Econ 24 - Notes

Chapter 1: The Fundamentals of Managerial  It only functions when multiple sellers of a product compete
in the market place.
Economic › Government and the Market
 Agents on eother side of the market find themselves
MANAGER disadvantaged in the market process, they attempt to induce
 Is a person who directs resources to achieve a stated goal. government to intervene on their behalf.
 All individuals who; 5. Recognize the Time Value of Money
1. Direct efforts of others, including those who delegate tasks within › GAP between the cost are born and benefits are received.
an organization such as firm, a family or a club › The opportunity cost of receiving the $1 in the future is the
2. Purchase inputs to be used in the production of goods and services forgone interest could be earned were $1 received today.
such as the output of a firm, food for the needy, or shelter for the
homeless.
3. In charge if making other decisions
 Has a responsibility for his or her own actions as well as for the
actions of individuals, machines, and other inputs under the managers
control.
 Manager’s task is to allocate resources so as to best meet the
manager’s goal
ECONOMICS
 Is the science of making decisions in the presence of scarce
resources.
 Anything used to produce a good or service or more
generally, to achieve a goal.
 Decision involves the allocation of scarce resources
MANAGERIAL ECONOMICS
 Is the study how to direct scarce resources in the way that most
efficiently achieves a managerial goal.
 It describes the methods useful for directing everything from the
resources of a household to maximize household welfare to the
resources of a firm to maximize profits.

THE ECONOMICS OF EFFECTIVE MANAGEMENT

1. Identify Goals and Constraints
› To have a well-defined goals because achieving diffirent goals
entails making different decisions
2. Recognize the Nature and Importance of Profits
› Accounting Profits
 Total amount of money taken in from sales minus the
dollar cost of producing goods or services.
› Economic Profits
 Difference between the total revenue and the total
opportunity cost of producing the firm goods and services.
 Includes both the explicit (or accounting) cost › Maximixing Short-Term Profits May Maximize Long-term
of the resource and the implicit cost of giving profits
up the best alternative use of the resource  If the growth rate in profits is less than the interest rate and
› The Role of Profits both are constant, maximizing current profits is the same as
 Adam Smith’s Classic line from The Wealth of Nations maximizing long-term profits.
 “It is not out of benevolence of the butcher, the 6. Use Marginal Analysis
brewer, or the baker, that we expect our › Is one of the most important managerial tools – a tool we will
dinner, but from their regard to their own use use repeatedly throughout this text in an alternative context.
interest.” › States that optimal managerial decisions involve comparing the
› The profits signal the owners resources where society most marginal (incremental) benefits of a decision with marginal
values the resources. costs.
› The Five Forces of Framework and Industry Profitability › Discrete Decisions
 A tool for helping managers see the “big picture”; it is a  N(Q) = B(Q) – C(Q)
schematic you can use to organize various industry
conditions that affect industry profitability and asses the
efficacy of alternative business strategies.


 Marginal Benefit
1) Entry  Refers to the additional benefits earned by
2) Power or Input Supplier using an additional unit of the managerial
- Industry profits tend to be lower when suppliers control variable
have the power to negotiate favorable terms for their
inputs.
3) Power of Buyers  Marginal Cost
- Industry profits tend to be lower when customers  Additional cost incurred by using an
or buyers have the power to negotiate favorable additional unit of the managerial control
terms for the products or services produce in the variable
industry
4) Industry Rivalry
- Tends to be less intense in concentrated industries  Marginal Net Benefit
that is, those with relatively new firms  Are the change in net benefits that arise from a
5) Substitutes one-unit change in Q.
- emphasized that the presence of close substitutes
erodes industry profitability.
3. Understand Incentives › Continuous Decisions
› It affects how resources are used and how hard workers work.  The basic principle for making decisions when the control
› To succeed, you must clearly grasp the role of incentives within variable id=s discrete also apply to the case of continuous
an organization such as a firm and how to construct incentives control variable.
to induce maximal effort from those you manage.
4. Understand Markets
› Consumer-Producer Rivalry
 Occurs because of the competing interests of consumers
and producers.
 Perfectly competitive Market
› Consumer-Consumer Rivalry
 Reduces the negotiating power of consumers in the
marketplace
 It arises because of the economic doctrine and scarcity
 Monopoly
› Producer-Producer Rivalry
 Econ 24 - Notes
 Often provides consumers with information
about the existence or quality of a product
 Persuasive
 Altering the underlying taste of consumers.
4. Consumer Expectations
5. Population
6. Other Factors

The Demand Function

› Factors that influence demand may be summarized
› Mathematical representation describing how many units will be
purchased at different prices for X, the price related to Good Y ,
income, and other factors
Linear Demand Function


 Marginal Value Curves are the Slopes of Total Curves
 When the control variable is infinitely
divisible, the slope of a total value curve at a
given point 1s the marginal value at that point. Consumer Surplus
In particular, the slope of the total benefit
› The value the consumer gets from a good but do not have
curve at a given Q is the marginal benefit of
to pay for it.
that level of Q. The slope of the total cost curve
at a given is the marginal cost of that level of
Q. The slope of the net benefit curve at a given
is the marginal net benefit of that level of Q.
› Incremental Decision
 Incremental Revenues
 In the case of yes-or-no decisions, the
additional revenues derived from a decision
 Incremental Costs ›
 The additional cost that stems from a decision › Above MP; below demand curve
› Formula:
Chapter 2: Market Forces: Demand and Supply SUPPLY
Market Supply Curve
DEMAND › Summarizes the total quantity all producers are willing and able to
Law of Demand produce at alternative prices, holding other factors that affect supply
› Price and Quantity Demand are inversely related. constant.
› That is, as the price of good rises (fall) and all other things remain
constant, the quantity demanded of the good falls (rises).
› Downward Slope
› Inverse Relationship
Market Demand Curve
› Interpolates the quantities consumers would be willing and able to
purchase at prices not explicitly dealt with in the market research.
› Main concerns are consumers
The Demand Curve

›
› Movement along the supply curve is what you call changes is
quantity supplied.

Supply Shifters
1. Input Prices
2. Technology or Government Regulations
3. Number of Firms
4. Substitutes in Production
Changes in Demand 5. Taxes
› Movement along the demand curve, such as the movement from A to 6. Producer Expectations
B, is called a change in the quantity demanded
› Whenever advertising, income, or the price of related good changes, The Supply Function
it leads to a change in demand. › Describes how much of the good will be produced at alternative
prices of the good, alternative prices of inputs, and alternative values
of other variables
Linear Supply Function

Producer Surplus
› Producer analogue to consumer surplus
› Amount producers receive more than the amount necessary to induce
them to produce the good.
› Above supply curve, Below market price
Demand Shifters
› Variable other than the price of a good that influences demand.
1. Income
 Normal Good
 A good whose demand increases when
consumer incomes rises
 Direct Relationship
 Inferior Good
 An increase in income reduces the demand for
this good
 Inverse Relationship
2. Price of Related Goods
 Substitutes MARKET EQUILIBRIUM
 An increase in the price of Good J, increases
the demand of Good N.
 Direct Relationship
 Complements
 An increase price of Good P, decreases the
demand in good Y.
 Inverse Relationship Price Ceiling
3. Consumer Taste/Advertising › Minimum price
 Informative Price Floor
› Maximum price
Full Economic Price
 Econ 24 - Notes
› The dollar amount paid to a firm under a price ceiling, plus the
nonpecuniary price.

CHAPTER 3: Quantitative Demand Analysis

The Elasticity Concept

An elasticity measures the responsiveness of one variable to changes in another

variable.

Two aspects of an elasticity are important:

(1) whether it is positive or negative and

(2) whether it is greater than 1 - If the absolute value of the elasticity is
greater than 1, the numerator is larger than the denominator in the
elasticity formula, Demand is perfectly elastic if the own price elasticity of demand is infinite in
(3) or less than 1 in absolute value - the numerator is smaller than the absolute value. In this case the demand curve is HORIZONTAL
denominator in the elasticity formula
- a small increase in price may induce their customers to stop buying
OWN PRICE ELASTICITY OF DEMAND their product, in favor of a competing generic version of the product

The own price elasticity of demand for good X Demand is perfectly inelastic if the own price elasticity of demand is zero. The
demand curve is VERTICAL

- when demand is perfectly inelastic, consumers do not respond at all to

changes in price.
- Many perceive products and services in the health care industry
(such as life-saving drugs) to have demand curves that are perfectly
demand is said to be elastic if the absolute value of the own price elasticity is inelastic.
greater than 1

demand is said to be inelastic if the absolute value of the own price elasticity
is less than 1:

unitary elastic if the absolute value of the own price elasticity is equal to 1

Factors Affecting the Own Price Elasticity

Available substitutes
Total Revenue Test
- One key determinant of the elasticity of demand for a good is the
If demand is elastic, an increase (decrease) in price will lead to a decrease
number of close substitutes for that good.
(increase) in total revenue. INVERSE
- the more substitutes available for the good, the more elastic the
If demand is inelastic, an increase (decrease) in price will lead to an increase demand for it.
(decrease) in total revenue. DIRECT - For example, the demand for food (a broad commodity) is more
inelastic than the demand for beef. Short of starvation, there are no
Finally, total revenue is maximized at the point where demand is unitary elastic. close substitutes for food, and thus the quantity demanded of food is
much less sensitive to price changes than is a particular type of food,
Businesses around the globe use the total revenue test to help manage cash flows.
For instance, Dell recently faced a dilemma regarding its pricing strategy for such as beef. When the price of beef increases, consumers can
computers: Should it increase prices to boost cash flow or adopt a “cut price and substitute toward other types of food, including chicken, pork, and fish.
make it up in volume” strategy? Thus, the demand for beef is more elastic than the demand for
food.
In other words, the quantity of computers sold will rise by 8.5 percent if prices
are reduced by 5percent. Since the percentage increase in quantity demanded is Time
greater than the percentage decline in prices (|EQx, Px| > 1), the price cut will
actually raise the firm’s sales revenues. - Demand tends to be more inelastic in the short term than in the
long term
- The more time consumers have to react to a price change, the more
elastic the demand for the good.
- Conceptually, time allows the consumer to seek out available
substitutes.

Expenditure Share

- Goods that comprise a relatively small share of consumers’ budgets

tend to be more inelastic than goods for which consumers spend a
sizable portion of their incomes.
- where a consumer spends her or his entire budget on a good, the
consumer must decrease consumption when the price rises. In
essence, there is nothing to give up but the good itself.
 Econ 24 - Notes
Marginal Revenue and the Own Price Elasticity of Demand

marginal revenue (MR) is the change in total revenue due to a change in

output, and that to maximize profits a firm should produce where marginal
revenue equals marginal cost.

CROSS PRICE ELASTICITY

reveals the responsiveness of the demand for a good to changes in the price
of a related good. for a linear demand function,
demand is elastic at high prices and inelastic at lower prices.

Elasticities for Nonlinear Demand Functions

log-linear demand. Demand is log-linear if the logarithm of demand is a linear

function of the logarithms of prices, income, and other variables.

whenever goods X and Y are substitutes, an increase in the price of Y leads

to an increase in the demand for X. Thus, EQx, Py > 0, POSITIVE,
whenever goods X and Y are substitutes.

When goods X and Y are complements, an increase in the price of Y leads

to a decrease in the demand for X. Thus, EQx, Py < 0 NEGATIVE
To determine the elasticity of demand from the given demand
whenever goods X and Y are complements
function Qxd=8Px0.5Py0.25M0.12HQxd=8Px0.5Py0.25M0.12H, we examine
Cross-price elasticities play an important role in the pricing decisions of the exponents related to the price of good x (Px) in this equation. The exponent
firms that sell multiple products. for Px is 0.5.

In elasticity terms:

 If the exponent is less than 1, the demand is inelastic.

 If the exponent is equal to 1, the demand is unitary elastic.

 If the exponent is greater than 1, the demand is elastic.

Since 0.5 is less than 1, the correct answer is A. inelastic

REGRESSION ANALYSIS

INCOME ELASTICITY As a manager, you may obtain estimates of demand and elasticity from published
studies available in the library or from a consultant hired to estimate the demand
Income elasticity is a measure of the responsiveness of consumer demand to function based on the specifics of your product.
changes in income.
Econometrics is simply the statistical analysis of economic data

For example, suppose the econometrician believes that, on average, there is a linear
relation between Y and X, but there is also some random variation in the
relationship. Mathematically, this would imply that the true relationship between
When good X is a normal good, an increase in income leads to an increase in the Y and X iswhere a and b are unknown parameters and e is a random variable
consumption of X. Thus, EQx, M > 0 POSITIVE when X is a normal good. (an error term) that has a zero mean.

When X is an inferior good, an increase in income leads to a decrease in the

consumption of X. Thus, EQx, M < 0 when X NEGATIVE, an inferior good.

OTHER ELASTICITIES

ADVERTISING ELASTICITIES - the own advertising elasticity of demand for

good X is the ratio of the percentage change in the consumption of X to the
percentage change in advertising spent on X.

The cross-advertising elasticity between goods X and Y would measure the

percentage change in the consumption of X that results from a 1 percent change
in advertising directed toward Y.

These values of a and b, which frequently are denoted â and bˆ, are called parameter
estimates, and the corresponding line is called the least squares regression.

Evaluating the Statistical Significance of Estimated Coefficients

The standard error of each estimated coefficient is a measure of how much each
estimated coefficient would vary in regressions based on the same underlying true
demand relation, but with different observations.

The t-statistic of a parameter estimate is the ratio of the value of the parameter
estimate to its standard error
Elasticities for Linear Demand Functions
 Econ 24 - Notes

The R-square (also called the coefficient of determination) tells the fraction of
the total variation in the dependent variable that is explained by the regression.

An alternative measure of goodness of fit, called the F-statistic, does not suffer
from this shortcoming. The F-statistic provides a measure of the total variation
explained by the regression relative to the total unexplained variation. The greater
the F-statistic, the better the overall fit of the regression line through the actual
data