1-Prelim-Nature-and-Scope-of-Managerial-Economics (1).pptx

Nature and Scope of Managerial Economics  What is Managerial Economics? “Managerial Economics applies economic tools and techniques to business and administrative decision- making.”  How is Managerial Economics Useful? How is Managerial Economics Useful? 1. Evaluatin...

Nature and Scope of Managerial Economics  What is Managerial Economics? “Managerial Economics applies economic tools and techniques to business and administrative decision- making.”  How is Managerial Economics Useful? How is Managerial Economics Useful? 1. Evaluating Choice Alternative s 2. Making the Best Decisions How is Managerial Economics  Managerial economics helps Useful? managers recognize how economic forces affect 1.Evaluatin organizations and describes the economic consequences of g Choice managerial behavior. Alternativ  Managerial economics helps managers arrive at a set of es operating rules that aid in the efficient use of scarce human and capital resources. By 2. Making the following businesses, these rules, nonprofit Best organizations and government agencies are able to meet Decisions objectives efficiently. How is Managerial Economics Useful? 1. Evaluating  Managerial economics Choice offers a comprehensive Alternative application of s economic theory and methodology to 2.Making management decision- making. the Best Decisions How is Managerial Economics Useful?  For example, a grocery retailer may offer consumers a highly 1. Evaluating price-sensitive product, such as milk, at an extremely low Choice markup over cost - say, 1 per Alternative cent to 2 per cent - while offering less price-sensitive s products, nonprescription such drugs, as at markups of as high as 40 per cent over cost. 2.Making  Managerial economics describes the Best the logic of this pricing practice with respect to the goal of Decisions profit maximization. Theory of the Firm  Theory of the Firm The model of business is called the theory of the firm. At its simplest level, a business enterprise represents a series of contractual relationships that specify the rights and responsibilities of various parties.  Theory of the Firm  In its simplest version, the firm is thought to have profit maximization as its primary goal. The firm's owner-manager is assumed to be working to maximize the firm's short-run profits.  Today, the emphasis on profits has been broadened to encompass uncertainty and the time value of money. In this more complete model, the primary goal of the firm is long-term expected value maximization. The Expected Value Maximization is the optimization of profits in light of uncertainty and time value of money.  Theory of the Firm  The value of the firm is the present value of the firm's expected future net cash flows.  If cash flows are equated to profits for simplicity, the value of the firm today, or its present value, is the value of expected profits, discounted back to the present at an appropriate interest rate. This model can be expressed as follows:  Theory of the Firm 2. Limitations of the 1. Limited Availability amount of investment of Essential Inputs available – such as skilled labor, raw - the available financial capital for the materials, energy, specialized project determines its future. machinery and warehouse. 3. Contractual Requirements - labor contracts limit flexibility in worker scheduling and job assignments. 4. Quality Requirements 5. Legal Restrictions - nutritional requirements for feed - Laws that define minimum wages, mixtures, and customer service health and safety standards, requirements for minimum pollution emission standards, and fair satisfaction levels. pricing and marketing practices all limit managerial flexibility. Constraints of the Theory of the Firm  Theory of the Firm Limitations of the Theory of the Firm  In practice, do managers try to…? OPTIMIZE SATISFICE …seek …seek the best satisfactory solution. rather than optimal results. Do managers seek the sharpest needle in a haystack (optimize), or do they stop after finding one sharp enough for sewing (satisfice)?  Theory of the Firm Limitations of the Theory of the Firm  Research shows that vigorous competition typically forces managers to seek value maximization in their operating decisions.  Competition in the capital markets forces managers to seek value maximization in their financing decisions as well.  Moreover, recent studies show a strong correlation between firm profits and managerial compensation. Management has strong economic incentives to pursue value maximization through their decisions.  Theory of the Firm Limitations of the Theory of the Firm  It is sometimes overlooked that managers must consider all relevant costs and benefits before they can make reasoned decisions.  It is unwise to seek the best technical solution to a problem if the costs of finding such a solution greatly exceed resulting benefits.  As a result, what often appears to be satisficing on the part of management can be interpreted as value-maximizing behavior once the costs of information gathering and analysis are considered.  Profit Measurement  Profit Measurement “Free enterprise depends upon profits and the profit motive. Both play a role in the efficient allocation of economic resources worldwide.” Accounting or Economic Business Profit versus Profit  This profit is business  Profit that is usually profit minus the implicit defined as the residual of (noncash) costs of capital sales revenue minus the and other owner- explicit costs of doing provided inputs used by business. the firm. The concepts of business profit and economic profit can be used to explain the role of profits in a free-enterprise economy.  Profit Measurement Why do profits vary among firms???  Profit Measurement Disequilibrium Profit Theories - Frictional Profit Theory -  abnormal profits observed following unanticipated changes in demand or cost conditions.  Unanticipated shocks (in the market demand) produce positive or negative economic profits for some firms.  For example, A rise in the use of plastics and aluminum in automobiles drives down the profits of steel manufacturers. - Monopoly Profit Theory -  Above-normal profits caused by barriers to entry that limit competition.  Economies of scale, high capital requirements, patents or import protection enable some firms to build monopoly positions that allow above-normal profits for extended periods.  Monopoly profits can also arise because of luck (being in the right industry at the right time) or from anticompetitive behavior.  Profit Measurement Compensatory Profit Theories - Innovation Profit Theory -  describes above-normal profits that arise following successful invention or modernization.  For example, Apple Corporation has earned above-normal rates of return as an early innovator with its iPod line of portable digital music and video players.  Profits that are due to innovation are susceptible to the onslaught of competition from new and established competitors. - Compensatory Profit Theory -  describes above-normal rates of return that reward firms for extraordinary success in meeting customer needs and maintaining efficient operations.  Compensatory profit theory also recognizes economic profit as an important reward to the entrepreneurial function of owners and managers.  Profit Measurement Economic profits play an important role in any market-based economy.  Above-normal profits serve as a valuable signal that firm or industry output should be increased.  Expansion by established firms or entry by new competitors occurs quickly during high profit periods.  Just as above-normal profits signal the need for expansion and entry, below-normal profits signal the need for contraction and exit.  Economic profits are one of the most important factors affecting the allocation of scarce economic resources.  Above-normal profits also reward innovation and efficiency, just as below-normal profits penalize stagnation and inefficiency. Role of Profits in the Economy  Role of Business in Society  Role of Business in Society “Business makes a big contribution to economic betterment around the globe.” Why Firms Exist?  Because they are Useful.  Because of Public Consent. “No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other. You cannot serve both God and money. - Matthew 6:24 Thank you for Listening...