Microeconomics for Managers (MEM) Lecture Notes PDF

MICROECONOMICS FOR MANAGERS (MEM) Biresh Sahoo, Ph.D. Lecture 1  About me in brief … TEACHING & RESEARCH ⚫ Over 25 years of experiences after Ph.D. ⚫ TAPMI, Manipal ⚫ National Graduate Institute for Policy Studies (GRIPS...

MICROECONOMICS FOR MANAGERS (MEM) Biresh Sahoo, Ph.D. Lecture 1  About me in brief … TEACHING & RESEARCH ⚫ Over 25 years of experiences after Ph.D. ⚫ TAPMI, Manipal ⚫ National Graduate Institute for Policy Studies (GRIPS), Tokyo, Japan ⚫ Vienna University of Economics and Business (WU-Wien), Vienna, Austria ⚫ XIMB since 2009... 7/10/2024 2 POST-DOCTORAL FELLOWSHIP ⚫ JSPS Fellowship by the Ministry of Education, Japan (2001-02) ⚫ Lise Meitner Fellowship by the Board of Austrian Science Fund (FWF), Austria (2008-09) ⚫ I am the first scholar from India so far to receive this coveted fellowship. ⚫ Postdoctoral Fellowship by the FRCT, Govt. of Portugal for 36 months (2007-08) 7/10/2024 3  HONORS ⚫ Associate Editor of OMEGA: The International Journal of Management Science since September 2016 (I am the first scholar so far from India to enter the Editorial Board of this prestigious journal) ⚫ Expert for Czech Science Foundation, Czech Republic (2016) ⚫ Member of Faculty Selection Committee at NISER, Bhubaneswar, IIT-Bhubaneswar, and Utkal University, Bhubaneswar 7/10/2024 4 ⚫ External Examiner for Ph.D. thesis evaluation for ⚫ Vienna University of Economics and Business (Austria), ⚫ Pondicherry Central University (India) ⚫ BITS Pilani (India) ⚫ Resource Person for conducting MDP programs on Efficiency and Productivity Analysis for ⚫ IIT Bhubaneswar ⚫ Punjabi University, Patiala ⚫ Amrita School of Business, Coimbatore ⚫ State Bank of India, Mumbai 7/10/2024 5  AWARDS ⚫ Omega Best Reviewer Award (2015) ⚫ I am the first scholar from India so far to receive this prestigious award ⚫ AIMS International Young Management Researcher Award (2008) ⚫ AIJM Outstanding Editor of the Year Award (2012) 7/10/2024 6 CONTRIBUTION TO XIMB ⚫ XIMB research productivity ranks at 16th in India ⚫ my own rank at ⚫ 20 across all areas of management (1968- 2015), ⚫ 9 across all areas of management (2005-2015) and ⚫ 4 in Economics (1968-2015) Source: https://doi.org/10.1016/j.omega.2016.02.004 ⚫ As per the recent quality research benchmarking study by TAPMI (2013-2017), I appeared in the list of Top Five Contributors of Management Research in India Source: https://www.tapmi.edu.in/wp-content/uploads/2020/02/Quality- Benchmarking-Exercise_2020.pdf 7/10/2024 7 MY RESEARCH IMPACT (as of July 8, 2024) ⚫ PUBLONS (WEB OF SCIENCE) ⚫ TOTAL TIMES CITED: 1219 ⚫ H-INDEX: 20 ⚫ SCOPUS (ELSEVIER SCIENCE) ⚫ TOTAL TIMES CITED: 1573 ⚫ H-INDEX: 23 ⚫ GOOGLE SCHOLAR ⚫ TOTAL TIMES CITED: 2612 ⚫ H-INDEX: 26 7/10/2024 8 MY WORK INTEREST AREAS Microeconomic Theory Efficiency and Productivity Assessment (Data Envelopment Analysis) Economics of Benchmarking 7/10/2024 9 MICROECONOMICS FOR MANAGERS (MEM) COURSE DESCRIPTION LEARNING OBJECTIVES COURSE MODULES EVALUATION CRITERIA READING LISTS 7/10/2024 10 COURSE DESCRIPTION ⚫ The course deals with an application of microeconomics principles to decision making. It examines: ⚫ the factors underlying demand and supply ⚫ the behavior of firms under various market structures ⚫ the role of price system in the economy 7/10/2024 11 LEARNING OBJECTIVES ⚫ Learn how the four core principles of economics can be used to analyze choices and make better decisions by individuals (consumers and producers). ⚫ Understand how demand and supply respond to changing market conditions and forecast the consequences of government policies. ⚫ To learn how the concept of production technology can be used to perform benchmarking exercise against the industry best practices. ⚫ Learn how businesses set prices to remain profitable when they have market power. 7/10/2024 12 COURSE MODULES ⚫ Module I: Theory of the consumer and demand analysis (8 sessions) ⚫ Module II: Theory of the producer and supply analysis (8 sessions) ⚫ Module III: Pricing strategy under market structure with monopoly power (4 sessions) 7/10/2024 13  EVALUATION CRITERIA ⚫ Quizzes (4 out of 6) : 40 points (= 4 ×10) ⚫ Assignment : 05 points ⚫ Presentation : 05 points ⚫ Classroom participation : 10 points ⚫ End-term examination : 40 points ⚫ Total : 100 points Minimum points to pass: 30 7/10/2024 14 READING LISTS ⚫ Textbook Mankiw, N. G. and Taylor, M. P. Microeconomics, Delhi: Cengage ⚫ Reference Books ⚫ Varian, H.R., Intermediate Microeconomics: A Modern Approach, New York: W. W. Norton & Company. ⚫ McEachern, William A. and Kaur, S. MICRO ECON, New Delhi: Cengage Learning. ⚫ Baye, M.R. and Prince, J.T., Managerial Economics and Business Strategy, New Delhi: McGraw Hill Education (India) Pvt. Ltd. ⚫ Frank, R.H., Microeconomics and Behavior, New York: McGraw-Hill Publishing Company. ⚫ Stevenson, B. and Wolfers, J. Principles of Microeconomics, London: Palgrave Macmillan. 7/10/2024 15 The core principles of economics ⚫ Learn the four core principles that provide the foundation of all economic analysis ⚫ Use these four core principles to analyze choices and make better decisions. 7/10/2024 16 Roadmap (1 of 5) ▪ A principled approach to economics ▪ Understand economics as a way of thinking, grounded in a set of broadly applicable principles that you’ll find useful “in the ordinary business of life.” ▪ (1) The cost-benefit principle ▪ Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice and only pursue those whose benefits are at least as large as their costs. ▪ (2) The opportunity cost principle ▪ The true cost of something is the next best alternative you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs ▪ (3) The marginal principle ▪ Decisions about quantities are best made incrementally. You should break “how many” decisions down into a series of smaller or marginal decisions. ▪ (4) The interdependence principle ▪ Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of 7/10/2024 these factors change, your best choice might change. 17 A principled approach to economics ⚫ Economics is the science of making decisions in the presence of scarce resources. ⚫ Resources are anything used to produce a good or service or achieve a goal. ⚫ Decisions are important because scarcity implies trade-offs. ⚫ You will learn four core principles of economics that help you make better decisions at two levels: ⚫ Microeconomics: The study of individual decision making and the implications for specific markets. ⚫ Macroeconomics: The study of decision making across the whole economy. 7/10/2024 18 A systematic framework for making individual decisions (Microeconomics) ▪ Individual decisions — choices — are the foundation of all economic forces. ▪ Four core principles provide a systematic framework for analyzing decisions: 1. the cost-benefit principle. 2. the opportunity cost principle. 3. the marginal principle. 4. the interdependence principle. 7/10/2024 19 Discussion question (1) ⚫ What decisions did you make today? 7/10/2024 20 Roadmap (2 of 5) ▪ A principled approach to economics ▪ Understand economics as a way of thinking, grounded in a set of broadly applicable principles that you’ll find useful “in the ordinary business of life.” ▪ The cost-benefit principle ▪ Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice and only pursue those whose benefits are at least as large as their costs. ▪ The opportunity cost principle ▪ The true cost of something is the next best alternative you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs ▪ The marginal principle ▪ Decisions about quantities are best made incrementally. You should break “how many” decisions down into a series of smaller or marginal decisions. ▪ The interdependence principle ▪ Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of 7/10/2024 these factors change, your best choice might change. 21 The cost-benefit principle ▪ Costs and benefits are the incentives that shape decisions. ▪ The cost-benefit principle says that you should ▪ evaluate the full set of costs and benefits of any choice. ▪ pursue only those choices whose benefits (B) are at least as large as their costs (C). 7/10/2024 22  Quantifying costs and benefits: an example ▪ You walk into a coffee shop and need to decide whether to buy a cup of coffee. ▪ The coffee costs $3. ▪ Should you buy the coffee? 7/10/2024 23  Example continued … ▪ The cost-benefit principle says you should buy the coffee if the benefit is at least as large as the cost of $3. ▪ What is the benefit of your consumption of the coffee? 7/10/2024 24  Example continued … ▪ How do you compare intangible benefits to monetary costs? ▪ Economist trick: Convert each cost and each benefit into its monetary equivalent. ▪ What is your willingness to pay? ▪ That is, what is the most that you would be willing to pay to obtain a particular benefit? 7/10/2024 25  Example continued … ▪ Your willingness to pay is how much you value the good. ▪ Are you willing to pay $5 for a cup of coffee? ▪ How about $4? Maybe $3? How about just $2? ▪ The amount you are willing to pay depends on how much you like coffee, not the price. 7/10/2024 26  Example continued … ▪ Suppose you are willing to pay up to $4 for a good cup of coffee. ▪ You are always willing to pay less than $4! ▪ Now apply the cost-benefit principle: ▪ The cost of coffee (C) = $3. ▪ The benefit of coffee (B) = $4. ▪ Since B > C, you purchase the coffee. 7/10/2024 27 Discussion question (2) ▪ Think about something you purchased today. What was its cost? ▪ Using willingness to pay, what was its benefit? ▪ Did you correctly apply the cost-benefit principle? 7/10/2024 28  Money is the measuring stick, not the objective. ▪ Money is a common measuring stick that allows you to compare a wide variety of costs and benefits. ▪ Money allows you to take account of a wide variety of nonfinancial issues, such as satisfaction or time. 7/10/2024 29 Maximize your economic surplus ▪ When you follow the cost-benefit principle, every decision you make will yield larger benefits than costs. ▪ Economic surplus is the total benefits (B) minus the total costs (C) flowing from a decision. ▪ It is a measure of how much your decision has improved your well-being. ▪ By maximizing your economic surplus, you can make good decisions. 7/10/2024 30  Discussion question (3) Think about the last time you purchased a good or service. ▪ What were your benefits? What were your costs? ▪ What were the seller’s benefits? What were the seller’s costs? ▪ Did you both benefit more than your costs? 7/10/2024 31 MICROECONOMICS FOR MANAGERS (MEM) Biresh Sahoo, Ph.D. MEM Lecture 2  Applying the cost-benefit principle ▪ Nerida Kyle, a 23-year-old economics graduate, is about to start her first full-time job. She likes her new apartment, but there is no metro rail station nearby, buses come only rarely, and she’s too far from work to bike or walk. ▪ Should she buy a car or take an Uber each way? 7/12/2024 2  Nerida came up with the following costs: ▪ The cost of purchasing a car is $10,000. ▪ However, she can sell it for $8,000 after a year. ▪ Work is 5 miles away, and the car gets 25 miles to the gallon. ▪ She works 50 weeks per year. ▪ Gas costs $3 per gallon. ▪ Insurance costs $1,500 per year. ▪ Repairs cost $500 per year. ▪ Parking costs $5 per day. ▪ Uber fares are $10 per ride. 7/12/2024 3 7/12/2024 4  Practice question Suppose that you are willing to pay up to $15 to purchase a meal at your favorite restaurant. The meal currently costs $16. Should you buy it? A. Yes because $16 is not that much higher than $15 B. Yes because the benefit is higher than the cost C. No because the cost is higher than the benefit D. No because you cannot quantify the benefit 7/12/2024 5 Roadmap (3 of 5) ▪ A principled approach to economics ▪ Understand economics as a way of thinking, grounded in a set of broadly applicable principles that you’ll find useful “in the ordinary business of life.” ▪ The cost-benefit principle ▪ Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice and only pursue those whose benefits are at least as large as their costs. ▪ The opportunity cost principle ▪ The true cost of something is what you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs ▪ The marginal principle ▪ Decisions about quantities are best made incrementally. You should break “how many” decisions down into a series of smaller or marginal decisions. ▪ The interdependence principle ▪ Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of 7/12/2024 these factors change, your best choice might change. 6  The opportunity cost principle ▪ Opportunity cost: The true cost of something is what you must give up to get it. ▪ Your decisions should reflect this opportunity cost rather than just the out-of-pocket financial costs. ▪ When you make a decision, pay attention to the trade-offs; you are giving up your best alternative. ▪ When economists or management scientists say “costs,” they really mean opportunity costs. 7/12/2024 7  Opportunity costs reflect scarcity The opportunity cost arises because of a fundamental economic problem: scarcity. ▪ Scarcity occurs because resources are limited. ▪ But when we use resources for one thing, we are unable to use them for another. ▪ Therefore, all choices require a trade-off! 7/12/2024 8  Discussion question (4) ▪ The opportunity cost principle is asking you to focus on the trade-offs you face. ▪ You decided to come to class today. What is the best alternative that you were forced to give up as a result of your decision? ▪ What was the scarce resource that led to this choice? 7/12/2024 9  Calculating your opportunity costs Ask yourself two questions: 1. What happens if you pursue your choice? 2. What happens under your next best alternative? 7/12/2024 10  Calculating opportunity costs: an example ▪ Nerida has noticed that many of the executives she admires have advanced degrees. In the long run, she might be even more successful if she has an MBA. ▪ But is it worth it? 7/12/2024 11  Example continued… 1. What happens if Nerida pursues an MBA (two years of school)? ▪ She pays $60,000/yr in tuition, pays for room and board ($24,000/yr), spends time studying (10 hours a day), and quits her current job (loses that income). 2. What happens if Nerida pursues her next best alternative (continuing to work at her current job)? ▪ She earns $70,000/yr, still must pay for rent and meals (i.e., $24,000/yr), and spends her time 7/12/2024 working (1o hours a day, say). 12  Example continued… Costs of her choice - Costs of her next best = Opportunity costs alternative if Nerida pursues an If she continues to The cost of an MBA, relative to MBA work full time instead working full time Tuition costs $60,000 She won’t pay tuition $60,000 tuition She quits her job She earns $70,000 + from her job $70,000 in forgone income Room and board cost Rent and meals cost + $24,000 $24,000 No opportunity cost (she must pay for housing and food whether she pursues an MBA 10 hours per day 10 hours per day at + studying work No opportunity cost: she works 10 hours per day in either way = $130,000 per year in total opportunity cost 7/12/2024 13  Four Important Lessons About Opportunity Costs 1. Some out-of-pocket costs are opportunity costs, such as the cost of MBA tuition and fees. 2. Opportunity costs don’t need to involve out-of-pocket financial costs. 3. Not all out-of-pocket costs are real opportunity costs. 4. Some nonfinancial costs are not opportunity costs. 7/12/2024 14  The “Or What?” Trick ▪ To apply the opportunity cost principle correctly, ask yourself “or what?” ▪ Should Nerida pursue an MBA, OR should she keep working? ▪ Should you study economics for another hour, OR should you go to bed? ▪ Asking “or what?” forces you to consider the alternatives. 7/12/2024 15  Discussion Questions (5) What are the opportunity costs of each of the following choices? ▪ Should you hang out with your friends Sunday afternoon? Or what? ▪ Should you do an unpaid internship this summer? Or what? ▪ Should you hire your best friend to work in the family business? Or what? ▪ Should you invest your savings in the stock market? Or what? 7/12/2024 16  You should ignore sunk costs A sunk cost is a cost that has been incurred and cannot be reversed. ▪ A sunk cost exists whether you make your choice or not, so it is not an opportunity cost. ▪ When weighing costs and benefits, a good decision maker ignores sunk costs. 7/12/2024 17  Discussion question (6) ▪ Yesterday you bought a Halloween costume for $35 to wear to a friend’s Halloween party. But today you’re feeling sick, and as you dress to go to the party, you realize that you won’t enjoy it. Do you head to the party? ▪ You buy a $700 package deal to Puerto Rico (PR) for spring break, but later your friends decide to go to Miami, where they stay with your friend’s family for free. You’d rather spend time with your friends, but you’ve already bought tickets. Do you go to PR? 7/12/2024 18  Practice question (2) You paid $13 for movie tickets. But 30 minutes into the film, you’ve seen enough! The acting is terrible, the plot is predictable, and the jokes are cringe-worthy. Do you stay for the last hour? A. Yes, you paid $13, so you should stay for the whole film. B. Yes, the benefits of staying outweigh the costs. C. No, the opportunity cost of staying is $13 plus what you could have done with the hour. D. No, $13 is a sunk cost, and the opportunity cost of the alternative use of the hour is higher than the benefit of staying in the movie. 7/12/2024 19 Roadmap (4 of 5) ▪ A principled approach to economics ▪ Understand economics as a way of thinking, grounded in a set of broadly applicable principles that you’ll find useful “in the ordinary business of life.” ▪ The cost-benefit principle ▪ Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice and only pursue those whose benefits are at least as large as their costs. ▪ The opportunity cost principle ▪ The true cost of something is the next best alternative you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs ▪ The marginal principle ▪ Decisions about quantities are best made incrementally. You should break “how many” decisions down into a series of smaller or marginal decisions. ▪ The interdependence principle ▪ Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors change, your best choice might change. 7/12/2024 20  The marginal principle ▪ Decisions about quantities are best made incrementally. ▪ You should break down “how many” decisions into a series of smaller, or marginal, decisions. ▪ Then you weigh the marginal benefits and marginal costs to make good decisions. ▪ Marginal benefit: The extra benefit from one unit (of goods purchased, hours studied, etc.). ▪ Marginal cost: The extra cost from one extra unit. 7/12/2024 21  When is the marginal principle useful? ▪ The marginal principle is useful for “how many” decisions but not for “either/or” choices. ▪ The cost-benefit principle is useful for “either/or” choices. ▪ Apply the marginal principle first, then the cost-benefit principle. 7/12/2024 22  Applying the marginal principle How much to buy? Marginal principle Should I buy one more? Iterate Cost-benefit principle No Buy one Is marginal benefit STOP more ≥ marginal cost? Yes 7/12/2024 23  Discussion questions (7) Can you apply the marginal principle to simplify the following decisions? How many workers Should I hire one should I hire? more worker? How many pairs of Should I buy one shoes should I buy? more pair of shoes? How many classes Should I take one more should I take? class this semester? 7/12/2024 24  Thank you for your patience 7/12/2024 25 MICROECONOMICS FOR MANAGERS (MEM) Biresh Sahoo, Ph.D. MEM Lecture 3  Using the rational rule The marginal principle provides a rule of thumb that will help you maximize your economic surplus. ▪ The Rational Rule: If something is worth doing, keep doing it until your marginal benefits equals your marginal costs. ▪ Following the rational rule leads to good decisions. ▪ Following the rational rule maximizes economic surplus. 7/16/2024 2  Applying the rational rule Nerida is trying to figure out how many workers to hire. Below are her projections: No of Meals Total Marginal Total costs Marginal Profit or workers served benefits benefits ($10 per meal cost (change economic (Revenue = (Change in food cost + $300 in total cost surplus $25 x no of total benefits per waiter + from hiring (Total meals) from hiring $500 rent + an extra benefits - an extra $1,000 for worker) total costs) worker) Nerida’s time) 2 160 3 210 4 250 5 280 6 300 7 310 7/16/2024 3 No Meals Total Marginal Total costs Marginal Profit or of served benefits benefits ($10 per cost economic wor (Revenue = (Change in meal food (change in surplus kers $25 x no of total costs + $300 total cost (Total meals) benefits per waiter + from benefits - from $500 rent + hiring an total costs) hiring an $1,000 for extra extra Nerida’s worker) worker) time) 2 160 $4,000 $3,700 $300 3 210 $5,250 $1,250 $4,500 $800 $750 4 250 $6,250 $1,000 $5,200 $700 $1,050 5 280 $7,000 $750 $5,800 $600 $1,200 6 300 $7,500 $500 $6,300 $500 $1,200 7 310 $7,750 $250 $6,700 $400 $1,050 7/16/2024 4  Discussion questions (8) ▪ Consumer: How many cups of coffee should I buy today? ▪ Producer: How many tons of coffee should I produce? ▪ Worker: How many hours should I work as a barista? 7/16/2024 5  Practice question (4) According to the marginal principle (and the rational rule), economic surplus is maximized when A. total cost equals total benefit. B. average cost equals average benefit. C. marginal cost equals marginal benefit. D. producers make as much as possible. 7/16/2024 6 Roadmap (5 of 5) ▪ A principled approach to economics ▪ Understand economics as a way of thinking, grounded in a set of broadly applicable principles that you’ll find useful “in the ordinary business of life.” ▪ The cost-benefit principle ▪ Costs and benefits are the incentives that shape decisions. You should evaluate the full set of costs and benefits of any choice and only pursue those whose benefits are at least as large as their costs. ▪ The opportunity cost principle ▪ The true cost of something is the next best alternative you must give up to get it. Your decisions should reflect this opportunity cost, rather than just the out-of-pocket financial costs ▪ The marginal principle ▪ Decisions about quantities are best made incrementally. You should break “how many” decisions down into a series of smaller or marginal decisions. ▪ The interdependence principle ▪ Your best choice depends on your other choices, the choices others make, developments in other markets, and expectations about the future. When any of these factors change, your best choice might change. 7/16/2024 7  The interdependence principle ▪ Your best choice depends on the other choices you make, the choices others make, developments in other markets, and expectations about the future. ▪ When any of these factors change, your best choice might change. 7/16/2024 8  Four types of interdependencies 1. Dependencies between each of your individual choices 2. Dependencies between people or businesses in the same market 3. Dependencies between markets 4. Dependencies through time 7/16/2024 9  Four types of interdependence: an example How do you choose your classes for the semester? 1. Your choices: If you take an economics class, you won't be able to take other classes scheduled at the same time. 2. Others’ choices: If another student takes the last spot in a popular class, then you will have to take a different class. 3. Other markets: If you believe that the skills you will learn in economics have become more valuable, then your decision on which class to take depends on outcomes in other markets. 4. Future choices: Your decision to study economics today changes the classes you have met the prerequisites for, and this might lead to take more economics courses. 7/16/2024 10  Discussion question (9) Think about a choice you made today. ▪ How was it affected by the other choices you made today? ▪ The choices others made? ▪ Your future choices? 7/16/2024 11  Practice question (5) You decide that reading the textbook tonight will lay the foundation for your later success in your economics class. Which of the four types of interdependencies is this? A. dependencies between each of your individual choices B. dependencies between people or businesses in the same market C. dependencies between markets D. dependencies through time 7/16/2024 12  Principles in short Here's a memory trick. Always ask these four questions: ▪ One more? (the marginal principle) ▪ Benefit beat cost? (the cost-benefit principle) ▪ Or what? (the opportunity cost principle) ▪ What else? (the interdependence principle) 7/16/2024 13  Using the core principles in practice Here's the four-step process (MCOI) you should work through when confronting a problem: 1. Use the marginal principle by breaking down "how many" choices into simpler marginal choices. 2. Apply the cost-benefit principle by assessing whether the marginal benefit exceeds the marginal cost. 3. Apply the opportunity cost principle to evaluate all relevant costs and benefits, and ask “or what?” 4. Use the interdependence principle to identify how changes in other factors might lead you to make a different decision. 7/16/2024 14  Additional Problems for Practice 7/16/2024 15 Q1. A government is considering implementing a policy to reduce air pollution in a major city. The policy will cost $200 million to implement and maintain annually. It is estimated that the policy will reduce healthcare costs by $150 million per year and increase productivity by $70 million per year due to healthier workers. Additionally, the policy will provide non-monetary benefits such as improved quality of life and increased biodiversity, estimated to be worth $30 million per year. a) Calculate the total annual benefits of the policy. b) Determine whether the policy is economically justified. 7/16/2024 16  a) Calculate the total annual benefits of the policy. Total Benefits (B) = reduction in healthcare costs + increase in productivity + non-monetary benefits = 150 + 70 + 30 = 250 million b) Determine whether the policy is economically justified. Total Cost (C) = 200. Since B > C, i.e., the net benefit is positive ($50 million), the policy is economically justified. 7/16/2024 17 Q2. A city council is debating whether to invest $500 million annually in a new public transportation system. The system is expected to generate $80 million in revenue per year and save $60 million annually in road maintenance and congestion costs. Moreover, the project is anticipated to have a positive environmental impact valued at $20 million per year and to increase property values by $10 million annually. a) Calculate the total annual benefits of the new public transportation system. b) Determine if the investment is justified. c) Discuss any additional factors that should be considered beyond the direct monetary costs and benefits. 7/16/2024 18  a) Calculate the total annual benefits of the new public transportation system. Total annual benefits (B) = revenue + savings in road maintenance and congestion costs + environmental benefits + increased property values = 80 + 60 + 20 + 10 = 170 million b) Determine if the investment is justified. The investment is justified if total benefits (B) exceeds total cost (C). B = 170 million C = 500 million Since B < C, i.e., the net benefit is negative (-$330 million), the investment is not economically justified. 7/16/2024 19  c) Discuss any additional factors that should be considered beyond the direct monetary costs and benefits. Additional factors could include: Long-term urban development and attractiveness of the city Reduced traffic congestion and improved quality of life Potential for economic growth due to better transportation infrastructure Environmental sustainability and reduction in carbon footprint 7/16/2024 20 Q3. A school district is considering investing $10 million in a new education program aimed at improving student performance. The program is expected to result in higher graduation rates, leading to an estimated increase in lifetime earnings for graduates amounting to $25 million. Furthermore, the program is projected to reduce crime rates, saving the community $5 million in law enforcement and social costs. a) Compute the total benefits of the education program. b) Using the B-C Principle, should the school district implement the program? c) Identify any potential long-term benefits or costs that might not be immediately quantifiable. 7/16/2024 21 a) Compute the total benefits of the education program. Total benefits (B) = increase in lifetime earnings for graduates + savings in law enforcement and social costs = 25 + 5 = 30 million b) Using the B-C Principle, should the school district implement the program? B = 30 million C = 10 million Since B > C, i.e., the net benefit is positive ($20 million), the program should be implemented. 7/16/2024 22  c) Identify any potential long-term benefits or costs that might not be immediately quantifiable. Potential long-term benefits: Improved societal well-being and reduced inequality Higher future tax revenues due to increased earnings Better health outcomes due to higher education levels Long-term economic growth driven by a more educated workforce Potential long-term costs: Maintenance and updating of the program Opportunity costs of alternative investments 7/16/2024 23  Q4. A hospital is considering a new technology that costs $2 million upfront and $500,000 annually in maintenance. The technology is projected to save $1 million annually in operational costs and reduce patient recovery times, resulting in additional revenue of $400,000 per year. Additionally, the hospital estimates that improved patient outcomes will generate societal benefits worth $300,000 annually. a) Calculate the total annual benefits of the new technology. b) Determine whether the hospital should invest in the new technology. c) Discuss how uncertainty in the estimates might affect the decision. 7/16/2024 24 a) Calculate the total annual benefits of the new technology. Total annual benefits (B) = savings in operational costs + additional revenue from reduced recovery times + societal benefits from improved outcomes = 1 + 0.4 + 0.3 = 1.7 million b) Determine whether the hospital should invest in the new technology. The investment is justified if total benefits exceed total costs. Total costs = 2 million (upfront) + 0.5 million (annual maintenance) = 2.5 million 7/16/2024 25  Annualizing the upfront cost over a reasonable period (e.g., 10 years), assuming a simple straight-line depreciation: Annual cost (C) = (2/10) million + 0.5 million = 0.2 million + 0.5 million = 0.7 million Since the B > C, i.e., net benefit is positive ($1 million), the hospital should invest in the new technology. 7/16/2024 26  c) Discuss how uncertainty in the estimates might affect the decision. Uncertainty in estimates can affect the decision: a) If the savings in operational costs or additional revenue are overestimated, the net benefit may be lower. b) If maintenance costs are underestimated, the net benefit may decrease. c) Societal benefits might be difficult to quantify accurately. Sensitivity analysis should be conducted to assess the impact of varying key parameters. 7/16/2024 27 Q5. A company is evaluating a renewable energy project that requires an initial investment of $50 million and annual operating costs of $5 million. The project is expected to generate energy worth $8 million annually and reduce carbon emissions, providing environmental benefits valued at $3 million per year. a) Calculate the total annual benefits of the renewable energy project. b) Using the B-C Principle, decide if the company should proceed with the project. c) Analyze the potential impact of fluctuations in energy prices on the project's viability. 7/16/2024 28  a) Calculate the total annual benefits of the renewable energy project. Total annual benefits (B) = value of generated energy + environmental benefits = 8 + 3 = 11 million b) Using the B-C Principle, decide if the company should proceed with the project. Total costs = 50 million (initial) + 5 million (annual operating costs) = 55 million Annualizing the initial cost over a reasonable period (e.g., 20 years), assuming a simple straight-line depreciation: 7/16/2024 29  Annual cost (C) = (50/20) + 5 = 2.5 + 5 = 7.5 million Since B > C, i.e., the net benefit is positive ($3.5 million), the company should proceed with the project. c) Analyze the potential impact of fluctuations in energy prices on the project's viability. Fluctuations in energy prices can impact the project's viability: If energy prices decrease, the value of generated energy may be lower, reducing total benefits. If energy prices increase, the value of generated energy may be higher, increasing total benefits. 7/16/2024 30 Sensitivity analysis should be performed to understand the impact of different energy price scenarios. Long-term contracts or hedging strategies could be considered to mitigate the risk of price fluctuations. 7/16/2024 31  Thank you for your patience 7/16/2024 32