problems of the firm to formulate rational managerial decisions It is sometimes referred to as business economics and is a branch of economics that applies microeconomic analysis to decision methods of businesses and other managerial units It draws heavily on quantitative techniques including regression analysis, correlation and calculus It attempts to help optimize business decisions given firms objectives and constraints What is managerial economics? Economics is relevant for business decisions: What is the demand for firms product? How much to charge from customers/pay for inputs? What are the relevant costs of production? Should the firm enter into a new market? Economic practice involves principles and modeling for specific answers: analysis and prediction Relevant economic fields: finance, marketing, industrial organization, labor economics, macroeconomics (public policy making), statistics Managerial economics (cont.) Decision-making lies at the heart of business activity The range of business decisions is vast: Should a high-tech company undertake expensive research (pros and cons, and potential risks)? What kind of bid should a company submit to obtain a contract with government? How to price a product in response to new competitors entry in the market? The best way to become familiar with managerial economics is to study real-world decision-making Decision-making Steps to decision-making (in general): Define the problem facing the management What is the key objectives (profits, revenues)? What are the possible courses of action and what parameters can the decision-maker control? What are the consequences of each alternative action and how would the outcome change if the conditions change? What is the preferred course of action (is it optimal)? Perform sensitivity analysis (underscores uncertainty about the future) Decision-making (cont.) Choice is an essential element of human decisions Economics is the study of understanding how we make choices It seeks to build a theoretical model or roadmap for rational choices, to explain and evaluate the social interaction Choices that the society must make: What goods to produce? What is the best way to produce them? Who will produce them (e.g., public/private sector)? For whom to produce? Economics and choice Scarcity and choice are central for decision making and the discipline of economics Individuals and societies cannot have everything they desire because resources are limited leads to choices Goods and services, and productive resources that are scarce have positive prices, which results from the interaction between supply and demand for them Examples of scarce goods: natural resources, labor, land, physical capital, financial resources Scarcity and decision making How does scarcity influence business decisions? How do constraints limit firms operations? Examples: How much to produce? Should a firm make its own spare parts or buy them from an outside vendor? Should a firm buy or lease a fleet of trucks it uses to transport its products to markets? Should a firm expand to international markets? Should a firm hire more labor or invest in capital? Scarcity (cont.) Importance of markets Mankiw: Principles of Economics What is a market? A place? A product or service? Which sellers? Which buyers? Demand substitutability / differentiation important Products or services are considered to be in the same market if similar in the eyes of BUYERS Relevance of existing and potential buyers Relevance of existing and potential sellers Ease of entry and exit Importance of markets (cont.) MIT In a free and voluntary exchange, both parties (producers and consumers) must gain, or at least one gains while the other is no worse off, for a trade to take place Having a good product does not necessarily sell if there is no demand for it (e.g., nobody uses typewriters anymore) Markets tend to exploit all mutually beneficial trades Important issues: The law of one price (in equilibrium) Market power Symmetry of information (or the lack of it) Are externalities present? Importance of markets (cont.) Role of government policies Mankiw 2009. Demand and supply are also influenced by economic policy decisions of the government and central bank E.g., investment decisions are affected by the cost and availability of credit; employment decisions are influenced by labor market policies and taxation Aggregate demand: Y = C + I + e*(X M) + G Aggregate supply: Y = f(L, K, .) Decisions about fiscal, monetary, exchange rate, and income policies important for consumers and firms They influence expectations and behavior Government policies (cont.) Governments policy objectives differ from those of the private sector Private sector maximizes profits/value of the firm Government has broader objectives, for instance, to promote social welfare and full employment Government often tries to balance benefits and costs of its decisions to the society (cost-benefit analysis more important that making profits) Government also considers distributional effects For instance, how are costs and benefits distributed (e.g., building a public road)? Government policies (cont.)