JWI 515 Managerial Economics, Week1 Summary, 10/11/12
Summary below is based on readings (Hirschey, 2009), class lectures and learning from class discussions. Excellent opportunity for me to revisit the core economic principles and get trained in making better business decisions.
Ia. Managerial economics (week1 lecture1)
************************************
- uses powerful economic concepts and quantitative methods to solve managerial decision problems. Economic concepts include marginal analysis, theory of consumer demand, theory of the firm, industrial org and firm behavior, public choice theory, cost functions, supply demand curves, elasticity. Quantitative methods include Numerical analysis, Statistical estimation, Forecasting, game-theory, optimization techniques, information systems
- It is about winning through applied microeconomics. Maximize the value and efficiency for society by making constrained decisions and allocating scarce resources.
- Navigating competitive environment by making informed decisions, quickly adapting to changes in economic conditions
- illuminate economic forces at individual, firm, economy and market levels
- it is heavily quantitative and statistical; theoretical
- Heart of it is the Economizing problem: To maximize ability to meet unlimited wants and needs of businesses, households and society, using Resources that are are limited. Factors of production are limited resources such as Land, labor, capital, entrepreneurial ability. Organizations will pay for factors of production per current wages for labor, interest for capital and land, and make goods and services to sell. Consumers will purchase the products made with talent and pay with money. Companies will use sales revenue to pay for costs of business. Companies operate with joint effort between investors, suppliers, workers, management and serve customers. Understanding interrelationships is key to meet short term and long term goals. Companies are constrained by legal issues, regulations, public policy, market forces, supply chain, pricing factors, labor union, min wages. Constrained optimization is needed.
Ib. Types of Profits
1a. Normal Profit
******************
Normal profit is the rate of return expected to attract and retain capital
A business is making an economic loss when it fails to earn a normal profit.
1b. Economic Profit
*******************
Economic Profit is the above normal rate of return required to satisfy the firm's shareholders.
Economic Profit = Business Profit - Implicit cost (Opportunity Cost)
Use this to answer "Is it worthwhile running the business? Are opportunity costs (tangible and intangible) too high ? Is this a successful business ?"
1c. Business Profit
*******************
Business Profit (Accounting Profit) = Total Revenues - Explicit Cost
Use this to answer "Is the business viable ?"
If a firm produces an accounting profit that is lower than normal profit, then it is not viable in the long run.
2a. Explicit Accounting Cost (tangible, financial)
***************************************************
Cost of goods sold, rent, wages, interest, insurance
2b. Implicit Opportunity Cost (intangible, non-monetary)
********************************************************
Foregone value associated with current use rather than next-best use of an asset.
It is the highest-valued opportunity that must be turned down to allow current use.
In the job market, it is the income opportunity provided by next-best employment opportunity.
If another firm offers to double your salary, you can't afford to turn in down as the opportunity cost of staying with the current employer is too high.
Reference: Managerial Economics, Hirschey, 2009
Ic. Why Profit is important
***************************
- it is an indicator of business success
when positive, it signals a firms need to expand; says firm realized a gain for society and will continue to grow and prosper; attracts new entrants
when negative, it indicates a firm is in trouble; says the firm needs to change or die
- it is important for business and society
having a profit allows a firm to better fulfill the needs of society
IIa. Optimize, don't compromise (week1, lecture2)
************************************
Ability to identify and analyze costs properly helps make better decisions.
Optimization means to make something as effective, perfect, or useful as possible.
Optimal decision making requires evaluation of choices and alternatives to pick winners and losers.
This is vitally important to optimize resources to achieve the firm's objectives.
IIb. Revenue
*************
Total Revenue = Quantiy sold * Price of product
Average Revenue = Total revenue/Number of units sold => use this to Determine which customers drive most revenues and which product lines lag competition
IIc. Marginal Revenue
*********************
Marginal Revenue = change in total revenue from producing one more unit of product
Typically downward sloping line as prices decline with increasing output. When Total Revenue is maximized, marginal revenue equals zero. Each additional unit of production results in lesser and lesser added revenue. Negative marginal revenue occurs past the point of maximum revenue.
IId. Costs
**********
Short run costs - operating period in which at least one input is fixed eg. no time to buy or install new machinery
Long run costs - total flexibility in use of inputs
Fixed Costs - exists in short run; does not fluctuate with output
eg. machinery, buildings, trucks, mortgage payment, insurance premium, AMC
Variable Costs - fluctuates with level of production & output; exist in short run and long run;
eg. utility expenses, hourly wages, gas, phone bills, temps salary
Total cost = Fixed cost + Variable cost
Marginal Cost = change in total cost from producing one more unit of product; typically positive
Average cost = total costs/number of units sold = cost per unit
If Marginal cost is greater than average cost, average cost will rise.
IIe. Profit
************
Total profit = Total Revenue - Total costs
Marginal profit = change in total profit from a one-unit change in output.
When a firm maximizes profit, marginal profit equals zero
At point of maximum profitability, marginal revenue = marginal cost; does not make sense to keep expanding.
IIf. Optimization with Incremental decision making
***************************************************
One extra unit of production can affect revenue, cost and profit.
Incremental decision making analyzes effect of alternate choices.
IIg. To run a business, key metrics to track are: Revenues, Costs, Profits
***********************************************************************************
The aim of the firm is to Maximize Revenue, Minimize Costs, Maximize Profits. Revenue and Profit should show an upward slope with time while costs should ideally show a downward slope with time. Dysfunctional business will have these relationships reversed eg. IBM in 1993 (Gerstner, "who says elephants can't dance", 2002). Turning around such firms will require a solid grasp of concepts in managerial economics.
Dr DP
Summary below is based on readings (Hirschey, 2009), class lectures and learning from class discussions. Excellent opportunity for me to revisit the core economic principles and get trained in making better business decisions.
Ia. Managerial economics (week1 lecture1)
************************************
- uses powerful economic concepts and quantitative methods to solve managerial decision problems. Economic concepts include marginal analysis, theory of consumer demand, theory of the firm, industrial org and firm behavior, public choice theory, cost functions, supply demand curves, elasticity. Quantitative methods include Numerical analysis, Statistical estimation, Forecasting, game-theory, optimization techniques, information systems
- It is about winning through applied microeconomics. Maximize the value and efficiency for society by making constrained decisions and allocating scarce resources.
- Navigating competitive environment by making informed decisions, quickly adapting to changes in economic conditions
- illuminate economic forces at individual, firm, economy and market levels
- it is heavily quantitative and statistical; theoretical
- Heart of it is the Economizing problem: To maximize ability to meet unlimited wants and needs of businesses, households and society, using Resources that are are limited. Factors of production are limited resources such as Land, labor, capital, entrepreneurial ability. Organizations will pay for factors of production per current wages for labor, interest for capital and land, and make goods and services to sell. Consumers will purchase the products made with talent and pay with money. Companies will use sales revenue to pay for costs of business. Companies operate with joint effort between investors, suppliers, workers, management and serve customers. Understanding interrelationships is key to meet short term and long term goals. Companies are constrained by legal issues, regulations, public policy, market forces, supply chain, pricing factors, labor union, min wages. Constrained optimization is needed.
Ib. Types of Profits
1a. Normal Profit
******************
Normal profit is the rate of return expected to attract and retain capital
A business is making an economic loss when it fails to earn a normal profit.
1b. Economic Profit
*******************
Economic Profit is the above normal rate of return required to satisfy the firm's shareholders.
Economic Profit = Business Profit - Implicit cost (Opportunity Cost)
Use this to answer "Is it worthwhile running the business? Are opportunity costs (tangible and intangible) too high ? Is this a successful business ?"
1c. Business Profit
*******************
Business Profit (Accounting Profit) = Total Revenues - Explicit Cost
Use this to answer "Is the business viable ?"
If a firm produces an accounting profit that is lower than normal profit, then it is not viable in the long run.
2a. Explicit Accounting Cost (tangible, financial)
***************************************************
Cost of goods sold, rent, wages, interest, insurance
2b. Implicit Opportunity Cost (intangible, non-monetary)
********************************************************
Foregone value associated with current use rather than next-best use of an asset.
It is the highest-valued opportunity that must be turned down to allow current use.
In the job market, it is the income opportunity provided by next-best employment opportunity.
If another firm offers to double your salary, you can't afford to turn in down as the opportunity cost of staying with the current employer is too high.
Reference: Managerial Economics, Hirschey, 2009
Ic. Why Profit is important
***************************
- it is an indicator of business success
when positive, it signals a firms need to expand; says firm realized a gain for society and will continue to grow and prosper; attracts new entrants
when negative, it indicates a firm is in trouble; says the firm needs to change or die
- it is important for business and society
having a profit allows a firm to better fulfill the needs of society
IIa. Optimize, don't compromise (week1, lecture2)
************************************
Ability to identify and analyze costs properly helps make better decisions.
Optimization means to make something as effective, perfect, or useful as possible.
Optimal decision making requires evaluation of choices and alternatives to pick winners and losers.
This is vitally important to optimize resources to achieve the firm's objectives.
IIb. Revenue
*************
Total Revenue = Quantiy sold * Price of product
Average Revenue = Total revenue/Number of units sold => use this to Determine which customers drive most revenues and which product lines lag competition
IIc. Marginal Revenue
*********************
Marginal Revenue = change in total revenue from producing one more unit of product
Typically downward sloping line as prices decline with increasing output. When Total Revenue is maximized, marginal revenue equals zero. Each additional unit of production results in lesser and lesser added revenue. Negative marginal revenue occurs past the point of maximum revenue.
IId. Costs
**********
Short run costs - operating period in which at least one input is fixed eg. no time to buy or install new machinery
Long run costs - total flexibility in use of inputs
Fixed Costs - exists in short run; does not fluctuate with output
eg. machinery, buildings, trucks, mortgage payment, insurance premium, AMC
Variable Costs - fluctuates with level of production & output; exist in short run and long run;
eg. utility expenses, hourly wages, gas, phone bills, temps salary
Total cost = Fixed cost + Variable cost
Marginal Cost = change in total cost from producing one more unit of product; typically positive
Average cost = total costs/number of units sold = cost per unit
If Marginal cost is greater than average cost, average cost will rise.
IIe. Profit
************
Total profit = Total Revenue - Total costs
Marginal profit = change in total profit from a one-unit change in output.
When a firm maximizes profit, marginal profit equals zero
At point of maximum profitability, marginal revenue = marginal cost; does not make sense to keep expanding.
IIf. Optimization with Incremental decision making
***************************************************
One extra unit of production can affect revenue, cost and profit.
Incremental decision making analyzes effect of alternate choices.
IIg. To run a business, key metrics to track are: Revenues, Costs, Profits
***********************************************************************************
The aim of the firm is to Maximize Revenue, Minimize Costs, Maximize Profits. Revenue and Profit should show an upward slope with time while costs should ideally show a downward slope with time. Dysfunctional business will have these relationships reversed eg. IBM in 1993 (Gerstner, "who says elephants can't dance", 2002). Turning around such firms will require a solid grasp of concepts in managerial economics.
Dr DP
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