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CA5102: MANAGERIAL ECONOMICS 1st Departmental Examination LECTURE Six (6) Basic Principles Comprising Effective...

CA5102: MANAGERIAL ECONOMICS 1st Departmental Examination LECTURE Six (6) Basic Principles Comprising Effective Management MODULE 01: FUNDAMENTALS OF ECONOMICS Definition Of Economics 1. IDENTIFY GOALS AND CONSTRAINTS ➔ Science of making decisions on the allocation of Goals limited resources in the presence of unlimited ➔ Depend on the manager’s aim wants and needs. ➔ Different goals require different decisions ➔ Resources: anything used to produce a product or service. Example: ➔ Decisions: important since scarcity implies trade-offs (giving up something to attain ➔ marketing department : maximize sales or something). market share :: finance department : revenue growth or risk reduction Factors Of Production Constraints ➔ The factors of production are: ➔ Hinder managers from accomplishing the goals Land Capital of the organization Example: Labor Entrepreneur End Goal Of Economics ➔ available technology, capital, and labor and input prices ➔ To satisfy the needs and wants of people (who are insatiable). 2. RECOGNIZE THE NATURE AND ➔ Goal of profit-oriented firms: profit maximization IMPORTANCE OF PROFIT by effective resource allocation ➔ Profits Managerial Economics ◆ Show which products customers spend money on ➔ Economics applied in decision-making ◆ Tell resource holders which resources ➔ Econometrics - involves empirical proofs for (used to make products) are most highly economic models valued Manager ➔ Adam Smith, the "Father of Modern Economics” ➔ Person who directs resources to achieve a stated goal ◆ By creating profit for itself, an ➔ Directs the efforts of others and purchases organization meets society's need for inputs of the firm's output products. ➔ Directs the product price or quality decisions ➔ The high demand and low supply [which creates Types of Businesses high economic profits] of products induce new firms to enter the market, causing price drops ➔ Labor-intensive (requires heavy manpower) and economic profit decline. ➔ Capital-intensive (requires high finance) ➔ Importance of Profits in a Free Market Economics Of Effective Management Economy 1. Identify goals and constraints ◆ Accounting profit - total amount of 2. Recognize the nature and importance of profits money taken in from sales (total 3. Understand the incentives revenue) minus the amount of cost of 4. Understand the markets producing goods or services 5. Recognize the time value of money 6. Use marginal analysis Formula PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 1  accounting profit = total revenue - Buyer concentration, price/value explicit costs of substitute products or services, relationship-specific investments, customer switching costs, ◆ Economic profit government restraints. Industry profits less when buyers Formula can bargain/negotiate for lower economic profit = total revenue - prices for the products. opportunity cost ◆ Opportunity cost - explicit costs (e.g. Power of Situation when buyer power is wages, rent, and cost of materials) plus Buyers high: implicit costs (forgone salary or forgone The buyer is well-informed rent) of giving up the best alternative about the product. 3. UNDERSTAND INCENTIVES The buyer purchases a ➔ Monetary and Non-Monetary substantial amount of standardized products. 4. UNDERSTAND THE MARKETS Substitute products are ➔ Five Forces Framework - identifies the state of available in the market. competition and profitability of an industry ◆ Michael Porter - academician and Concentration, price, quantity, management guru who pioneered the quality, or service competition, Five Forces Framework. degree of differentiation, switching costs, timing of decisions, information, and government Entry costs, speed of adjustment, restraints. sunk costs, economies of scale, network effects, reputation, Businesses get higher and more switching costs, government stable profits when there are less restraints. Industry Rivalry numbers or decreased intensity of competition. Sustainability of Threat of New Increases competition and industry profits vary according to Entry decreases sales of existing the nature and intensity of businesses in a wide variety of competing firms. industry settings. Situation when rivalry is less: Example: Toyota employed There are few businesses or there globalization strategies and is monopoly in the industry. pierced the car industry. Price/value of surrogate products Supplier concentration, or services, price/value of price/productivity of alternative complementary products or inputs, relationship-specific services, network effects, investments, supplier switching government restraints. costs, and government restraints. Substitutes and Industry profits depend on the Industry profits are less when Complements price and value of interrelated suppliers can bargain/negotiate for products and services. Customers Power of (Input) higher prices for their supplies. may opt to purchase a substitute, Suppliers especially in the unavailability or Situation when supplier power is steep price of the product's low: "When inputs are relatively complements). standardized and relationship specific investments are minimal, input markets are not highly concentrated or alternative inputs ➔ Rivalries in Economic Transactions are available with similar marginal ◆ Influence the bargaining power of productivity" buyers and sellers PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 2  ◆ A customer purchases a product, a interest rate to generate the consumer uses a product. given future value Where: PV = Present Value FV = Future Value i = interest rate n = number of years ◆ Present Value of a Stream of Future Values Cumulative present value of Consumer-Producer Rivalry - future cash flows Consumers negotiate for low prices, while producers negotiate for high prices. Both attempt to "rip off" each other. Consumer-Consumer Rivalry - Induced by the economic ◆ The Net Present Value of a Project doctrine of scarcity, consumers Present Value (PV) of the compete for (the right to income stream generated by the purchase) limited goods. project minus the current cost of the project Producer-Producer Rivalry - The best-quality products at the NPV = FV - OCW best-price are sold more in the market. Where: ○ Example: Two gas NPV = Net Present Value stations across one FV = Future Value another OCW = Opportunity Cost of Waiting Government and the Market - Result interpretation The market induces the Net present value is (+): the project is government (highly influences profitable because the current value of the the market process) to intervene earnings from the project exceeds the current when disadvantaged. cost of the project Net present value is (-): the project should ○ Example: when the be rejected since the costs exceed the prices are too steep, present value of the income stream that consumers ask for a project generates salary increase ◆ Present Value of Indefinitely Lived 5. RECOGNIZE THE TIME VALUE OF MONEY Assets Some decisions generate cash ➔ Explains how much money an entity needs so flows that continue indefinitely. the investment will earn in the future Consider an asset that ➔ Timing of decisions involves a gap between the generates a cash flow from one time between costs are born and benefits to three years for an indefinite received period of time. ➔ Used by managers to properly account for the The asset generates a perpetual timing of receipts and expenditures stream of identical cash flows at ➔ J the end of each period. ◆ Present Value of a Single Future Value Amount that would have to be PVperpetuity = invested today at the prevailing PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 3  ➔ Optimal managerial decisions involve comparing Where: the marginal benefits and marginal costs CF = Cash Flow ➔ To maximize net benefits i = Interest rate ◆ Present Value and Profit N(Q) = B(Q) - C(Q) Maximization Present value analysis is useful Where: in determining the value of a Q = control variable of a managerial objective firm B(Q) = total benefit ○ Since the value of a firm C(Q) = total cost is the present value of the stream of profits ➔ To maximize net benefits, the manager should (cash flow) generated increase the managerial control variable up to by the firm's physical, the point where marginal benefits equal marginal human and intangible costs. asset ◆ This level of the managerial control ○ The value of the firm variable corresponds to the level at today is the present which marginal net benefits are 0. value of its current and ◆ Nothing more can be gained from future profits further changes in that variable. Considers the long-term impact of managerial decisions on Marginal Net Benefits: MNB(Q) profits When economists say that the MNB(Q) = MB(Q) - MC(Q) goal of the firm is to maximize profit, it should be understood Where: that the firm should maximize its MB(Q) = Marginal Benefit value which is the present value MC(Q) = Marginal Cost of current and future profits ➔ Marginal benefit: MB(Q) ◆ The change in total benefits arising from Value of the firm before dividend payment a change in the managerial control variable, Q PV = Value of the firm ➔ Marginal cost: MC(Q) ◆ The change in the total costs arising Where: from a change in the managerial control PV = Present Value variable, Q i = Interest Rate ➔ Determining the Optimal Level of a Control g = Growth Rate Variable ◆ Imagine that profit is expected to grow at a constant growth rate each year and that profit growth rate is less than the interest rate Example: Suppose the interest rate is 10% and the firm is expected to grow at 5% for the foreseeable future. The firm's current profits are Php100,000,000.00. 6. USE MARGINAL ANALYSIS ➔ Determining the Optimal Level of a Control Variable II ➔ Business decisions ◆ ff should be made and ◆ f actions should be taken ◆ f ➔ One of the most ◆ f important managerial ◆ f tools ◆ f ➔ Analysis of benefits and ◆ f costs of the marginal ◆ f unit of a good or input ◆ f PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 4  ◆ f 10 20 ◆ Net Benefits - maximized at a point where the difference of a total benefit 0 30 and total cost is the greatest. ➔ Determining the Optimal Level of a Control Law of Demand Variable III ◆ ff ➔ Quantity of goods that consumers are willing ◆ f and able to purchase increases/decreases as ◆ f the price falls/rises. ◆ f ➔ Price and quantity demanded are inversely ◆ f related. ◆ f ➔ Demand Curve: Downward Slope ◆ f ◆ f ◆ f ◆ f ◆ The slope of Total Benefits Curve and slope of Total Cost Curve are equal when benefits are maximized (MNB: M(B) = M(C)) Shift in Quantity Demanded vs Shift in Demand ◆ Calculus Alternative Slope of a continuous function Changing only price → Changes in quantity of the derivative/marginal value demanded of that function ➔ Graphically represented by a movement along a given demand curve, holding other factors that impact demand constant. Total Benefit Curve 𝑑𝐵(𝑄) MB = 𝑑(𝑄) Total Cost Curve 𝑑𝐶(𝑄) MC = 𝑑(𝑄) Net Benefits 𝑑𝑁(𝑄) MNB = 𝑑(𝑄) Changing other factors, except price → Changes in demand ➔ Graphically represented by a shift of the entire MODULE 02: MARKET FORCES demand curve. DEMAND Market Demand Curve ➔ Illustrates the relationship between the total quantity and price per unit of a good all consumers are willing and able to purchase, holding other variables constant ➔ Demand Schedule ◆ When the price is set at the maximum, quantity demanded is 0. Demand Function P (Price) Qd (Quantity Demanded) ➔ The demand function for Good X is a mathematical representation describing how 30 0 many units will be purchased or demanded at different prices for x, the price of related Good Y, 20 10 income, and other factors that affect the demand of Good X. PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 5  Example: Suppose Bench as an advertisement on TV that they will be introducing a new line of Demand Shifters items (jeans) in their store (generation X - target market). ➔ Variables other than the price of a good that ◆ Population - As the population rises, influence demand are known as demand more and more individuals wish to buy a shifters. given product, and this has the effect of ➔ The movement along a demand curve, such as shifting the demand curve to the right. the movement from A to B, is called a change in Example: As a greater quantity demanded. proportion of the population ➔ A rightward shift in the demand curve is called ages, the demand for medical an increase in demand, since more of the good services will tend to increase. is demanded at each price. ◆ Consumer Expectations ➔ A leftward shift in the demand curve is called a If the consumers expect the decrease in demand. price of gasoline to increase ◆ Income - A change in income shifts the next week, its demand will entire demand curve. increase today (to avoid the Normal Good - Good for which price increase). an increase in income leads If consumers expect future to an increase in the demand prices to be higher, they will for that good. Conversely, when substitute current purchases for consumers suffer a decline in future purchases. income, the demand for a This type of consumer behavior normal good will decrease (shift often is referred to as to the left). stockpiling and generally ○ Example: steak, air occurs when products are travel, jewelry durable in nature. Inferior Good - Good for which ◆ Other Factors an increase in income leads Any variable that affects the to a decrease in the demand willingness or ability of for that good. consumers to purchase a ○ Example: second-hand particular good is a potential clothes, tricycles demand shifter ◆ Prices of Related Goods - Changes in ○ The availability of credit the prices of related goods generally and change in season shift the demand curve for a good. can also affect the Substitute Goods - Goods for willingness and ability of which an increase in the price consumers to purchase of one good leads to an a particular good. increase in the demand for the ○ Health scares affect the other good. demand for cigarettes. ○ Example: coke and ○ The birth of a baby pepsi, pizza hut and affects the demand for dominos diapers. Complementary Goods - ➔ Linear Demand Function Goods for which an increase in the price of one good leads to a decrease in the demand for the other good. Where: ○ Example: toothpaste Qxd = Number of demanded Good X units and toothbrush Px = Price of Good X ◆ Advertising and Consumer Tastes - PY = Price of Good Y Advertising often provides consumers M = Income with information about the existence or H = Any other variable affecting demand quality of a product, which in turn induces more consumers to buy the ➔ h product. Advertising can also influence ➔ The signs and magnitudes of the “α” coefficient demand by altering the underlying determine the impact of each variable on the tastes of consumers. number of units x demanded. PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 6  ➔ hfhf ➔ αx < 0 By the law of demand ➔ How to find the total value or benefit of two liters of water? Add the maximum amount you are αY > 0 If Good Y is a substitute of Good X willing to pay for each of these drops of water between 0 and 2. αM < 0 If Good X is an inferior good ➔ Example: Suppose that an economic consultant for X Corporation recently provided the firm's marketing manager with this estimate of the demand function for the firm's product: Qxd = 12,000 - 3Px + 4Py- 1M + 2Ax ◆ How many products of Good X will consumers purchase when Px = ₱200 1. Total Expenditure - is the per-unit market price per unit, Py = ₱15 per unit, M = ₱10,000, times the number of units consumed. and Ax = 2,000? Are Goods X and Y 2. Consumer Surplus - is the extra value that substitutes or complements? Is Good X consumers derive from a good but do not pay a normal or an inferior good? extra for it. 3. Total Consumer Value - is the sum of the Qxd = 12,000 - 3Px + 4Py- 1M + 2Ax maximum amount a consumer is willing to pay at different quantities. Qxd = 12,000 - 3(₱200) + 4(₱15) - 1(₱10,000) + 2(2,000) SUPPLY Qxd = 5,460 units Market Supply Curve Good X and Y are substitutes. Good X is an ➔ A curve indicating the total quantity of a good inferior good. that all producers in a competitive market would produce at each price, holding input prices, technology, and other variables affecting supply Inverse Demand Function constant. ➔ Used to construct a market demand curve Law of Supply ➔ Example: By setting Py = Php15.00, M = Php10,000.00, and A = 2,000, the demand ➔ As the price of a good increases, the quantity function is: supplied increases, holding other factors ➔ Qxd = 12,000- 3Px + 4(15) - 1(10,000) + 2(2,000) affecting supply constant ➔ The linear and demand function simplifies to: ➔ Price and quantity supplied are directly Qxd = 6,060 - 3Px related. ➔ Solving for Px in terms of Qxd results to: ➔ Supply Curve: Upward Slope Px = 2,020 - Qxd Consumer Surplus ➔ Extra value that consumers derive from a good, but do not pay extra for the amount that a consumer is willing to pay for an additional good decreases as more of a good is produced. PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 7 Changes in Quantity Supplied vs Changes in Supply ○ Ad Valorem Tax Also called Percentage Tax Literally means “according to value” An increase in the value of a good increases the amount of tax f f f f ff f Supply Shifters 7. Producer Expectations ○ Selling a unit of output today and selling 1. Input Prices/Cost of Production a unit of output tomorrow are substitutes 2. Technology/Government Regulation in production. ○ Include damage caused to technology by natural disasters Supply Function 3. Number of Firms ○ Entry = ↑ supply, Exit = ↓ supply ➔ The supply function for Good X is a 4. Substitutes in Production mathematical representation describing how 5. Producer Expectations many units will be produced at alternative prices ○ A producer expecting an increase in the for X, alternative input prices W, and alternative future price of a good will postpone values of other variables that affect the supply producing/selling the good and opt to for Good X produce/sell in the future Linear Supply Function 6. Taxes ○ Both taxes decrease supply ○ Excise Tax A per unit tax Tax on each unit of output sold, where tax revenue is collected Where: from the supplier Qxs = number of units of Good X produced Tax is applied to every unit, and Px = Price of Good x the amount of tax is calculated W = Price of an input by how many items were sold Pr = Price of technologically-related goods f H = value of any other variable affecting supply f ➔ The signs and magnitudes of the β coefficients f determine the impact of each variable on the f number of units of x produced. f f f βx > o By the law of demand f βY < o Increasing input price βM > o Technology lowers the cost of producing Good X ➔ Example ◆ Your research department estimates that the supply function for television sets is given by: Qxs = 2,000 + 3Px - 4Pr - 1Pw ◆ How many television sets are produced when Px = ₱400, Pr = ₱100 per unit, and Pw = Php2,000.00 ◆ Qxs = 2,000 + 3(400) - 4(100) - 1(2,000) PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 8  ◆ Qxs = 800 television sets A competitive market equilibrium exists at a price Pe, Inverse Supply Function such that: Qd(Pe) = Qs(Pe) ➔ Used to construct a market supply curve 8 = 4P ➔ By setting Pw = ₱2,000 and Pr = ₱100 in: Pe = ₱2.00 Qxs = 2,000 + 3Px - 4(100) -1(2,000) Qe = 10 - 2(₱2.00) and Qs = 2 + 2(₱2.00) ➔ The linear supply function simplifies to: Qe = 6 units Qxs = 3Px - 400 ➔ Solving this for Px in terms of Qxs results to: Surplus and Shortage Producer Surplus ➔ Surplus ◆ Above the market equilibrium ➔ Amount producers receive in excess of the amount necessary to induce them to produce the good ➔ Shortage ◆ Below the market equilibrium MARKET EQUILIBRIUM Competitive Market Equilibrium ➔ Determined by the intersection of the market Market Equilibrium, Excess Demand, and Excess demand and market supply. Supply ➔ A price and quantity such that there is no ➔ Market Equilibrium shortage or surplus in the market ◆ When the supply of an item is exactly ➔ Forces that drive market demand and market identical to its demand. Since there is supply are balanced, and there is no pressure neither a shortage or surplus in this on prices or quantities to change. situation, the price tends to stay stable. ➔ The equilibrium price is the price that equates quantity demanded with quantity supplied. Example: Consider a market with demand and supply functions, respectively, as: Qd = 10 - 2P and Qs = 2 + 2P ➔ Excess Supply PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 9  ◆ If the price is set too high (P1) and the market. market. demand is expected to be at Q2 but is actually lower than expected (Q1); Qd = 10 - 2(₱1.50) = 7 units Qd = 10 - 2(₱3.50) = 3 units excess supply (or surplus) is created. Qs = 2 + 2(₱1.50) = 5 units Qs = 2 + 2(₱3.50) = 9 units Since Qd > Qs, a shortage Since Qd > Qs, a shortage of 7 - 5 = 2 units exists. of 9 - 3 = 6 units exists. Full economic price of the The cost to the fifth unit is 5 = 10 - 2Pfull government of or Pfull = ₱2.50. Of this, purchasing the surplus is ➔ Excess Demand ₱3.50 x 6 = ₱21.00 ◆ If the price is set relatively low (P1) and Pfull=Price ceiling imposed the demand for a product is higher than = Nonpecuniary price expected (Q2) but the firm only supplies Q1; excess demand (or shortage) is ₱1.50 is the peso price/ created. price ceiling imposed. ₱1.00 is the Price Restrictions and Market Equilibrium nonpecuniary price ➔ In a competitive market equilibrium, price and quantity freely adjust to the forces of demand and supply. COMPARATIVE STATISTICS ➔ Sometimes, the government restricts how much Comparative Market Equilibrium prices are permitted to increase and decrease. ➔ Price Ceiling vs Price Floor ➔ The study of the movement from one equilibrium to another. Price Ceiling Price Floor ➔ Comparative markets, operating free or price located below the located above the restraints, will be analyzed when demand equilibrium and equilibrium and changes, supply changes, and demand and causes shortage causes surplus supply simultaneously change. maximum legal minimum price price that can be set by the Changes in Demand and Changes in Supply charged government used to used to Changes in Demand Changes in Supply safeguard safeguard ↑ demand only ↑ supply only consumers consumers ↑ equilibrium price ↓ equilibrium price ↑ equilibrium quantity ↑ equilibrium quantity ↓ demand only ↓ supply only ↓ equilibrium price ↑ equilibrium price ↓ equilibrium quantity ↓ equilibrium quantity Example Example Example: Example: Suppose that consumer Suppose that a bill before Consider a market with Consider a market with income is projected to Congress would require demand and supply demand and supply increase 2.5% and the all employees to provide functions, respectively, functions, respectively, number of individuals healthcare to their as: as: over 25 years old will workers. What is the reach an all-time high by impact on retail markets? Qd =10 - 2P and Qs =2 + Qd =10 - 2P and Qs =2 + the end of the next year. 2P 2P What is the impact on the rental market? A competitive market A competitive market equilibrium exists at a equilibrium exists at a price Pe, such that: price Pe, such that: Qd(Pe) = Qs(Pe) Qd(Pe) = Qs(Pe) Suppose a ₱1.50 price Suppose a ₱3.50 price ceiling is imposed on the floor is imposed on the Income increases, therefore There will be a decrease PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 10  demand decreases in supply because there will be an increase in equilibrium price and a decrease in equilibrium quantity. Simultaneous Shifts in Supply and Demand ➔ Example: An earthquake hit Kobe, Japan and decreased the supply of fermented rice used to make sake wine. The stress caused by the earthquake led many to increase their demand for sake and other alcoholic beverages. What is the combined impact on Japan’s sake market? ➔ h ➔ h ➔ h ➔ h ➔ h ➔ hh ➔ Supply decreases as demand for sake wine increases Equilibrium Price and Quantity: The Impact of Simultaneous Shifts in Demand and Supply FLASHCARDS Managerial Economics Flashcards PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 11  d. In a market economy, the government controls all aspects of the economy, PRACTICE EXERCISE: THEORETICAL while in a command economy, there is no government intervention Instructions: Choose the best answer for each 7. What is the difference between a shortage question. and a scarcity? a. A shortage is a temporary condition, 1. What is the study of how individuals, firms, while scarcity is a permanent condition. and governments make choices in the face b. A shortage is a condition that exists of scarcity? when the quantity demanded exceeds a. Sociology the quantity supplied, while scarcity is a b. Psychology condition that exists when there are not c. Economics enough resources to produce everything d. Political Science that people want. 2. What is the opportunity cost of a decision? c. A shortage is a condition that exists a. The total cost of making the decision when the quantity supplied exceeds the b. The value of the best alternative forgone quantity demanded, while scarcity is a c. The amount of money spent on the condition that exists when there are not decision enough resources to produce everything d. The time spent making the decision that people want. 3. What does the law of demand state? d. A shortage is a condition that exists a. As the price of a good increases, the when the price of a good is too high, quantity demanded increases. while scarcity is a condition that exists b. As the price of a good increases, the when the price of a good is too low. quantity demanded decreases. 8. What is the difference between a surplus and c. As the price of a good decreases, the a scarcity? quantity demanded increases. a. A surplus is a condition that exists when d. The quantity demanded is not affected the quantity supplied exceeds the by price. quantity demanded, while scarcity is a 4. What does the law of supply state? condition that exists when there are not a. As the price of a good increases, the enough resources to produce everything quantity supplied decreases. that people want. b. As the price of a good increases, the b. A surplus is a condition that exists when quantity supplied increases. the quantity demanded exceeds the c. As the price of a good decreases, the quantity supplied, while scarcity is a quantity supplied increases. condition that exists when there are not d. The quantity supplied is not affected by enough resources to produce everything price. that people want. 5. What is equilibrium price? c. A surplus is a condition that exists when a. The price at which the quantity the price of a good is too high, while demanded equals the quantity supplied. scarcity is a condition that exists when b. The highest price that consumers are the price of a good is too low. willing to pay. d. A surplus is a condition that exists when c. The lowest price that producers are the price of a good is too low, while willing to accept. scarcity is a condition that exists when d. The price that maximizes profits for the price of a good is too high. producers. 9. Which of the following is NOT a factor of 6. What is the difference between a market production? economy and a command economy? a. Land a. In a market economy, resources are b. Labor allocated by the government, while in a c. Capital command economy, resources are d. Money allocated by the market. 10. Which of the following is the most b. In a market economy, resources are fundamental economic problem? allocated by the market, while in a a. Inflation command economy, resources are b. Unemployment allocated by the government. c. Scarcity c. In a market economy, there is no d. Inequality government intervention, while in a command economy, the government controls all aspects of the economy. PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 12  5. T&A plans to purchase new computers costing PRACTICE EXERCISE: PROBLEM SOLVING ₱200,000.00 with a useful life of five years, and Instruction: Read, analyze, and solve for what is it can be sold at the end of its estimated useful asked. life for ₱50,000.00. It will create a profit of ₱100,000.00 in the first year, ₱90,000.00 in the 1. Suppose that the total benefit and total cost from second year, and ₱80,000.00 in the third year, a continuous activity are, respectively, given by ₱70,000.00 in the fourth year, and ₱60,000.00 in the following equations: the fifth year. Business firm T&A also considers B(Q) = 100 + 36Q - 4Q2 and C(l) = 80 + 12Q investing the ₱200,000.00 that will grow 0.05%. [Note: MB(Q) = 36 - 8Q and MC(Q) = 12] Which transaction should be prioritized a. Write out the equation for the net considering the limited financial resources of the benefits. company? b. What are the net benefits when Q = 1? Q = 5? c. Write out the equation for the marginal net benefits. d. What are the marginal net benefits when Q = 1? Q = 5? e. What level of Q maximizes net benefits? f. At the value of Q that maximizes net benefits, what is the value of marginal net benefits? 2. Suppose the total benefit derived from a continuous decision, Q, is B(Q) = 20Q - 2Q2 and the corresponding total-cost is C(Q) = 4 + 2Q2, so that MB(Q) = 20 - 4Q and MC(Q) = 4Q. a. What is the total benefit when Q = 2? Q = 10? b. What is the marginal benefit when Q = 2? Q = 10? c. What is the total cost when Q = 2? Q = 10? d. What is the marginal cost when Q = 2? Q = 10? e. What level of Q maximizes total benefit? 3. Jayvee spends ₱30,000 per year on painting supplies and storage space. She recently received two job offers from a famous marketing firm-one offer was for ₱110,000 per year and the other was for ₱80,000. However, she turned both jobs down to continue a painting career. If Jayvee sells 25 paintings per year at a price of ₱8,000 each, a. What are her accounting profits? b. What are her economic profits? 4. Maria is the owner of a merchandising store. Monthly, she pays her employee ₱5,000.00, rent ₱8,000, and utilities expense ₱6,000.00. She was offered a monthly salary of ₱7,000.00 to work as a shopkeeper in a store across the street. The store’s monthly sales is ₱60,000.00. Determine her: a. Accounting profit b. Economic profit. PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 13  ANSWER KEY NB(1) = 20 + 24(1) - 4(1)2 NB(1) = 20 + 24 - 4 THEORETICAL NB(1) = 40 1. C 6. B When Q = 5: NB(5) = 20 + 24(5) - 4(5)2 2. B 7. B NB(5) = 20 + 120 - 100 NB(5) = 40 3. B 8. A c. MNB(Q) = MB(Q) - MC(Q) 4. B 9. D Given: 5. A 10. C MB(Q) = 36 - 8Q MC(Q) = 12 PROBLEM-SOLVING MNB(Q) = (36 - 8Q) - 12 1. Answers: 2. Answers: MNB(Q) = 36 - 8Q - 12 a. NB(Q) = 20 + 24Q - a. B(2) = 32 MNB(Q) = 24 - 8Q 4Q2 B(10) = 0 b. NB(1) = 40 b. MB(2) = 12 d. MNB(Q) = 1 and MNB(Q) = 5: NB(5) = 40 MB(10) = -20 c. MNB(Q) = 24 - 8Q c. C(2) = 12 When Q = 1: d. MNB(1) = 16 C(10) = 204 MNB(1) = 24 - 8(1) MNB(5) = -16 d. MC(2) = 8 MNB(1) = 24 - 8 e. Q = 3 MC(10) = 40 MNB(1) = 16 f. MNB(3) = 0 e. Q = 5 When Q = 5: 3. Answers: 4. Answers: MNB(5) = 24 - 8(5) a. ₱ 20,000,000 a. ₱ 41,000 MNB(5) = 24 - 40 b. ₱ 19,600,000 b. ₱ 48,000 MNB(5) = -16 5. Answer: e. MNB(Q) = 0: NPV = ₱45,977.76 24 - 8Q = 0 8Q = 24 Since the NPV exceeds the profits of simply investing Q=3 ₱200,000.00 for 5%, Zebra Corporation should purchase new ovens. f. Q = 3 MNB(3) = 24 - 8(3) MNB(3) = 24 - 24 SOLUTIONS MNB(3) = 0 PROBLEM 2 Given: PROBLEM 1 B(Q) = 20Q - 2Q2 MB(Q) = 20 - 4Q a. NB(Q) = B(Q) - C(Q) C(Q) = 4 + 2Q2 MC(Q) = 4Q Given: a. Total Benefit B(Q) = 100 + 36Q - 4Q2 When Q = 2: When Q = 10: C(Q) = 80 + 12Q B(2) = 20(2) - 2(2)2 B(10) = 20(10) - 2(10)2 B(2) = 40 - 8. B(10) = 200 - 200 NB(Q) = (100 + 36Q - 4Q2) - (80 + 12Q) B(2) = 32. B(10) = 0 NB(Q) = 100 + 36Q - 4Q2 - 80 - 12Q NB(Q) = 20 + 24Q - 4Q2 b. Marginal Benefit When Q = 2: When Q = 10: NB(Q) = 20 + 24Q - 4Q2 MB(2) = 20 - 4(2) MB(10) = 20 - 4(10) MB(2) = 20 - 8 MB(10) = 20 - 40 b. Q = 1, Q = 5 MB(2) = 12 MB(10) = -20 When Q = 1: c. Total Cost: PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 14 When Q = 2: When Q = 10: PROBLEM 5 C(2) = 4 + 2(2)2 C(10) = 4 + 2(10)2 C(2) = 4 + 8 C(10) = 4 + 200 C(2) = 12 C(10) = 204 d. Marginal Cost: When Q = 2: When Q = 10: PV = ₱95,238.10 + ₱81,632.65 + ₱69,107.01 MC(2) = 4(2) MC(10) = 4(10) NPV = PV - OCW MC(2) = 8 MC(10) = 40 NPV = ₱245,977.76 - ₱200,000.00 NPV = ₱45,977.76 e. Level of Q that maximizes Total Benefit: MB(Q) = 0: 20 - 4Q = 0 4Q = 20 REFERENCES Q=5 PROBLEM 3 Baye, M. (2018). Managerial Economics and Business a. Accounting Profit Strategy. Total Revenue = ₱8,000(25) Total Revenue = ₱200,000 McConnell, et.al. (2015). Economics: Principles, Total Costs = Explicit Costs Problems and Policies. Total Costs = ₱30,000 McGraw-Hill Education. (2017). Managerial Economics Accounting Profits = Total Revenue - Total Costs Business Strategy. Accounting Profits = ₱200,000 - ₱30,000 Accounting Profits = ₱170,000 Prepared by: b. Economic Profit Total Opportunity Costs = Sum of All Opportunity Cost DULAY, Danina Kaye Total Opportunity Costs = ₱110,000 + ₱80,000 Total Opportunity Costs = ₱190,000 Economic Profits = Total Revenue - Total Costs - Total Opportunity Cost Economic Profit = ₱200,000 - ₱30,000 - ₱190,000 Economic Profit = ₱200,000 - ₱220,000 Economic Profit = - ₱20,000 PROBLEM 4 a. Accounting Profit Total Revenue = ₱60,000 Explicit Costs Employee’s Salary = ₱5,000 Rent = ₱8,000 Utilities Expense = ₱6,000 Implicit Costs Forgone Shopkeeper Salary = ₱7,000 AP = Total Revenue - Explicit Costs AP = ₱60,000 - ₱19,000 Accounting Profit = ₱41,000 b. Economic Profit EP = Total Revenue - (Explicit Costs + Implicit Costs) EP = ₱60,000 - (₱19,000 + ₱7,000) EP = ₱60,000 - ₱12,000 Economic Profit = ₱48,000 PREPARED BY: ACCOUNTANCY STUDENT COUNCIL | 15