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Module 2 Managerial Economics

The document provides an overview of the objectives and key concepts of the Managerial Economics module, including exploring the relationship between economic concepts and business decision making, understanding microeconomics and industrial organization in relation to managerial economics, and examining how individual economic segments are affected by crises. It also discusses principal-agent problems that can occur between owners and managers when their objectives are not aligned and owners cannot perfectly monitor managers.

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Charice Anne Villamarin
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430 views29 pages

Module 2 Managerial Economics

The document provides an overview of the objectives and key concepts of the Managerial Economics module, including exploring the relationship between economic concepts and business decision making, understanding microeconomics and industrial organization in relation to managerial economics, and examining how individual economic segments are affected by crises. It also discusses principal-agent problems that can occur between owners and managers when their objectives are not aligned and owners cannot perfectly monitor managers.

Uploaded by

Charice Anne Villamarin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Managerial Economics

Module 2
Obj ecti ves

Explore the relationship of economic concepts and analysis to


business decision-making and strategies
1 Explain the roles of Microeconomics and Industrial
Organization to Managerial Economics
Engage ourselves to individual segments of economy and
analyze how they are affected by recent crisis
Understand the principal-agent problem and why it occurs
Manageri al Economi cs

▸ Microeconomics ▸ Industrial Organization

▸ To create a systematic and logical way of analyzing


business practices and tactics designed to get the most profit,
as well as formulating strategies for sustaining or protecting
these profits in the long-run
Economic theory 6

simplifies complexity.
Microeconomics

▪ the study and analysis of the behavior


of individual segments of the economy
Indi vi dual segments of economy:

Individual consumers

Workers and owners of resources

Individual firms

Industries

Markets for goods and services


Deci si ons i nvol ved:

Choosing the profit- maximizing production level

Cost minimization

How much to spend in advertising

Allocating production between 2 or more manufacturing plants

Setting the profit- maximizing price for the goods the firm sells
Business Practice or Tactics

routine business decisions managers must make to


earn the greatest profit under the prevailing market
conditions facing the firm
Microeconomics serves
as the “Swiss army knife” 11

for explaining most


business practices.
Industrial Organization

▪ branch of economics focusing on the behavior and structure


of firms and industries

▪ an additional complementary tool for business analysis

▪ supplies considerable insight into the nature, motivation, and


consequences of strategic actions firms may wish to undertake
Strategic Decisions

business actions taken to alter market conditions and


behavior of rivals in ways that increase and/or protect the
strategic firm’s profit

Strategic decisions differ from routine business


practices and tactics because strategic decisions do not
accept the existing conditions of competition as fixed, but
rather attempt to shape or alter the circumstances under
which a firm competes with its rival.
Opportunity Cost
▪ what a firm’s owners give up to use resources to produce goods
or services
2 Kinds of Inputs
Market-supplied resources Owner-supplied resources

▪ owned by others and hired, ▪ owned and used by a firm


rented or leased in
resource markets Examples: Money provided to
the business by its owners,
Examples: Labor, raw time and labor provided by the
materials purchased from owners, land, building and
commercial suppliers and capital equipment owned and
capital equipment rented or used by the firm
leased
Total economic cost

sum of opportunity costs of market supplied resources

opportunity costs of owner-supplied resources


Explicit Costs Implicit costs
the monetary the non monetary
payments made for opportunity costs of
market-supplied using a firm’s own
inputs resources
3 important types of implicit costs:
▪ Equity capital - opportunity cost of cash provided to a firm by its owners
▪ Opportunity cost of using land or capital owned by the firm
▪ Opportunity cost of the owner’s time spent in managing the firm
Principle:

The opportunity cost of using resources is the amount the firm


gives up by using these resources. Opportunity costs can be
either explicit costs or implicit costs. Explicit costs are the costs
of using market-supplied resources, which are monetary payments
to hire, rent or lease resources owned by others. Implicit costs are
the costs of using owner-supplied resources, which are the greatest
earnings foregone from using resources owned by the firm in the
firm’s own production process. Total economic cost is the sum of
explicit and implicit costs.
Explicit Costs
of
Market-Supplied Resources
The monetary payments to resource
owners

Implicit Costs
of
Owner-Supplied Resources
The returns forgone by not taking the
owners’ resources to market

Total Economic Cost


The total opportunity costs of both
kinds of resources
Economic Profit vs Accounting Profit
Economic Profit Total Revenue Total Economic Cost

Total Revenue Explicit Costs Implicit Costs

Accounting Profit Total Revenue Explicit Costs

Since the owners of firms must cover the costs of all resources used
by the firm, maximizing economic profit, rather than accounting
profit, is the objective of the firm’s owners.
Maximizing the Value of the Firm

Value of a firm
▪ the price for which the firm can be sold, which equals the present
value of future profits

Risk Premium
▪ an increase in the discount rate to compensate investors for
uncertainty about the future
Principle:

The value of a firm is the price for which it can be sold, and the
price is equal to the present value of the expected future profits
of the firm. The larger (smaller) the risk associated with future
profits, the higher (lower) the risk adjusted discount rate used to
compute the value of the firm, and the lower (higher) will be the
value of the firm.
Principle:

If cost and revenue conditions in any period are independent of


decisions made in other time periods, a manager will maximize the
value of a firm (the present value of the firm) by making decisions
that maximize profit in every single time period.
Some common mistakes managers make:

▪ Never increase output simply to reduce average costs

▪ Pursuit of market share usually reduces profit

▪ Focusing on profit margin won't maximize total profit

▪ Maximizing total revenues reduces profit

▪ Cost-plus pricing formulas don’t produce profit maximizing prices


Separation of Ownership
and Control of the Firm
The Principal-Agent Problem
▪ a manager takes an action or makes a decision that advances
the interests of the manager but reduces the value of the firm

A principle-agent problem arises between a firm’s


owner and manager when two conditions are met:
▪ the objectives of the owner and manager are not aligned

▪ the owner finds it either too costly or impossible in the case of moral hazard to
perfectly monitor the manage to block all management decisions that might be
harmful to the owner of the business
Principal-Agent Relationship

▪ relationship formed when a business owner (the principal)


enters an agreement with an executive manager (the agent)
whose job is to formulate and implement tactical and strategic
business decisions that will further the objectives of the
business owner (the principal)
Complete contract
▪ an employment contract that protects owners from every possible
deviation by managers from value maximizing decisions

Hidden actions
▪ actions or decisions taken by managers that cannot be observed by
owners for any feasible amount of monitoring

Moral hazard
▪ a situation in which managers take hidden actions that harm the
owners of the firm but further the interests of the managers
Project #1
Make a research or documentation on the topic:

“The Impact of COVID 19 to the Economy of Indigenous People”


▸ How are they able to manage during the quarantine period?

Please submit on or before August 21, 2020 via LMS.


R eference

Thomas, C. R., & Maurice, S. (2015). Managerial Economics: Foundations


of Business Analysis and Strategy. New York, NY: McGraw-Hill Education.

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