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What is profit?
What is profit?
Profit is the total amount of money taken in from sales minus the dollar cost of producing goods or services.
What are accounting profits?
What are accounting profits?
Accounting profits are what show up on the firm’s income statement and are reported to managers.
What are economic profits?
What are economic profits?
Economic profits are the difference between total revenue and total opportunity cost.
What are implicit costs?
What are implicit costs?
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How do explicit and implicit costs differ?
How do explicit and implicit costs differ?
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What is the opportunity cost of going to school?
What is the opportunity cost of going to school?
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What is the total economic cost of running a pizzeria that has explicit accounting costs of $20,000, an implicit cost of time valued at $30,000, and a potential rental value of $100,000?
What is the total economic cost of running a pizzeria that has explicit accounting costs of $20,000, an implicit cost of time valued at $30,000, and a potential rental value of $100,000?
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The pursuit of profit by a firm is necessarily bad for society.
The pursuit of profit by a firm is necessarily bad for society.
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What is the goal of firms in a global economy?
What is the goal of firms in a global economy?
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Match the following terms with their definitions:
Match the following terms with their definitions:
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What do profits signal to resource holders?
What do profits signal to resource holders?
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What was the operating loss reported by Amcott?
What was the operating loss reported by Amcott?
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How much did Amcott lose from the copyright infringement suit?
How much did Amcott lose from the copyright infringement suit?
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What percentage were the short-term interest rates when Amcott made its decision?
What percentage were the short-term interest rates when Amcott made its decision?
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What was the projected annual sales for the Magicword software?
What was the projected annual sales for the Magicword software?
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Managerial economics is likely to tell you what the stock market will do tomorrow.
Managerial economics is likely to tell you what the stock market will do tomorrow.
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What is the primary focus of managerial economics?
What is the primary focus of managerial economics?
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Which of the following defines a manager?
Which of the following defines a manager?
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Why is understanding constraints important in managerial decision-making?
Why is understanding constraints important in managerial decision-making?
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What economic concept involves the allocation of scarce resources?
What economic concept involves the allocation of scarce resources?
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What is the overall goal of most firms?
What is the overall goal of most firms?
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Which principle is NOT one of the six principles of effective managerial decision-making mentioned?
Which principle is NOT one of the six principles of effective managerial decision-making mentioned?
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Why was Ralph fired from his managerial post at Amcott?
Why was Ralph fired from his managerial post at Amcott?
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What was Ralph's projected annual sales goal for Magicword?
What was Ralph's projected annual sales goal for Magicword?
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Ralph planned to invest $______ million into Magicword.
Ralph planned to invest $______ million into Magicword.
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What was the projected net present value (NPV) of purchasing Magicword?
What was the projected net present value (NPV) of purchasing Magicword?
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Ralph was fired because of the mistakes of his legal department.
Ralph was fired because of the mistakes of his legal department.
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What is one of the key concepts Ralph failed to recognize?
What is one of the key concepts Ralph failed to recognize?
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What is the main focus of managerial economics?
What is the main focus of managerial economics?
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In managerial economics, it is assumed that everyone is acting in their own self-interest.
In managerial economics, it is assumed that everyone is acting in their own self-interest.
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Which of the following are sources of rivalry in economic transactions? (Select all that apply)
Which of the following are sources of rivalry in economic transactions? (Select all that apply)
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Define consumer–producer rivalry.
Define consumer–producer rivalry.
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What impact does consumer–consumer rivalry have?
What impact does consumer–consumer rivalry have?
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What is the role of government in the market process?
What is the role of government in the market process?
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The present value of $1.10 to be received one year from today is $1.00 if the interest rate is 10 percent.
The present value of $1.10 to be received one year from today is $1.00 if the interest rate is 10 percent.
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The present value (PV) of a future value (FV) received in n years is calculated as: $FV / (1 + i)^n where i is the _____ rate.
The present value (PV) of a future value (FV) received in n years is calculated as: $FV / (1 + i)^n where i is the _____ rate.
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What indicates a profitable project in terms of net present value?
What indicates a profitable project in terms of net present value?
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Match the formulae or concepts with their descriptions:
Match the formulae or concepts with their descriptions:
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What is the value of a perpetual bond that pays $100 at the end of each year when the interest rate is fixed at 5 percent?
What is the value of a perpetual bond that pays $100 at the end of each year when the interest rate is fixed at 5 percent?
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What does the value of a firm represent?
What does the value of a firm represent?
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What is the formula for the present value of a firm's future profits if profits are expected to grow at a constant rate g?
What is the formula for the present value of a firm's future profits if profits are expected to grow at a constant rate g?
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What happens to the value of a firm on the ex-dividend date?
What happens to the value of a firm on the ex-dividend date?
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What should the current profits of a firm be maximized for, according to the principles discussed?
What should the current profits of a firm be maximized for, according to the principles discussed?
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According to the demonstration problem, what is the value of the firm when current profits are $100 million with a 10 percent interest rate and 5 percent growth rate?
According to the demonstration problem, what is the value of the firm when current profits are $100 million with a 10 percent interest rate and 5 percent growth rate?
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How much is the value of the firm on the ex-dividend date when $100 million is paid out as dividends?
How much is the value of the firm on the ex-dividend date when $100 million is paid out as dividends?
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Is paying for a membership in advance financially beneficial according to the present value analysis?
Is paying for a membership in advance financially beneficial according to the present value analysis?
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Maximizing current profits may maximize the long-term profits of a firm if the growth rate is less than the interest rate.
Maximizing current profits may maximize the long-term profits of a firm if the growth rate is less than the interest rate.
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What is the main focus of marginal analysis in managerial economics?
What is the main focus of marginal analysis in managerial economics?
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Study Notes
Managerial Economics defined
- Managerial Economics is the study of how to direct scarce resources in the way that most efficiently achieves a managerial goal.
The Economics of Effective Management
- An effective manager must: * Identify goals and constraints * Recognize the nature and importance of profits * Understand incentives * Understand markets * Recognize the time value of money * Use marginal analysis
Goals and Constraints
- Different units within a firm may be given different goals, for example; the marketing department may focus on maximizing sales or market share, while the financial group might focus on earnings growth or risk-reduction strategies.
- Constraints make it difficult for managers to achieve goals, these constraints include such things as the available technology and the prices of inputs used in production.
Profits
- Economic profits are the difference between the total revenue and the total opportunity cost of producing the firm’s goods or services.
- Opportunity cost includes the explicit (or accounting) cost of a resource plus the implicit cost of giving up the best alternative use of the resource.
- Implicit costs can be hard to measure, but effective managers seek out data from other sources to identify and quantify them.
Opportunity cost examples
- What is the opportunity cost of reading this book?
- What is the opportunity cost of working as a manager at a Fortune 500 company?
Managerial decision examples for a computer firm
- Should the firm produce certain components or buy them from other manufacturers?
- Should the firm specialize in one type of computer or produce several different types?
- What is the optimal price to charge?
- How many computers should be produced?
- How many employees should be hired?
- How should the employees be compensated?
- How to ensure that employees work hard and produce quality products?
- How will the actions of rival computer firms affect decisions?
- The key to making sound decisions is to know what information is needed and then to collect and process the data.
Managerial decision examples outside of a Computer firm
- A food bank may need to decide how to best distribute food to the needy - a shelter for the homeless may need to decide how to help the largest possible number of people given a very tight budget.
Explicit Costs vs. Implicit Costs
- Explicit costs are the actual expenses a business incurs, like the price of a book or raw materials.
- Implicit costs are the opportunity costs of using resources for one purpose instead of another, such as giving up time to read a book or not working for someone else.
Economic Profits vs. Accounting Profits
- Accounting profits are the difference between revenue and explicit costs.
- Economic profits also factor in implicit costs, representing the opportunity cost of resources used in production.
The Role of Profits
- Profits act as a signal to resource holders, indicating where resources are most highly valued by society.
- When profits are higher in a given industry, new firms will enter, increasing competition.
- When losses are recorded, firms may exit the industry, leading to market adjustments based on demand.
Understanding Incentives
- Individuals often act in their own self-interest, understanding this is crucial for designing effective incentive systems within organizations.
- Aligning an individual's self-interest with the goals of the organization is key to maximizing productivity.
- Incentive plans, such as bonuses tied to profitability, can motivate employees to prioritize organizational success.
Understanding Markets
- Markets involve both buyers and sellers, and the relative power of each side determines the market outcome.
- Three sources of rivalry influence bargaining power: consumer-producer, consumer-consumer, and producer-producer.
- Understanding these rivalries helps managers make sound decisions in the face of competition.
Consumer-Producer Rivalry
- Consumers seek low prices, producers seek high prices.
- The balance between supply and demand acts as a natural check on extreme price fluctuations, even in monopolies.
- Examples include haggling over price between a car buyer and salesperson.
Consumer-Consumer Rivalry
- Limited resources lead to competition among consumers for available goods.
- This rivalry reduces the negotiating power of individual consumers, leading to higher prices.
- Occurs when demand exceeds supply.
Rivalry in the Marketplace
- Consumers compete with each other for scarce goods, paying the highest prices to secure them.
- Auctions exemplify consumer-consumer rivalry.
- Producer-producer rivalry occurs when multiple sellers compete for customers, offering the best quality at the lowest prices.
- Government involvement in the market is common when agents on either side find themselves disadvantaged, seeking to alter the balance of power.
Time Value of Money
- The value of $1 today is greater than $1 received in the future due to the forgone interest that could be earned.
- This concept is known as the time value of money.
- The present value (PV) of a future amount is the investment needed today to generate the future amount at the prevailing interest rate.
- The higher the interest rate, the lower the present value of a future amount.
- The present value of a future payment reflects the difference between the future value and the opportunity cost of waiting.
Net Present Value
- Net present value (NPV) is the present value of an investment's income stream minus the initial cost.
- A positive NPV indicates profitability since the present value of income exceeds the initial cost. A negative NPV means the cost outweighs the earnings.
Present Value of Indefinitely Lived Assets
- Some assets produce cash flows indefinitely, like perpetual bonds or preferred stocks.
- The present value of indefinitely lived assets can be calculated using specific formulas for perpetual streams.
- The value of a firm is determined by the present value of its profit stream generated by its assets.
Profit Maximization
- Maximizing profits means maximizing the value of the firm, which is the present value of its current and future profits.
- Under certain assumptions (constant growth rate of profits less than the interest rate), maximizing short-term profits is equivalent to maximizing the long-term value of the firm.
Present Value of a Firm
- The present value of a firm is the sum of the present values of its expected future earnings.
- The formula for the present value of a firm is:
PVFirm = P0/(1+i) + P0(1+g)/(1+i)^2 + P0(1+g)^2/(1+i)^3 + ...where:-
P0is the current profit -
iis the interest rate -
gis the growth rate of profits
-
- If the growth rate of profits is constant, then the present value of a firm can be calculated more easily:
PVFirm = P0(1+g)/(i-g) - The value of a firm immediately after it pays a dividend equal to its current profits is the present value of the firm minus the dividend payment.
Marginal Analysis
- Marginal analysis states that optimal managerial decisions involve comparing the marginal benefits of a decision with the marginal costs.
- Marginal benefits refer to the additional benefits from taking an action.
- Marginal costs refer to the additional costs associated with an action.
Time Value of Money
- The time value of money is the idea that money is worth more today than it is in the future, due to the possibility of earning interest or returns.
- The present value (PV) of a future amount is the value today of that amount when discounted at an appropriate rate.
Present Value of Membership Fees
- If you pay for a one-year membership in advance, the present value of the cost is the total fee paid upfront.
- If you pay for a membership in installments over the year, the present value of the cost is calculated by adding the present values of each installment.
- The present value of each installment is calculated using the formula:
PV = FV / (1 + i)^nwhere:-
FVis the future value of the installment -
iis the interest rate per period -
nis the number of periods
-
Key Terms
- Accounting cost: The explicit costs of production such as wages, raw materials, and rent.
- Accounting profits: Revenues minus accounting costs.
- Economic profits: Revenues minus both explicit and implicit costs.
- Explicit cost: A cost that is incurred when money is spent on inputs.
- Implicit cost: The opportunity cost of using a resource owned by the firm.
- Opportunity cost: The value of the best alternative forgone.
- Time value of money: The idea that money is worth more today than it is in the future.
- Net present value (NPV): The present value of all future net cash flows.
- Value of a firm: The present value of the firm's future earnings.
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Description
This quiz explores the key principles of Managerial Economics, including goal identification, constraints, and profit analysis. It covers the fundamentals necessary for effective management and resource allocation in a firm. Test your understanding of these critical economic concepts and their applications in management.
